**SECURITIES
      AND EXCHANGE COMMISSION**


Washington,
      D.C. 20549








FORM
      10-Q







x QUARTERLY
      REPORT UNDER SECTION 13 OR 15(d)


OF
      THE
      SECURITIES EXCHANGE ACT OF 1934





For
      the
      Quarter Ended September 30, 2007





o
      TRANSITION REPORT
      PURSUANT TO SECTION 13 OR 15(d)


OF
      THE
      SECURITIES EXCHANGE ACT OF 1934


For
      the
      Transition Period from to









Commission
      File Number 0-22710





**INTERPHARM
      HOLDINGS, INC** .





(Exact
      name of registrant as specified in its charter)





Delaware
            
            13-3673965State
                or other jurisdiction of
              corporation
                or organization)
            
            (I.R.S.
                Employer
              Identification
                Number)




75
                Adams Avenue, Hauppauge, New York
            
            11788(Address
                of principal executive offices)
            
            (Zip
                Code)





Issuer's
      telephone number, including area code (631) 952-0214





Indicate
      by check mark whether the Registrant (1) has filed all reports required to
      be
      filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
      the
      preceding 12 months (or for such shorter period that the registrant was required
      to file such reports), and (2) has been subject to such filing requirements
      for
      the past 90 days.





YES
x 
NO
o




Indicate
      by check mark whether the registrant is a large accelerated filer, an
      accelerated filer or a non-accelerated filer (as defined in Rule 12b-2 of the
      Act).





Large
      accelerated filer oAccelerated
      filer oNon-accelerated
      filer x





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





YES
o  NO x





As
      of the
      close of business on December 12, 2007, there were 66,738 shares of the
      Registrant's $0.01 par value per share Common Stock outstanding.









INTERPHARM
      HOLDINGS, INC. AND SUBSIDIARIES





TABLE
      OF
      CONTENTS





PagePART
                I
            Financial
                InformationItem
                1.
            Financial
                Statements & Notes
            1-34Item
                2.
            Managements
                Discussion & Analysis of Financial Condition and Results of
                Operations
            35-47Item
                3.
            Quantitative
                and Qualitative Disclosures about Market Risk
            47Item
                4.
            Controls
                and Procedures
            48PART
                II
            Other
                Information Required in ReportItem
                1.
            Legal
                Proceedings
            49Item
                6.
            Exhibits
            50Signatures
                Page
            51Exhibits/Certifications
            52-55










INTERPHARM
      HOLDINGS, INC. AND SUBSIDIARIES





CONDENSED
      CONSOLIDATED BALANCE SHEETS


(In
      thousands)





ASSETS




September
                30,
            
            June
                30,2007
            
            2007(Unaudited)CURRENT
                ASSETSCash
            
            $
            68
            
            $
            72Accounts
                receivable, net
            
            
            16,322
            
            
            12,945Inventories,
                net
            
            
            12,884
            
            
            17,295Prepaid
                expenses and other current assets
            
            
            2,618
            
            
            1,794Deferred
                tax assets
            
            
            —
            
            
            21Total
                Current Assets
            
            
            31,892
            
            
            32,127Land,
                building and equipment, net
            
            
            35,462
            
            
            34,498Deferred
                tax assets
            
            
            5,975
            
            
            5,954Investment
                in APR, LLC
            
            
            1,023
            
            
            1,023Other
                assets
            
            
            633
            
            
            772TOTAL
                ASSETS
            
            $
            74,985
            
            $
            74,374




*See
        Notes To Condensed Consolidated Financial Statements.*




1




INTERPHARM
      HOLDINGS, INC. AND SUBSIDIARIES





CONDENSED
      CONSOLIDATED BALANCE SHEETS


(In
        thousands)





LIABILITIES
      AND STOCKHOLDERS’ EQUITY





September
                30,
            
            June
                30,2007
            
            2007(Unaudited)CURRENT
                LIABILITIESCurrent
                maturities of long-term debt
            
            $
            17,706
            
            $
            12,057Accounts
                payable, accrued expenses and other liabilities
            
            
            20,003
            
            
            18,542Total
                Current Liabilities
            
            
            37,709
            
            
            30,599OTHER
                LIABILITIESLong-term
                debt, less current maturities
            
            
            14,082
            
            
            14,488Contract
                termination liability
            
            
            1,382
            
            
            1,356Other
                liabilities
            
            
            240
            
            
            5Total
                Other Liabilities
            
            
            15,704
            
            
            15,849TOTAL
                LIABILITIES
            
            
            53,413
            
            
            46,448COMMITMENTS
                AND CONTINGENCIESSeries
                B-1 Redeemable Convertible Preferred Stock:
              15
                shares authorized; issued and outstanding - 10 at September 30, 2007and
                June 30, 2007; liquidation preference of $10,000
            
            
            8,155
            
            
            8,155Series
                C-1 Redeemable Convertible Preferred Stock:
              10
                shares authorized; issued and outstanding - 10 atSeptember
                30, 2007 and June 30, 2007; liquidation preference of
                $10,000
            
            
            8,352
            
            
            8,352STOCKHOLDERS’
                EQUITYPreferred
                stocks, 10,000 shares authorized; issued andoutstanding
                - 5,132 at September 30, 2007 and June 30, 2007;aggregate
                liquidation preference of $3,588 at September 30, 2007and
                June 30, 2007.
            
            
            51
            
            
            51Common
                stock, $0.01 par value, 150,000 shares authorized; shares issued
                -66,738
                and 65,886 respectively.
            
            
            667
            
            
            659Additional
                paid-in capital
            
            
            30,282
            
            
            29,530Accumulated
                other comprehensive (loss) income
            
            
            (208
            )
            
            10Accumulated
                deficit
            
            
            (25,727
            )
            
            (18,831
            )TOTAL
                STOCKHOLDERS’ EQUITY
            
            
            5,065
            
            
            11,419TOTAL
                LIABILITIES AND STOCKHOLDERS’ EQUITY
            
            $
            74,985
            
            $
            74,374





*See
      Notes To Condensed Consolidated Financial Statements.*





2




INTERPHARM
      HOLDINGS, INC. AND SUBSIDIARIES


CONDENSED
      CONSOLIDATED STATEMENTS OF OPERATIONS


(UNAUDITED)


(In
      thousands, except per share data)




Three
                Months Ended
              September
                30,2007
            
            2006SALES,
                Net
            
            $
            17,715
            
            $
            22,827COST
                OF SALES(including
                related party rent expense of $165 and $102 for the three months
                ended
                September 30, 2007 and 2006, respectively)
            
            
            16,639
            
            
            13,850GROSS
                PROFIT
            
            
            1,076
            
            
            8,977OPERATING
                EXPENSESSelling,
                general and administrative
            
            
            3,772
            
            
            2,637Related
                party rent
            
            
            —
            
            
            18Research
                and development
            
            
            3,458
            
            
            3,419TOTAL
                OPERATING EXPENSES
            
            
            7,230
            
            
            6,074OPERATING
                (LOSS) INCOME
            
            
            (6,154
            )
            
            2,903OTHER
                EXPENSESInterest
                expense, net
            
            
            742
            
            
            287(LOSS)
                INCOME BEFORE INCOME TAXES
            
            
            (6,896
            )
            
            2,616PROVISION
                FOR INCOME TAXES
            
            
            —
            
            
            986NET
                (LOSS) INCOME
            
            
            (6,896
            )
            
            1,630Preferred
                stock beneficial conversion feature
            
            
            —
            
            
            1,094Preferred
                stock dividends
            
            
            41
            
            
            293NET
                (LOSS) INCOME ATTRIBUTABLE TO COMMON STOCKHOLDERS
            
            $
            (6,937
            )
            $
            243(LOSS)
                EARNINGS PER SHARE ATTRIBUTABLE TO COMMONSTOCKHOLDERSBasic
                (loss) earnings per share
            
            $
            (0.10
            )
            $
            0.00Diluted
                (loss) earnings per share
            
            $
            (0.10
            )
            $
            0.00Basic
                weighted average shares and equivalent shares outstanding
            
            
            66,196
            
            
            64,720Diluted
                weighted average shares and equivalent shares outstanding
            
            
            66,196
            
            
            67,857





*See
      Notes To Condensed Consolidated Financial Statements.*




3


INTERPHARM
      HOLDINGS, INC. AND SUBSIDIARIES





CONDENSED
      CONSOLIDATED STATEMENT OF STOCKHOLDERS’ EQUITY


(UNAUDITED)


(In
        thousands)


Preferred Stock
              
              Common Stock
              
              Additional
                Paid-In
              
              Accumulated
                Other
                Compre-hensive (Loss)
              
              Accumulated
              
              Total
                Stock-
                HoldersShares
              
              Amount
              
              Shares
              
              Amount
              
              Capital
              
              Income
              
              Deficit
              
              EquityBALANCE –
                  June 30, 2007
              
              
              5,132
              
              $
              51
              
              
              65,886
              
              $
              659
              
              $
              29,530
              
              $
              10
              
              $
              (18,831
              )
              $
              11,419Shares
                  issued for options and warrants exercised
              
              
              
              
              
              
              
              
              556
              
              
              6
              
              
              (1
              )
              
              
              
              
              
              
              
              5Series
                  B-1 dividends paid with common stock
              
              
              
              
              
              
              
              
              148
              
              
              1
              
              
              205
              
              
              
              
              
              
              
              
              206Series
                  C-1 dividends paid with common stock
              
              
              
              
              
              
              
              
              148
              
              
              1
              
              
              205
              
              
              
              
              
              
              
              
              206Stock
                  based compensation and modification expense
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              343
              
              
              
              
              
              
              
              
              343Change
                  in fair value of interest rate swap
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              (218
              )
              
              
              
              
              (218
              )Net
                  loss
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              (6,896
              )
              
              (6,896
              )BALANCE –
                  September 30, 2007
              
              
              5,132
              
              $
              51
              
              
              66,738
              
              $
              667
              
              $
              30,282
              
              $
              (208
              )
              $
              (25,727
              )
              $
              5,065




*See
      Notes To Condensed Consolidated Financial Statements.*




4




INTERPHARM
      HOLDINGS, INC. AND SUBSIDIARIES





CONDENSED
      CONSOLIDATED STATEMENTS OF COMPREHENSIVE (LOSS)


INCOME(UNAUDITED)


(In
        thousands)


Three
                  Months Ended
                September
                  30,2007
              
              2006NET
                  (LOSS) INCOME
              
              $
              (6,896
              )
              $
              1,630OTHER
                  COMPREHENSIVE (LOSS) INCOMEChange
                  in fair value of interest rate swap
              
              
              (218
              )
              
              13TOTAL
                  COMPREHENSIVE (LOSS) INCOME
              
              $
              (7,114
              )
              $
              1,643




*See
      Notes To Condensed Consolidated Financial Statements.*




5




INTERPHARM
      HOLDINGS, INC. AND SUBSIDIARIES


CONDENSED
      CONSOLIDATED STATEMENTS OF CASH FLOWS


(UNAUDITED)


(In
      thousands)





Three Months Ended
              September 30,2007
            
            2006CASH
                FLOWS FROM OPERATING ACTIVITIESNet
                (loss) income from continuing operations
            
            $
            (6,896
            )
            $
            1,630Adjustments
                to reconcile net (loss) income to net cash (used in) provided by
                operating
                activities:Accreted
                non-cash interest expense
            
            
            34
            
            
            —Depreciation
                and amortization
            
            
            904
            
            
            502Amortization
                of deferred financing fees
            
            
            30
            
            
            30Stock
                based compensation expense
            
            
            343
            
            
            211Deferred
                tax expense (benefit)
            
            
            —
            
            
            986Excess
                tax benefit from exercise of stock options
            
            
            —
            
            
            (28
            )Write-down
                of inventory
            
            
            975
            
            
            —Changes
                in operating assets and liabilities:Accounts
                receivable
            
            
            (3,377
            )
            
            (356
            )Inventories
            
            
            3,436
            
            
            358Prepaid
                expenses and other current assets
            
            
            (823
            )
            
            (135
            )Accounts
                payable, accrued expenses and other liabilities
            
            
            1,893
            
            
            1,013Deferred
                revenue
            
            
            —
            
            
            (3,167
            )Total
                adjustments
            
            
            3,415
            
            
            (586
            )NET
                CASH (USED IN) PROVIDED BY OPERATING ACTIVITIES
            
            
            (3,481
            )
            
            1,044CASH
                FLOWS FROM INVESTING ACTIVITIESPurchases
                of machinery and equipment, net
            
            
            (1,507
            )
            
            (930
            )Deposits
                and other long-term assets
            
            
            (51
            )
            
            —NET
                CASH USED IN INVESTING ACTIVITIES
            
            
            (1,558
            )
            
            (930
            )CASH
                FLOWS FROM FINANCING ACTIVITIESProceeds
                from sale of Series C-1 preferred stock and warrants, net
            
            
            —
            
            
            9,993Expenditures
                relating to sale of Series B-1 preferred stock and
                warrants
            
            
            —
            
            
            (70
            )Proceeds
                from options exercised
            
            
            5
            
            
            142Proceeds
                from long-term debt
            
            
            —
            
            
            240Excess
                tax benefit from exercise of stock options
            
            
            
            
            
            28Collections
                on stock subscription receivable
            
            
            —
            
            
            57Proceeds
                from line of credit
            
            
            5,581
            
            
            —Repayments
                of long-term debt
            
            
            (551
            )
            
            (439
            )NET
                CASH PROVIDED BY FINANCING ACTIVITIES
            
            
            5,035
            
            
            9,951NET
                (DECREASE) INCREASE IN CASH
            
            
            (4
            )
            
            10,065CASH –
                Beginning
            
            
            72
            
            
            1,438CASH –
                Ending
            
            $
            68
            
            $
            11,503




*See
        Notes To Condensed Consolidated Financial Statements.*
  6
  INTERPHARM
        HOLDINGS, INC. AND SUBSIDIARIES





CONDENSED
      CONSOLIDATED STATEMENTS OF CASH FLOWS (continued)


(UNAUDITED)


(In
      thousands)





Three Months Ended
              September 30,2007
            
            2006SUPPLEMENTAL
                DISCLOSURES OF CASH FLOW INFORMATIONCash
                paid during the periods for:Interest
            
            $
            645
            
            $
            314Non-Cash
                Investing or Financing Transactions:Tax
                Benefit in connection with exercise of stock options
            
            $
            —
            
            $
            28Acquisition
                of machinery and equipment in exchange for capital lease
                payable
            
            $
            212
            
            $
            156Reclassification
                of equipment deposits to building and equipment
            
            $
            150
            
            $
            —Series
                B-1 dividends paid with common stock
            
            $
            206
            
            $
            79Series
                C-1 dividends paid with common stock
            
            $
            206
            
            $
            —Accrual
                of Series B-1 dividends
            
            $
            —
            
            $
            211Accrual
                of Series C-1 dividends
            
            $
            —
            
            $
            41Change
                in fair value of interest rate swap
            
            $
            (218
            )
            $
            13




See
      Notes To Condensed Consolidated Financial
      Statements.




7
 INTERPHARM
          HOLDINGS, INC. AND SUBSIDIARIES
 NOTES
          TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
 (In
          thousands, except per share data)




**NOTE
      1 -** **Basis
      of Presentation**





The
      accompanying interim unaudited condensed consolidated financial statements
      include the accounts of Interpharm Holdings, Inc. and its subsidiaries that
      are
      hereafter referred to as the “Company”. All intercompany accounts and
      transactions have been eliminated in consolidation.





These
      financial statements have been prepared in accordance with accounting principles
      generally accepted in the United States of America for interim financial
      information and with the instructions to Form 10-Q. Accordingly, they do not
      include all of the information and footnotes required by accounting principles
      generally accepted in the United States of America for complete financial
      statements. In the opinion of management, such interim statements reflect all
      adjustments (consisting of normal recurring accruals) necessary to present
      fairly the financial position and the results of operations and cash flows
      for
      the interim periods presented. The operating results for the three months ended
      September 30, 2007 are not necessarily indicative of the results that may be
      expected for the fiscal year ending June 30, 2008. The condensed consolidated
      financial statements should be read in conjunction with the audited consolidated
      financial statements and notes thereto included in the Company’s Annual Report
      on Form 10-K for the year ended June 30, 2007.





**NOTE
      2 -** **Summary
      of Significant Accounting Policies**





Nature
      of Business


The
      Company, through its wholly-owned subsidiary, Interpharm, Inc. (“Interpharm,
      Inc.”), is in the business of developing, manufacturing and marketing generic
      prescription strength and over-the-counter pharmaceutical products for wholesale
      distribution throughout the United States.





Revenue
      Recognition


The
      Company recognizes product sales revenue when title and risk of loss have
      transferred to the customer, when estimated provisions for chargebacks and
      other
      sales allowances including discounts, rebates, etc., are reasonably
      determinable, and when collectibility is reasonably assured. Accruals for these
      provisions are presented in the condensed consolidated financial statements
      as
      reductions to revenues. Accounts receivable are presented net of allowances
      relating to the above provisions of $4,480 and $4,865 at September 30, 2007
      and
      June 30, 2007, respectively.





In
      addition, the Company is party to supply agreements with certain pharmaceutical
      companies under which, in addition to the selling price of the product, the
      Company receives payments based on sales or profits associated with these
      products realized by its customer. The Company recognizes revenue related to
      the
      initial selling price upon shipment of the products as the selling price is
      fixed and determinable and no right of return exists. The additional revenue
      component of these agreements is recognized by the Company at the time its
      customers record their sales and is based on pre-defined formulas contained
      in
      the agreements. Receivables related to this revenue of $619 and $594 at
      September 30, 2007 and June 30, 2007, respectively, are included in “Accounts
      receivable, net” in the accompanying Condensed Consolidated Balance Sheets.





8
 INTERPHARM
          HOLDINGS, INC. AND SUBSIDIARIES
 NOTES
          TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
 (In
          thousands, except per share data)




**NOTE
      2 -** **Summary
      of Significant Accounting Policies, continued**





Earnings
      (Loss) Per Share


Basic
      earnings (loss) per share (“EPS”) of common stock is computed by dividing net
      income (loss) attributable to common stockholders by the weighted average number
      of shares of common stock outstanding during the period. Diluted EPS reflects
      the amount of net income (loss) for the period available to each share of common
      stock outstanding during the reporting period, giving effect to all potentially
      dilutive shares of common stock from the potential exercise of stock options
      and
      warrants and conversions of convertible preferred stocks.





Use
      of
      Estimates in the Financial Statements


The
      preparation of financial statements in conformity with accounting principles
      generally accepted in the United States of America requires management to make
      estimates and assumptions that affect the reported amounts of assets and
      liabilities and disclosure of contingent assets and liabilities at the date
      of
      the financial statements and the reported amounts of revenue and expenses during
      the reporting period. These estimates are often based on judgements,
      probabilities, and assumptions that management believe are reasonable, but
      that
      are not inherently uncertain and unpredictable. As a result, actual results
      could differ from those estimates. Management periodically evaluates estimates
      used in the preparation of the consolidated financial statements for continued
      reasonableness. Appropriate adjustments, if any, to the estimates used are
      made
      prospectively based on such periodic evaluations.





Stock
      Based Compensation


The
      Company accounts for stock based compensation arrangements using the fair value
      recognition provisions of Statement of Financial Accounting Standards (“SFAS”)
      No. 123 (Revised 2004), “Share-Based Payment,” (“SFAS No. 123(R)”). The
      Company estimates fair value of employee stock options using the Black Scholes
      Model. Key assumptions in the Black Scholes model include stock price, expected
      volatility, risk free interest rate, expected life, and expected forfeiture
      rates. The compensation cost of these arrangements is recognized over the
      requisite service period, which in the case of employees is often the vesting
      period. As a result, the Company’s net loss before taxes for the three months
      ended September 30, 2007 and its net income before taxes for the three month
      period ended September 30, 2006 included a non cash stock based compensation
      expense of $343 and $211, respectively.





Impairment
      of Long-Lived Assets


The
      Company reviews its long-lived assets for impairment whenever events or changes
      in circumstances indicate that the carrying amount of the assets may not be
      fully recoverable. To determine if impairment exists, the Company compares
      the
      estimated future undiscounted cash flows from the related long-lived assets
      to
      the net carrying amount of such assets. Once it has been determined that
      impairment exists, the carrying value of the asset is adjusted to fair value.
      Factors considered in the determination of fair value include current operating
      results, trends and the present value of estimated expected future cash
      flows.





Reclassifications


Certain
      reclassifications have been made to the audited condensed consolidated financial
      statements for the prior period in order to have them conform to the current
      period’s classifications. These reclassifications have no effect on previously
      reported net income.





9
 INTERPHARM
          HOLDINGS, INC. AND SUBSIDIARIES
 NOTES
          TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
 (In
          thousands, except per share data)




**NOTE
      2 -** **Summary
      of Significant Accounting Policies** **,
      continued**





New
      Accounting Pronouncements





On
      July
      1, 2007, the Company adopted Financial Accounting Standards Board (“FASB”)
      Interpretation No. 48, “Accounting for Uncertainty in Income Taxes”, (“FIN 48”).
      This interpretation clarified the accounting for uncertainty in income taxes
      recognized in accordance with Statement of Financial Accounting Standards
      (“SFAS”) No. 109, “Accounting for Income Taxes” (“SFAS No.109”).  FIN 48
      prescribes a recognition threshold and measurement attribute for the financial
      statement recognition and measurement of an income tax position taken or
      expected to be taken in an income tax return. Adoption of the provisions of
      FIN
      48 did not have a material impact on the Company’s condensed consolidated
      financial position, results of operations, or its cash flows for the three
      months ended September 30, 2007 (see Note 9).





In
      March 2006, the FASB issued SFAS No. 156, “Accounting for Servicing of
      Financial Assets” (“ SFAS
      156 ”),
      which
      amends SFAS 140, “Accounting for Transfers and Servicing of Financial Assets and
      Extinguishments of Liabilities”, with respect to the accounting for separately
      recognized servicing assets and servicing liabilities. SFAS
      156
      permits the choice of the amortization method or the fair value measurement
      method, with changes in fair value
      recorded in income, for the subsequent measurement for each class of separately
      recognized servicing assets and servicing liabilities. This guidance was
      effective for the Company as of July 1, 2007.   Adoption of the provisions
      of SFAS 156 did not have a material impact on the Company’s condensed
      consolidated financial position, results of operations, or its cash flows for
      the three months ended September 30, 2007.





In
      September 2006, the FASB issued SFAS No. 157, "Fair Value Measurements" ("SFAS
      157"). SFAS 157 defines fair value, establishes a framework for measuring fair
      value in generally accepted accounting principles, and expands disclosures
      about
      fair value measurements. It codifies the definitions of fair value included
      in
      other authoritative literature; clarifies and, in some cases, expands on the
      guidance for implementing fair value measurements; and increases the level
      of
      disclosure required for fair value measurements. Although SFAS 157 applies
      to
      (and amends) the provisions of existing authoritative literature, it does not,
      of itself, require any new fair value measurements, nor does it establish
      valuation standards. SFAS 157 is effective for financial statements issued
      for
      fiscal years beginning after November 15, 2007, and interim periods within
      those
      fiscal years. This statement will be effective for the Company's fiscal year
      beginning July 2008. The Company will evaluate the impact of adopting SFAS
      157
      but does not expect that it will have a material impact on the Company's
      consolidated financial position, results of operations or cash
      flows.





10
 INTERPHARM
          HOLDINGS, INC. AND SUBSIDIARIES
 NOTES
          TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
 (In
          thousands, except per share data)




**NOTE
      2 -** **Summary
      of Significant Accounting Policies, continued**




In
      December 2006, the FASB issued FASB Staff Position (“FSP”) EITF 00-19-2
“Accounting for Registration Payment Arrangements” (“FSP EITF 00-19-2”). FSP
      00-19-2 provides guidance related to the accounting for registration payment
      arrangements and specifies that the contingent obligation to make future
      payments or otherwise transfer consideration under a registration arrangement,
      whether issued as a separate arrangement or included as a provision of a
      financial instrument or arrangement, should be separately recognized and
      measured in accordance with SFAS No. 5, “Accounting for
      Contingencies.”  FSP 00-19-2 requires that if the transfer of
      consideration under a registration payment arrangement is probable and can
      be
      reasonably estimated at inception, the contingent liability under such
      arrangement shall be included in the allocation of proceeds from the related
      financing transaction using the measurement guidance in Statement No. 5. FSP
      00-19-2 applies immediately to any registration payment arrangements entered
      into subsequent to the issuance of FSP 00-19-2. This guidance was effective
      for
      the Company as of July 1, 2007.  Adoption of the provisions of FSP 00-19-2
      did not have a material impact on the Company’s condensed consolidated financial
      position, results of operations, or its cash flows for the three months ended
      September 30, 2007.




In
      February 2007, the FASB issued Statement (“SFAS”) No. 159, “The Fair Value
      Option for Financial Assets and Financial Liabilities – including an amendment
      of FASB Statement No. 115 *”* (“SFAS
      159”). This Statement permits entities to choose to measure many financial
      instruments and certain other items at fair value. The objective is to improve
      financial reporting by providing entities with the opportunity to mitigate
      volatility in reported earnings caused by measuring related assets and
      liabilities differently without having to apply complex hedge accounting
      provisions. The fair value option established by this Statement permits all
      entities to choose to measure eligible items at fair value at specified election
      dates. A business entity shall report unrealized gains and losses on items
      for
      which the fair value option has been elected in earnings (or another performance
      indicator if the business entity does not report earnings) at each subsequent
      reporting date. Most of the provisions of this Statement apply only to entities
      that elect the fair value option. However, the amendment to FASB Statement
      No.
      115, Accounting for Certain Investments in Debt and Equity Securities, applies
      to all entities with available-for-sale and trading securities. Some
      requirements apply differently to entities that do not report net income. This
      Statement is effective as of the beginning of an entity’s first fiscal year that
      begins after November 15, 2007. The Company does not expect the adoption of
      SFAS
      No. 159 to have a material impact on its consolidated financial
      statements.





11
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          HOLDINGS, INC. AND SUBSIDIARIES
 NOTES
          TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
 (In
          thousands, except per share data)




**NOTE
      3 – Management’s Liquidity Plan**





At
      September 30, 2007 the Company had an accumulated deficit of $25,727 and
      operating activities used $3,481 of cash for the three months then ended. In
      an
      effort to meet the Company’s cash requirements and generate positive cash flows
      from operations management has taken various actions and steps to revise its
      operating and financial requirements, including:





·
            Seeking
                additional financing from our existing shareholders and other strategic
                investors, including $8,000 raised in November 2007 (see Note 18
                **–** Subsequent Events)


·
            Reducing
                headcount to an efficient level while still carrying out the Company’s
                future growth plan


·
            Increasing
                revenue through the launch of new products, identifying new customers
                and
                expanding relationships with existing
                customers


·
            Scaling
                back the Company’s research and development activities to the extent
                necessary to be able to fund operations and continue to execute the
                Company’s overall business plan





Management
      believes that the plans and initiatives described above will result in
      sufficient liquidity to meet cash requirements at least through September 30,
      2008. However, there can be no assurance that the Company will achieve its
      cash
      flow and profitability goals, that it will be able to raise additional capital
      sufficient to meet operating expenses or implement its plans or, if capital
      is
      available, that it will be available on terms acceptable to the Company. In
      such
      event, the Company may have to revise its plans and significantly reduce its
      operating expenses, which could have an adverse effect on revenue and operations
      in the short term.





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          HOLDINGS, INC. AND SUBSIDIARIES
 NOTES
          TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
 (In
          thousands, except per share data)




**NOTE
      4 -** **Accounts
      Receivable**





Accounts
      receivable are comprised of amounts owed to the Company through the sales of
      its
      products throughout the United States. These accounts receivable are presented
      net of allowances for doubtful accounts, sales returns, discounts, rebates
      and
      customer chargebacks. Allowances for doubtful accounts were approximately $30
      at
      September 30, 2007 and June 30, 2007. The allowance for doubtful accounts is
      based on a review of specifically identified accounts, in addition to an overall
      aging analysis. Judgments are made with respect to the collectibility of
      accounts receivable based on historical experience and current economic trends.
      Actual losses could differ from those estimates. Allowances relating to
      discounts, rebates, and customer chargebacks were $4,480 and $4,865 at September
      30, 2007 and June 30, 2007, respectively. The Company
      sells some of its products indirectly to various government agencies referred
      to
      below as “indirect customers.” The Company enters into agreements with its
      indirect customers to establish pricing for certain products. The indirect
      customers then independently select a wholesaler from which to actually purchase
      the products at these agreed-upon prices. The Company will provide credit to
      the
      selected wholesaler for the difference between the agreed-upon price with the
      indirect customer and the wholesaler’s invoice price if the price sold to the
      indirect customer is lower than the direct price to the wholesaler. This credit
      is called a chargeback. The provision for chargebacks is based on expected
      sell-through levels by the Company’s wholesale customers to the indirect
      customers, and estimated wholesaler inventory levels. As sales to the large
      wholesale customers increase, the reserve for chargebacks will also generally
      increase. However, the size of the increase depends on the product mix. The
      Company continually monitors the reserve for chargebacks and makes adjustments
      to the reserve as deemed necessary. Actual chargebacks may differ from estimated
      reserves.





The
      changes in the allowance for customer chargebacks, discounts and other credits
      that reduced gross revenue for the three months ended September 30, 2007 and
      2006 was as follows:





Three Months Ended
              September 30,2007
            
            2006Reserve
                balance - beginning
            
            $
            4,865
            
            $
            2,315Actual
                chargebacks, discounts and other credits taken in the current period
                (a)
            
            
            (5,003
            )
            
            (2,732
            )Current
                provision related to current period sales
            
            
            4,618
            
            
            2,357Reserve
                balance - ending
            
            $
            4,480
            
            $
            1,940





(a)
      Actual chargebacks, discounts and other credits are determined based upon the
      customer’s application of amounts taken against the accounts receivable
      balance.





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          HOLDINGS, INC. AND SUBSIDIARIES
 NOTES
          TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
 (In
          thousands, except per share data)




**NOTE
      5 -** **Inventories** ****





Inventories
      consist of the following:





September 30,
              2007
            
            June 30,
              2007(Unaudited)Finished
                goods
            
            $
            3,764
            
            $
            3,085Work
                in process
            
            
            4,891
            
            
            7,260Raw
                materials
            
            
            3,695
            
            
            6,286Packaging
                materials
            
            
            764
            
            
            664Total
            
            $
            13,114
            
            $
            17,295Less:
                Reserve for obsolescence
            
            
            (230
            )
            
            —Total
            
            $
            12,884
            
            $
            17,295





The
      Company reduces the carrying value of inventories to a lower of cost or market
      basis for inventory whose net book value is in excess of market. Aggregate
      reductions in the carrying value with respect to inventories still on hand
      at
      September 30, 2007 and June 30, 2007 that were determined to have a carrying
      value in excess of market were $745 and $1,157, respectively.  As a result,
      the Company reduced the carrying value of inventory on hand to its market value
      by these amounts as of September 30, 2007 and June 30, 2007,
      respectively.




The
      Company performs a quarterly review of inventory items to determine if an
      obsolescence reserve adjustment is necessary. The allowance not only considers
      specific items and expiration dates, but also takes into consideration the
      overall value of the inventory as of the balance sheet date. The inventory
      obsolescence reserve value at September 30, 2007 was $230.





**NOTE
      6 -** **Land,
      Building and Equipment**





Land,
      building and equipment consist of the following:





September 30,
              2007
            
            June 30,
              2007
            
            Estimated
              Useful
              Lives(Unaudited)Land
            
            $
            4,924
            
            $
            4,924
            
            
            N/ABuilding
            
            
            12,460
            
            
            12,460
            
            
            39 YearsMachinery
                and equipment
            
            
            17,670
            
            
            16,881
            
            
            5-7 YearsComputer
                equipment
            
            
            2,587
            
            
            2,065
            
            
            3-5 YearsConstruction
                in Progress
            
            
            188
            
            
            186
            
            
            N/AFurniture
                and fixtures
            
            
            982
            
            
            953
            
            
            5 YearsLeasehold
                improvements
            
            
            4,912
            
            
            4,386
            
            
            5-15 Years43,723
            
            
            41,855Less:
                accumulated depreciation and amortization
            
            
            8,261
            
            
            7,357Land,
                Building and Equipment, net
            
            $
            35,462
            
            $
            34,498





Depreciation
      and amortization expense for the three months ended September 30, 2007 and
      2006
      was approximately $904 and $458, respectively.





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          HOLDINGS, INC. AND SUBSIDIARIES
 NOTES
          TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
 (In
          thousands, except per share data)




**NOTE
      7 -** **Accounts
      Payable, Accrued Expenses and Other Current
      Liabilities**





Accounts
      payable, accrued expenses and other current liabilities consist of the
      following:





September 30,
              2007
            
            June 30,
              2007(Unaudited)Inventory
                purchases
            
            $
            11,316
            
            $
            9,525Research
                and development expenses
            
            
            3,468
            
            
            3,003Other
            
            
            5,219
            
            
            6,014Total
            
            $
            20,003
            
            $
            18,542





**NOTE
      8 -** **Debt**





Long-term
      Debt






A
      summary of the outstanding long-term debt is as
      follows:


September 30,
              2007
            
            June 30,
              2007(Unaudited)Revolving
                credit facility
            
            $
            15,447
            
            $
            9,866Real
                estate term loan
            
            
            10,734
            
            
            10,933Machinery
                and equipment term loans
            
            
            5,257
            
            
            5,601Capital
                leases
            
            
            415
            
            
            18331,853
            
            
            26,583Less:
                amount representing interest on capital leases
            
            
            65
            
            
            38Total
                long-term debt
            
            
            31,788
            
            
            26,545Less:
                current maturities
            
            
            17,706
            
            
            12,057Long-term
                debt, less current maturities
            
            $
            14,082
            
            $
            14,488







In
      February, 2006, the Company entered into a four-year financing arrangement
      with
      Wells Fargo Business Credit (“WFBC”). This financing agreement provided an
      original maximum credit facility of $41,500 comprised of:





·  $22,500
      revolving credit facility (the “facility”)


·  $12,000
      real estate term loan


·  $
      3,500
      machinery and equipment (“M&E”) term loan


·  $
      3,500
      additional / future capital expenditure facility





15
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          HOLDINGS, INC. AND SUBSIDIARIES
 NOTES
          TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
 (In
          thousands, except per share data)




**NOTE
      8 –** **Debt,
      continued**





The
      funds
      made available through this facility paid down, in its entirety, the $20,445
      owed on the previous credit facility. The revolving credit facility borrowing
      base is calculated as (i) 85% of the Company’s eligible accounts receivable plus
      the lesser of 50% of cost or 85% of the net orderly liquidation value of its
      eligible inventory. The advances pertaining to inventory are capped at the
      lesser of 100% of the advance from accounts receivable or $9,000. The $12,000
      loan for the real estate in Yaphank, NY is payable in equal monthly installments
      of $67 plus interest through February 2010 at which time the remaining principal
      balance of approximately $8,800 is due. The $3,500 M&E loan is payable in
      equal monthly installments of $58 plus interest through February 2010 at which
      time the remaining principal balance is due. With respect to additional capital
      expenditures, the Company is permitted to borrow 90% of the cost of new
      equipment purchased to a maximum of $3,500 in borrowings amortized over 60
      months. As of September 30, 2007, there was approximately $150 available for
      additional capital expenditure borrowings.




The
      WFBC
      credit facility is collateralized by substantially all of the assets of the
      Company. In addition, the Company is required to comply with certain financial
      covenants. As of June 30, 2007, the Company had defaulted under the Senior
      Credit Agreement with respect to (i) financial reporting obligations, including
      the submission of its annual audited financial statements for the fiscal year
      ended June 30, 2007, and (ii) financial covenants related to minimum net cash
      flow, maximum allowable leverage ratio, maximum allowable total capital
      expenditures and unfinanced capital expenditures (collectively, the “Defaults”).
      WFBC has waived the Defaults based upon the Company’s consummation and receipt
      of $8,000 related to the issuance of subordinated debt described in Note 18
      -
      Subsequent Events. As of September 30, 2007, the Company had defaulted under
      the
      Senior Credit Agreement with respect to its financial reporting obligations,
      including the submission of its quarterly financial statements for the three
      months ended September 30, 2007. WFBC has waived this default as of September
      30, 2007. There were no additional covenants in place at September 30,
      2007.


The
        revolving credit facility and term loans bear interest at a rate of the prime
        rate less 0.5% or, at the Company’s option, LIBOR plus 250 basis points.
        However, as a result of the defaults discussed above, the Company was charged
        interest at the default rate of prime plus 1.0% from July 1, 2007 through
        September 30, 2007. Subsequent to September 30, 2007 and through the forbearance
        period, interest will be charged at a rate of prime plus 2.5%. At September
        30,
        2007, the interest rate on this debt was 8.75%. Pursuant to the requirements
        of
        the WFBC agreement, the Company has put in place a lock-box arrangement.
        The
        Company will incur a fee of 25 basis points per annum on any unused amounts
        of
        this credit facility.


In
      connection with WFBC credit facility, the Company incurred deferred financing
      costs of $482, which are being amortized over the term of the WFBC credit
      facility and are included in Other Assets. Of this amount, $30 has been
      recognized as amortization expense for the three months ended September 30,
      2007
      and 2006.




With
        respect to the real estate term loan and the $3,500 M&E loan, the Company
        entered into interest rate swap contracts (the “swaps”), whereby the Company
        pays a fixed rate of 7.56% and 8.00% per annum, respectively. However, as
        a
        result of the defaults discussed above, the Company was charged interest
        at the
        default rates of 9.06% and 9.50%, respectively from July 1, 2007 through
        September 30, 2007. Subsequent to September 30, 2007 and through the forbearance
        period, interest will be charged at 10.56% and 11.00% respectively. The swaps
        mature in 2010. The swaps are a cash flow hedge (i.e. a hedge against interest
        rates increasing). As all of the critical terms of the swaps and loans match,
        they are structured for short-cut accounting under SFAS No. 133, “Accounting For
        Derivative Instruments and Hedging Activities’” and by definition, there is no
        hedge ineffectiveness or a need to reassess effectiveness. Fair value of
        the
        interest rate swaps at September 30, 2007 and June 30, 2007 was approximately
        $(208) and $10 and is included in Other Liabilities and Other Assets,
        respectively.





16
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          HOLDINGS, INC. AND SUBSIDIARIES
 NOTES
          TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
 (In
          thousands, except per share data)




**NOTE
      8 –** **Debt,
      continued**





Capital
      Leases





The
      Company has acquired equipment under a capital lease with annual interest at
      8.89% that expires September 2012. The asset and liability under the capital
      lease is recorded at the fair value of the asset. The cost of the asset included
      in machinery and equipment is $138 for the three months ended September 30,
      2007. The asset is depreciated over its estimated useful life.





On
      September 14, 2007, the Company acquired equipment under a capital lease with
      annual interest at 9.23% that expires August 2010. The asset and liability
      under
      the capital lease is recorded at the fair value of the asset. The cost of the
      asset included in computer equipment is $211 for the three months ended
      September 30, 2007. The asset is depreciated over its estimated useful life.




**NOTE
      9-** **Income
      Taxes**





At
      September 30, 2007, the Company has remaining Federal net operating losses
      (“NOLs”) of $39,009 available through 2027. Pursuant to Section 382 of the
      Internal Revenue Code regarding substantial changes in Company ownership,
      utilization of the Federal NOLs is limited. As a result of losses incurred
      in
      fiscal years 2005, 2006 and 2007, which indicate uncertainty as to the Company’s
      ability to generate future taxable income, the “more-likely-than-not” standard
      has not been met and therefore some amount of the Company’s deferred tax asset
      may not be realized. As such, the company recorded a partial valuation allowance
      against its deferred tax assets as of September 30, 2007.





In
      calculating its tax provision for the three month periods ended September 30,
      2007 and 2006, the Company applied aggregate effective tax rates of
      approximately 0% and 38%, respectively, thereby creating income tax expense
      of
      $0 and $986, respectively, and adjusted its deferred tax assets by like amounts.
      The decrease in effective tax rates is the result of the Company increasing
      its
      valuation allowance during the three months ended September 30,
      2007.





The
      Company has adopted the provisions of Financial Accounting Standards Board
      ("FASB") Interpretation No. 48, "Accounting for Uncertainty in Income Taxes
      - an
      interpretation of FASB Statement No. 109"("FIN 48"), on January 1, 2007. FIN
      48
      clarifies the accounting for uncertainty in income taxes recognized in an
      enterprise's financial statements in accordance with SFAS No. 109, "Accounting
      for Income Taxes," and prescribes a recognition threshold and measurement
      process for financial statement recognition and measurement of a tax position
      taken or expected to be taken in a tax return. FIN 48 also provides guidance
      on
      derecognition, classification, interest and penalties, accounting in interim
      period, disclosure and transition.




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          HOLDINGS, INC. AND SUBSIDIARIES
 NOTES
          TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
 (In
          thousands, except per share data)




**NOTE
      9-** **Income
      Taxes, continued**





Based
      on
      the company's evaluation, it has been concluded that there are no significant
      uncertain tax positions requiring recognition in the Company's financial
      statements.  The Company's evaluation was performed for its significant
      jurisdictions, United States Federal and New York State Corporate income tax
      returns for tax years ended June 30, 2004 through June 30, 2007, the only
      periods subject to examination. The Company believes that its income tax
      positions and deductions would be sustained on audit and does not anticipate
      any
      adjustments that would result in a material change to its financial
      position.  In addition, the company did not record a cumulative effect
      adjustment related to the adoption of FIN 48.





The
      Company's policy for recording interest and penalties associated with audits
      is
      to record such items as a component of income taxes.    There
      were no amounts accrued for penalties or interest as of or during the three
      months ended September
      30 ,
      2007.  The Company does not expect its unrecognized tax benefit position to
      change during the next twelve months.  Management is currently unaware of
      any issues under review that could result in significant payments, accruals
      or
      material deviations from its position.





**NOTE
      10-** **Earnings
      (Loss) Per Share**





The
      calculations of basic and diluted EPS are as follows:


Three Months Ended
                September 30,2007
              
              2006Numerator:Net
                  (loss) income
              
              $
              (6,896
              )
              $
              1,630Less:
                  Preferred stock dividendsSeries
                  A-1
              
              
              (41
              )
              
              (41
              )Series
                  B-1
              
              
              —
              
              
              (211
              )Series
                  C-1
              
              
              —
              
              
              (41
              )Less:
                  Series C-1 beneficial conversion feature
              
              
              —
              
              
              (1,094
              )Net
                  income (loss) attributable to common stockholders
              
              $
              (6,937
              )
              $
              243Denominator:Denominator
                  for basic and diluted EPS weighted average shares outstanding
              
              
              66,196
              
              
              64,720Effect
                  of dilutive securities:Stock
                  options
              
              
              —
              
              
              3,137Denominator
                  for diluted EPS
              
              
              66,196
              
              
              67,857Basic
                  EPS:
              
              $
              (0.10
              )
              $
              0.00Diluted
                  EPS:
              
              $
              (0.10
              )
              $
              0.00




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          HOLDINGS, INC. AND SUBSIDIARIES
 NOTES
          TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
 (In
          thousands, except per share data)




**NOTE
      10-** **Earnings
      (Loss) Per Share, continued**





Stock
      options, warrants and convertible preferred stock, equivalent to 28,502 and
      18,056 shares of the Company’s common stock, were not included in the
      computation of diluted earnings per share for the three months ended September
      30, 2007 and 2006, respectively, as their inclusion would be
      antidilutive.





As
      of
      September 30, 2007, the total number of common shares outstanding and the number
      of common shares potentially issuable upon exercise of all outstanding stock
      options and conversion of preferred stocks (including contingent conversions)
      is
      as follows:





Common
                stock outstanding
            
            
            66,738Stock
                options outstanding
            
            
            10,892Warrants
                outstanding
            
            
            4,564Common
                stock issuable upon conversion of preferred stocks:Series
                C
            
            
            6Series
                A-1 (maximum contingent conversion) (a)
            
            
            4,855Series
                B-1
            
            
            6,520Series
                C-1
            
            
            6,520Total
                (b)
            
            
            100,095





(a)
            The
                Series A-1 shares are convertible only if the Company reaches $150
                million
                in annual sales or upon a merger, consolidation, sale of assets or
                similar
                transaction.





(b)
            Assuming
                no further issuance of equity instruments, or changes to the equity
                structure of the Company, this total represents the maximum number
                of
                shares of common stock that could be outstanding through July 24,
                2017
                (the end of the current vesting and conversion
                periods).


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          HOLDINGS, INC. AND SUBSIDIARIES
 NOTES
          TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
 (In
          thousands, except per share data)





**NOTE
      11 –** **Series
      B-1 Redeemable Convertible Preferred Stock**





In
      May
      2006, the Company entered into a Securities Purchase Agreement (the “Agreement”)
      with Tullis-Dickerson Capital Focus III, L.P. (“Tullis”). Under the Agreement,
      the Company agreed to issue and sell to Tullis, and Tullis agreed to purchase
      from the Company, for a purchase price of $10,000 (net proceeds of $9,858)
      an
      aggregate of 10 shares of a newly designated series of the Company’s preferred
      stock (“B-1”), together with 2,282 warrants to purchase shares of common stock
      of the Company with an exercise price of $1.639 per share. The warrants have
      a
      five year term. The Series B-1 Stock and warrants sold to Tullis are convertible
      and/or exercisable into a total of 8,802 shares of common stock. The B-1 shares
      are convertible into common shares at a conversion price of $1.5338, and have
      an
      annual dividend rate of 8.25%, payable quarterly, which can be paid, at the
      Company’s option, in cash or the Company’s common stock. In addition, the B-1
      shareholders have the right to require the Company to redeem all or a portion
      of
      the B-1 shares upon the occurrence of certain triggering events, at a price
      per
      preferred share to be calculated on the day immediately preceding the date
      of a
      triggering event. A triggering event shall be deemed to have occurred at such
      time as any of the following events: (i) failure to cure a conversion failure
      by
      delivery of the required number of shares of common stock within ten trading
      days; (ii) failure to pay any dividends, redemption price, change of control
      redemption price, or any other amounts when due; (iii) any event of default
      with
      respect to any indebtedness, including borrowings under the WFBC Credit and
      Security Agreement, under which the oblige of such indebtedness are entitled
      to
      and do accelerate the maturity of at least an aggregate of $3,000 in outstanding
      indebtedness; and (iv) breach of any representation, warranty, covenant or
      other
      term or condition in the Series B-1 Transaction Document.





For
      the
      three months ended September 30, 2007, the Company issued 148 shares of common
      stock as payment of $206 of previously accrued dividends. In connection with
      the
      Consent and Waiver Agreement (discussed in Note 8 - Debt and Note 18 -
      Subsequent Events), Tullis waived their rights to receive dividends for the
      quarters ended September 30, 2007 and December 31, 2007.





With
      respect to the Company’s accounting for the preferred stock, EITF Topic D-98,
      paragraph 4, states that Rule 5-02.28 of Regulation S-X requires securities
      with redemption features that are not solely within the control of the issuer
      to
      be recorded outside of permanent equity. As described above, the terms of the
      Preferred Stock include certain redemption features that may be triggered
      by events that are not solely within the control of the Company, such as a
      potential default with respect to any indebtedness, including borrowings under
      the WFBC financing arrangement. Accordingly, the Company has classified the
      B-1
      shares as temporary equity and the value ascribed to the B-1 shares upon initial
      issuance in May 2006 was the amount received in the transaction less the
      relative fair value ascribed to the warrants and direct costs associated with
      the transaction. The Company allocated $1,704 of the gross proceeds of the
      sale
      of B-1 shares to the warrants based on estimated fair value. In accordance
      with
      EITF Issue No. 00-27 "Application of EITF Issue No. 98-5 to Certain Convertible
      Instruments," ("EITF 00-27") the Company recorded a non-cash charge of $1,418
      to
      accumulated deficit during the quarter ended June 30, 2006. The non-cash charge
      measures the difference between the relative fair value of the B-1 shares and
      the fair market value of the Company's common stock issuable pursuant to the
      conversion terms on the date of issuance. As of June 30, 2007, the Company
      had
      defaulted under the Senior Credit Agreement with respect to the Existing
      Defaults, as described in Note 8 – Debt, and WFBC has waived the Defaults.
      The Company does not expect to be in default in the future under its credit
      facility (the only redemption feature outside of its control), nor does it
      plan
      to redeem the Series B-1 preferred stock. As such the Company believes it is
      not
      probable that the Series B-1 preferred stock will become
      redeemable.


20
 INTERPHARM
          HOLDINGS, INC. AND SUBSIDIARIES
 NOTES
          TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
 (In
          thousands, except per share data)





**NOTE
      11 –** **Series
      B-1 Redeemable Convertible Preferred Stock, continued**





In
      addition, in May 2006, in connection with the sale of the B-1 shares the Company
      entered into a Registration Rights Agreement, as amended, with Tullis. Under
      the
      terms of this Registration Rights Agreement the Company is subject to penalties
      (a) if, within 60 days after a request to do so is made by the holders of such
      preferred stock, the Company does not timely file with the Securities
      and Exchange Commission a registration statement covering the resale of shares
      of its common stock issuable to such holders upon conversion of the preferred
      stock, (b) if a registration statement is filed, such registration statement
      is
      not declared effective within 180 days after the request is made or (c) if
      after
      such a registration is declared effective, after certain grace periods the
      holders are unable to make sales of its common stock because of a failure to
      keep the registration statement effective or because of a suspension or
      delisting of its common stock from the American Stock Exchange or other
      principal exchange on which its common stock is traded. The penalties will
      accrue on a daily basis so long as the Company is in default of the Registration
      Rights Agreement. The maximum amount of a registration delay penalty as defined
      in the Registration Rights Agreement is 18% of the aggregate purchase price
      of
      Tullis’ registrable securities included in the related registration statement.
      Unpaid registration delay penalties shall accrue interest at the rate of 1.5%
      per month until paid in full. If the Company fails to get a registration
      statement effective penalties shall accrue at an amount equal to 1.67% per
      month
      of the aggregate purchase price of Tullis’ registrable securities included in
      the related registration statement. If the effectiveness failure continues
      for
      more than 180 days the penalty rate shall increase to 3.33%. In addition, if
      the
      Company fails to maintain the effectiveness of a registration statement,
      penalties shall accrue at a rate of 3.33% per month of the aggregate purchase
      price of the registrable securities included in the related registration. The
      Company is also subject to penalties if there is a failure to timely deliver
      to
      a holder (or credit the holder’s balance with Depository Trust Company if the
      common stock is to be held in street name) a certificate for shares of our
      common stock if the holder elects to convert its preferred stock into common
      stock. Therefore, upon the occurrence of one or more of the foregoing events
      the
      Company’s business and financial condition could be materially adversely
      affected and the market price of its common stock would likely
      decline.


21
 INTERPHARM
          HOLDINGS, INC. AND SUBSIDIARIES
 NOTES
          TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
 (In
          thousands, except per share data)





**NOTE
      11 –** **Series
      B-1 Redeemable Convertible Preferred Stock, continued**





The
      Company’s Series B-1 redeemable convertible preferred stock is summarized as
      follows at September 30, 2007:





Shares IssuedShares
            
            And
            
            Par Value
            
            LiquidationAuthorized
            
            Outstanding
            
            Per Share
            
            Preference15
            
            
            10
            
            $
            100
            
            $
            10,000





As
      of
      June 30, 2007, the Company was in default under the Securities Purchase
      Agreement due to (A) the failure of the Company to timely file with the
      Securities and Exchange Commission (and deliver to Tullis) its Annual Report
      on
      Form 10-K for the year ended June 30, 2007; and (B) the failure of the Company
      to prevent the suspension of trading of its Common Stock on the American Stock
      Exchange as a result of (A). Tullis provided the Company with a waiver of these
      defaults based upon the Company’s consummation and receipt of $8,000 related to
      the issuance of subordinated debt described in Note 18 - Subsequent Events.
      In
      addition, the Company notified Tullis that it would be in default under the
      Securities Purchase Agreement due to the failure of the Company to timely file
      with the Securities and Exchange Commission (and deliver to Tullis) its Form
      10-Q for the three months ended September 30, 2007.  Tullis provided the
      Company with a waiver of this default on November 15, 2007.





**NOTE
      12 –** **Series
      C-1 Redeemable Convertible Preferred Stock**





On
      September 11, 2006, the Company entered into a Securities Purchase Agreement
      (the “C-1 Agreement”) with Aisling Capital, L.P. (the “Buyer”). Under the C-1
      Agreement, the Company agreed to issue and sell to the Buyer, and the Buyer
      agreed to purchase from the Company, for a purchase price of $10,000 (net
      proceeds of $9,993) an aggregate of 10 shares of a newly designated series
      of
      the Company’s preferred stock (“C-1”), together with 2,282 warrants to purchase
      shares of common stock of the Company with an exercise price of $1.639 per
      share. The warrants have a five year term. The Series C-1 Stock and warrants
      sold to the Buyer are convertible and/or exercisable into a total of 8,802
      shares of common stock. The C-1 shares are convertible into common shares at
      a
      conversion price of $1.5338, and have an annual dividend rate of 8.25%, payable
      quarterly, which can be paid, at the Company’s option, in cash or the Company’s
      common stock. In addition, the C-1 shareholders have the right to require the
      Company to redeem all or a portion of the C-1 shares upon the occurrence of
      certain triggering events, as defined, at a price per preferred share to be
      calculated on the day immediately preceding the date of a triggering event.
      A
      triggering event shall be deemed to have occurred at such time as any of the
      following events: (i) failure to cure a conversion failure by delivery of the
      required number of shares of common stock within ten trading days; (ii) failure
      to pay any dividends, redemption price, change of control redemption price,
      or
      any other amounts when due; (iii) any event of default with respect to any
      indebtedness, including borrowings under the WFBC Credit and Security Agreement,
      under which the oblige of such indebtedness are entitled to and do accelerate
      the maturity of at least an aggregate of $3,000 in outstanding indebtedness;
      and
      (iv) breach of any representation, warranty, covenant or other term or condition
      in the Series C-1 Transaction Document.


22
 INTERPHARM
          HOLDINGS, INC. AND SUBSIDIARIES
 NOTES
          TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
 (In
          thousands, except per share data)




**NOTE
      12 –** **Series
      C-1 Redeemable Convertible Preferred Stock, continued**





For
      the
      three months ended September 30, 2007, the Company issued 148 shares of common
      stock as payment of $206 of previously accrued dividends. In connection with
      the
      Consent and Waiver Agreement (discussed in Note 8 – Debt and Note 18 -
      Subsequent Events), Aisling waived their rights to receive dividends for the
      quarters ended September 30, 2007 and December 31, 2007.





With
      respect to the Company’s accounting for the preferred stock, EITF Topic D-98,
      paragraph 4, states that Rule 5-02.28 of Regulation S-X requires securities
      with redemption features that are not solely within the control of the issuer
      to
      be recorded outside of permanent equity. As described above, the terms of the
      Preferred Stock include certain redemption features that may be triggered
      by events that are not solely within the control of the Company, such as a
      potential default with respect to any indebtedness, including borrowings under
      the WFBC financing arrangement. Accordingly, the Company has classified the
      C-1
      shares as temporary equity and the value ascribed to the C-1 shares upon initial
      issuance in September 2006 was the amount received in the transaction less
      the
      relative fair value ascribed to the warrants and direct costs associated with
      the transaction. The Company allocated $1,641of the gross proceeds of the sale
      of C-1 shares to the warrants based on estimated fair value. In accordance
      with
      EITF Issue No. 00-27 "Application of EITF Issue No. 98-5 to Certain Convertible
      Instruments," ("EITF 00-27") the Company recorded a non-cash charge of $1,094
      to
      Accumulated deficit during the quarter ended September 30, 2006. The non-cash
      charge measures the difference between the relative fair value of the C-1 shares
      and the fair market value of the Company's common stock issuable pursuant to
      the
      conversion terms on the date of issuance. As of June 30, 2007, the Company
      had
      defaulted under the C-1 Agreement with respect to the Existing Defaults, as
      described in Note 8 – Debt, and WFBC has waived the Defaults. The Company
      does not expect to be in default in the future under its credit facility (the
      only redemption feature outside of its control), nor does it plan to redeem
      the
      Series C-1 preferred stock. As such the Company believes it is not probable
      that
      the Series C-1 preferred stock will become redeemable.





In
      addition, on September 11, 2006, in connection with the sale of the C-1 shares
      the Company entered into a Registration Rights Agreement, as amended, with
      the
      Buyer. Under the terms of this Registration Rights Agreement the Company is
      subject to penalties (a) if, within 60 days after a request to do so is made
      by
      the holders of such preferred stock, the Company does not timely file with
      the
      Securities and Exchange Commission a registration statement covering the resale
      of shares of its common stock issuable to such holders upon conversion of the
      preferred stock, (b) if a registration statement is filed, such registration
      statement is not declared effective within 180 days after the request is made
      or
      (c) if after such a registration is declared effective, after certain grace
      periods the holders are unable to make sales of its common stock because of
      a
      failure to keep the registration statement effective or because of a suspension
      or delisting of its common stock from the American Stock Exchange or other
      principal exchange on which its common stock is traded. The penalties will
      accrue on a daily basis so long as the Company is in default of the Registration
      Rights Agreement. The maximum amount of a registration delay penalty as defined
      in the Registration Rights Agreement is 18% of the aggregate purchase price
      of
      the Buyers registrable securities included in the related registration
      statement. Unpaid registration delay penalties shall accrue interest at the
      rate
      of 1.5% per month until paid in full. If the Company fails to get a registration
      statement effective penalties shall accrue at an amount equal to 1.67% per
      month
      of the aggregate purchase price of the Buyers registrable securities included
      in
      the related registration statement. If the effectiveness failure continues
      for
      more than 180 days the penalty rate shall increase to 3.33%. In addition, if
      the
      Company fails to maintain the effectiveness of a registration
      statement, penalties shall accrue at a rate of 3.33% per month of the aggregate
      purchase price of the registrable securities included in the related
      registration. The Company is also subject to penalties if there is a failure
      to
      timely deliver to a holder (or credit the holder’s balance with Depository Trust
      Company if the common stock is to be held in street name) a certificate for
      shares of our common stock if the holder elects to convert its preferred stock
      into common stock. Therefore, upon the occurrence of one or more of the
      foregoing events the Company’s business and financial condition could be
      materially adversely affected and the market price of its common stock would
      likely decline.


23
 INTERPHARM
          HOLDINGS, INC. AND SUBSIDIARIES
 NOTES
          TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
 (In
          thousands, except per share data)





**NOTE
      12 –** **Series
      C-1 Redeemable Convertible Preferred Stock, continued**








The
      Company’s Series C-1 redeemable convertible preferred stock is summarized as
      follows at September 30, 2007:




Shares IssuedShares
            
            And
            
            Par Value
            
            LiquidationAuthorized
            
            Outstanding
            
            Per Share
            
            Preference10
            
            
            10
            
            $
            100
            
            $
            10,000





As
      of
      June 30, 2007, the Company was in default under the C-1 Agreement due to (A)
      the
      failure of the Company to timely file with the Securities and Exchange
      Commission (and deliver to the Buyer) its Annual Report on Form 10-k for the
      year ended June 30, 2007; and (B) the failure of the Company to prevent the
      suspension of trading of its Common Stock on the American Stock Exchange as
      a
      result of (A). The Buyer provided the Company with a waiver of these defaults
      based upon the Company’s consummation and receipt of $8,000 related to the
      issuance of subordinated debt described in Note 18 - Subsequent Events. In
      addition, the Company notified Aisling that it would be in default under the
      Securities Purchase Agreement due to the failure of the Company to timely file
      with the Securities and Exchange Commission (and deliver to Aisling) its Form
      10-Q for the three months ended September 30, 2007.  Aisling provided the
      Company with a waiver of this default on November 15, 2007.


24
 INTERPHARM
          HOLDINGS, INC. AND SUBSIDIARIES
 NOTES
          TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
 (In
          thousands, except per share data)





**NOTE
      13 –** **Equity
      Securities**





Preferred
      Stocks


During
      the quarter ended September 30, 2007, the Company issued 148 shares of the
      Company’s common stock to each of the Series B-1 and C-1 stockholders,
      respectively, for dividends earned for the quarter ended June 30, 2007 of $206
      for each of the Series B-1 and Series C-1 stockholders,
      respectively.





Common
      Stock


During
      the three months ended September 30, 2007, the Company issued shares of its
      common stock as follows:





· 148
      shares were issued to Series B-1 and C-1 preferred stock shareholders,
      respectively, in settlement of dividends for the quarter ended June 30,
      2007;





Stock
      Options and Appreciation Rights


As
      of
      September 30, 2007 and during the three month period ended September 30, 2007:





· the
      Company recognized approximately $3 as income in connection with 100 previously
      issued stock appreciation rights (“SARs”). The SARs must be exercised between
      July 1, 2008 and December 31, 2008. The SARs are recorded at fair value and
      are
      marked to market at each reporting period. As of September 30, 2007, the total
      liability related to the SARs is $43;





· total
      unrecognized compensation cost related to stock options granted was $1,514.
      The
      unrecognized stock option compensation cost is expected to be recognized over
      a
      weighted-average period of approximately 2.93 years;





· total
      options outstanding and total options exercisable to purchase the Company’s
      common stock as of September 30, 2007, amounted to 10,892  and
      8,821, respectively;  These options had a weighted average exercise price
      of $1.13 and $1.11, respectively.  At September 30, 2007, these options had
      intrinsic value of $3,301, and $2,813, respectively.





· 80
      options to purchase the Company’s common stock were issued to certain employees
      at the market price on the date of the grant and had vesting periods ranging
      from 2.44 to 4.93 years from the date of issuance, and having a weighted average
      exercise price of $0.98 on the date of grant.  There was no intrinsic value
      in these options at September 30, 2007.





· in
      connection with separation agreements involving three employees, the Company
      accelerated the vesting of 388 options, which are exercisable until December
      10,
      2007. As a result of these transactions, the Company recognized $246 expense
      during the quarter ended September 30, 2007.





· the
      Company issued 556 shares (548 resulting from a cashless exercise of 1,100
      options), resulting in $5 proceeds, were issued in connection with exercises
      of
      options to purchase the Company’s stock.







25
 INTERPHARM
          HOLDINGS, INC. AND SUBSIDIARIES
 NOTES
          TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
 (In
          thousands, except per share data)


**NOTE
      14 -** **401k
      Plan**







In
      2006,
      the Company initiated a pre-tax savings plan covering substantially all
      employees, which qualifies under Section 401(k) of the Internal Revenue
      Code. Under the plan, eligible employees may contribute a portion of their
      pre-tax salary, subject to certain limitations. The Company contributes and
      matches 100% of the employee pre-tax contributions, up to 3% of the employee’s
      compensation plus 50% of pre-tax contributions that exceed 3% of compensation,
      but not to exceed 5% of compensation. The Company may also make profit-sharing
      contributions in its discretion which would be allocated among all eligible
      employees, whether or not they make contributions. Company contributions were
      approximately $92 and $68 for the three month period ended September 30, 2007
      and 2006 respectively.




**NOTE
      15 -** **Economic
      Dependency**





Major
      Customers


The
      Company had the following customer concentrations for the three month periods
      ended September 30, 2007 and 2006:




Three Months Ended
              September 30,2007
            
            2006Customer
                “A”
            
            
            14
            %
            
            *Customer
                “B”
            
            
            13
            %
            
            *Customer
                “C”
            
            
            *
            
            
            22
            %Customer
                “D”
            
            
            *
            
            
            14
            %Customer
                “E”
            
            
            *
            
            
            16
            %Customer
                “F”
            
            
            *
            
            
            11
            %




*  Sales
      to
      customer were less than 10%




Accounts
      Receivable





September 30,
              2007Customer
                “A”
            
            $
            1,611Customer
                “B”
            
            
            3,852Customer
                “C”
            
            
            2,664Customer
                “D”
            
            
            118Customer
                “E”
            
            
            1,654Customer
                “F”
            
            
            1,236





The
      Company has supply agreements to sell various strengths of Ibuprofen, and
      commencing October 2005, various strengths of Naproxen, to the Department of
      Veteran Affairs through two intermediary wholesale prime vendors whose data
      are
      combined and reflected in Customer “B” above.





Major
      Suppliers


For
      the
      three months ended September 30, 2007 and 2006, the Company purchased materials
      from two suppliers totaling approximately 46% and 50%, respectively. At
      September 20, 2007 and 2006, aggregate amounts due to these suppliers included
      in accounts payable, were approximately $6,045 and $4,300,
      respectively.


26
 INTERPHARM
          HOLDINGS, INC. AND SUBSIDIARIES
 NOTES
          TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
 (In
          thousands, except per share data)





**NOTE
      16 -** **Related
      Party Transactions**





**Rents**


The
      Company leases one of its business premises located in Hauppauge, New York,
      (“Premises”) from an entity owned by three stockholders (“Landlord”), under a
      noncancelable lease expiring in October 2019.





Under
      the
      terms of the lease for the Premises, upon a transfer of a majority of the issued
      and outstanding voting stock of Interpharm, Inc., which occurred on May 30,
      2003, and every three years thereafter, the annual rent may be adjusted to
      fair
      market value, as determined by an independent appraiser. Effective May 1, 2006,
      the Company is paying the Landlord a base rent of $660 annually. For the three
      months ended September 30, 2007 and 2006, the rents paid in accordance with
      this
      lease were $165 and $120, respectively.





**Investment
      in APR, LLC.**


In
      February and April 2005, the Company purchased 5 Class A membership interests
      (“Interests”) from each of Cameron Reid (“Reid”), the Company’s Chief Executive
      Officer, and John Lomans (“Lomans”), who has no affiliation with the Company,
      for an aggregate purchase price of $1,023 (including costs of $23) of APR,
      LLC,
      a Delaware limited liability company primarily engaged in the development of
      complex bulk pharmaceutical products (“APR”). The purchases were made pursuant
      to separate Class A Membership Interest Purchase Agreements dated February
      16,
      2005 between the Company and Reid and Lomans (the “Purchase Agreements”). At the
      time of the purchases, Reid and Lomans owned all of the outstanding Class A
      membership interests of APR, which had, outstanding, 100 Class A membership
      interests and 100 Class B membership interests. As a result, the Company owns
      10
      of the 100 Class A membership interests outstanding. The two classes of
      membership interests have different economic and voting rights, and the Class
      A
      members have the right to make most operational decisions. The Class B interests
      are held by one of the Company’s major customers and suppliers.




In
      accordance with the terms of the Purchase Agreements, the Company has granted
      to
      Reid and Lomans each a proxy to vote 5 of the Interests owned by the Company
      on
      all matters on which the holders of Interests may vote.





The
      Board
      of Directors approved the purchases of Interests at a meeting held on February
      15, 2005, based on an analysis and advice from an independent investment banking
      firm. Reid did not participate during the Company’s deliberations on this
      matter. The Company is accounting for its investment in APR pursuant to the
      cost
      method of accounting.





**Purchase
      from APR, LLC**


In
      the
      prior year, the Company placed an order valued at $160 for a certain raw
      material from APR. The Company currently purchases the same raw material from
      an
      overseas supplier at a price 37% greater than the price APR is currently willing
      to offer. The Company believes sourcing the raw material from APR would not
      only
      resolve intermittent delays in obtaining this material from overseas but would
      also improve gross margins on products using the raw material. Supply of this
      raw material is being coordinated with the Company’s requirement projections for
      the fiscal year ended June 30, 2008. As of September 30, 2007, the Company
      has
      advanced $80 to APR in connection with this order.




27
 INTERPHARM
          HOLDINGS, INC. AND SUBSIDIARIES
 NOTES
          TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
 (In
          thousands, except per share data)




**NOTE
      16 -** **Related
      Party Transactions, continued**





**Separation
      Agreements**


As
      of
      September 10, 2007, the Company entered into separation agreements in connection
      with the termination of employment of Bhupatlal K. Sutaria, the brother of
      the
      Chairman of the Company’s Board of Directors and the Company’s former President,
      Vimla Sutaria, the wife of the Chairman of the Company’s Board of Directors, and
      Jyoti Sutaria, the wife of Bhupatlal K. Sutaria. In connection with his
      separation agreement, Bhupatlal K. Sutaria received six months of salary
      aggregating $138, accelerated vesting of 200 stock options and a “cashless” or
“net” exercise feature with respect to all of his 700 vested options.
      Accordingly, on September 21, 2007, Mr. Sutaria exercised all of his available
      options under this agreement.





In
      connection with her separation agreement, Jyoti Sutaria received accelerated
      vesting of 100 stock options and a “cashless” exercise feature with respect to
      all of her 400 vested options. Accordingly, on September 21, 2007, Mrs. Sutaria
      exercised all of her available options under this agreement.





In
      connection with her separation agreement, Vimla Sutaria received accelerated
      vesting of 88 stock options and a “cashless” exercise feature with respect to
      all of her 350 vested options which expired on December 10, 2007 (see Note
      13).





**NOTE
      17 –** **Commitments
      and Contingencies**





**Litigation**


An
      action
      was commenced on June 1, 2006, by Ray Vuono (“Vuono”) in the Supreme Court of
      the State of New York, County of Suffolk (Index No. 13985/06).  The action
      alleged that plaintiff was owed an amount exceeding $10 million in unpaid
“finder’s fees” under an advisory agreement between plaintiff and Atec Group,
      Inc.





By
      motion
      dated July 26, 2006, the Company moved to dismiss Vuono’s complaint in its
      entirety.  Vuono cross-moved to disqualify the Company's counsel due to an
      alleged conflict of interest.  By recent decision and order dated March 29,
      2007, the Court dismissed Vuono’s claims as they pertain to any fees claimed by
      Vuono related to a reverse merger of Interpharm, Inc. and the Company and
      declined to dismiss other claims.  The dismissed claims represent
      approximately $7 million of the total of $10 million claimed by Vuono.  The
      Court deferred its decision on Vuono’s motion to disqualify counsel, and held a
      hearing on the matter on September 24, 2007. A final decision on the motion
      to
      disqualify is not expected until early 2008. The action, including all
      discovery, is stayed pending the Court’s decision.





The
      Company will continue to vigorously defend the action.





In
      May
      2007, a former employee commenced an action against the Company with the
      New York State Division of Human Rights.  The complaint against the Company
      alleges claims of race discrimination. The total sought by the former employee
      in the action is unspecified.  The Company believes that the claims are
      without merit and the Company is vigorously defending the action. 
Currently, the Company cannot predict with certainty the outcome of this
      litigation.


28
 INTERPHARM
          HOLDINGS, INC. AND SUBSIDIARIES
 NOTES
          TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
 (In
          thousands, except per share data)


**NOTE
      17 –** **Commitments
      and Contingencies, continued**





On
      October 8, 2007, Leiner Health Products LLC and the Company entered into a
      Settlement Agreement and Release (“Settlement”) in connection with an October
      2005 manufacturing and supply agreement for ibuprofen tablets. As part of the
      Settlement, Leiner executed a Promissory Note for $477 for the amount it owed
      the Company. On October 12, 2007, the Company notified Leiner that one lot
      of
      this product was subject to a voluntary recall. Leiner has subsequently
      threatened to hold any additional payments under the Settlement until they
      receive reasonable assurances from the Company that the additional lots in
      their
      possession would not be subject to the recall as well. If all lots were
      recalled, Leiner would be entitled to a reimbursement by the Company of
      approximately $256. However, the Company does not believe any further lots
      will
      be recalled.




On
      November 8, 2007, Leiner failed to make its initial principal payment under
      the
      Promissory Note, and indicated that it did not intend to make future payments
      under the Note.  In response, the Company declared Leiner in default under
      the Promissory Note and accelerated the unpaid principal obligations.  On
      November 26, 2007, the Company commenced litigation, via a motion for summary
      judgment in lieu of complaint, in New York Supreme Court, Suffolk County
      entitled *Interpharm
      Holdings, Inc. v. Leiner Health Products LLC,* 36642/2007,
      seeking to recover the full principal amount of the promissory note plus costs
      and interest.  Leiner’s answer is due on or around December 28, 2007, and a
      decision on the Company’s motion for summary judgment is expected by early
      spring.





The
      testing, manufacturing and marketing of pharmaceutical products subject the
      Company to the risk of product liability claims. The Company believes that
      it
      maintains an adequate amount of product liability insurance, but no assurance
      can be given that such insurance will cover all existing and future claims
      or
      that it will be able to maintain existing coverage or obtain additional coverage
      at reasonable rates.





From
      time
      to time, the Company is a party to litigation arising in the normal course
      of
      its business operations. In the opinion of management, it is not anticipated
      that the settlement or resolution of any such matters will have a material
      adverse impact on the Company’s financial condition, liquidity or results of
      operations.





**Operating
      Leases**


Property
      Lease


In
      January 2007 the Company entered into a seven year lease for approximately
      20
      square feet of office space. The lease provides the Company an option to extend
      the lease for a period of three years. According to the terms of the lease
      the
      base annual rental for the first year will be $261 and will increase by 3%
      annually thereafter. Further, the Company is required to pay for renovations
      to
      the facility, currently estimated at approximately $300.


29
 INTERPHARM
          HOLDINGS, INC. AND SUBSIDIARIES
 NOTES
          TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
 (In
          thousands, except per share data)


**NOTE
      17 –** **Commitments
      and Contingencies, continued**





**Significant
      Contracts**


Tris
      Pharmaceuticals, Inc.


During
      February 2005, the Company entered into an agreement (“Solids Agreement”), for
      solid dosage products (“solids”) with Tris. In July 2005, the Solids Agreement
      was amended. According to the terms of the Solids Agreement, as amended, the
      Company will collaborate with Tris on the development, manufacture and marketing
      of eight solid oral dosage generic products. The amendment to this agreement
      requires Tris to deliver Technical Packages for two soft-gel products and one
      additional solid dosage product. Some of the products included in this
      agreement, as amended, may require the Company to challenge the patents for
      the
      equivalent branded products. This agreement, as amended, provides for payments
      of an aggregate of $4,800 to Tris, whether or not regulatory approval is
      obtained for any of the solids products. The Solids Agreement also provides
      for
      an equal sharing of net profits for each product, except for one product, that
      is successfully sold and marketed, after the deduction and reimbursement of
      all
      litigation-related and certain other costs. The excluded product provides for
      a
      profit split of 60% for the Company and 40% for Tris. Further, this agreement
      provides the Company with a perpetual royalty-free license to use all technology
      necessary for the solid products in the United States, its territories and
      possessions.





In
      April
      2006, the Company and Tris further amended the Solids Agreement. This second
      amendment required Tris to deliver a Technical Package for one additional solid
      dosage product.





Further,
      terms of this second amendment required the Company to pay to Tris an additional
      $300 associated with the original agreement.





During
      October 2006, the Company entered into a new agreement (“New Liquids Agreement”)
      with Tris Pharma, Inc. (“Tris”), which terminated the agreement entered into in
      February 2005, which was for the development and licensing of up to twenty-five
      liquid generic products (“Liquids Agreement”). According to the terms of the New
      Liquids Agreement, Tris will, among other things, be required to develop and
      deliver the properties, specifications and formulations (“Product Details”) for
      fourteen generic liquid pharmaceutical products (“Liquid Products”). The Company
      will then utilize this information to obtain all necessary approvals. Further,
      under the terms of the New Liquids Agreement Tris will manufacture, package
      and
      label each product for a fee. The Company was required to pay Tris $1,000,
      whether or not regulatory approval is obtained for any of the liquid products.
      The Company has paid in full the $1,000; $250 having been paid during the term
      of the initial Liquids Agreement; $500 paid upon the execution of the New
      Liquids Agreement, and the balance of $250 paid December 15, 2006. In addition,
      Tris is to receive 40% of the net profits, as defined, in accordance with the
      terms in the New Liquids Agreement.





The
      Company further amended the Solids Agreement in October 2006, modifying the
      manner in which certain costs will be shared as well as clarifying the parties’
respective audit rights.





Since
      inception, we have incurred approximately $5,425 of research and development
      costs associated with the Tris agreements of which the Company has paid the
      full
      amount due as of September 30, 2007. The combined costs of these agreements
      could aggregate up to $5,800. The balance on the solids agreement, as amended,
      of $375 could be paid within two years if all milestones are reached. There
      is
      no outstanding balance to be paid related to the liquid agreement as of
      September 30, 2007.


30
 INTERPHARM
          HOLDINGS, INC. AND SUBSIDIARIES
 NOTES
          TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
 (In
          thousands, except per share data)


**NOTE
      17 –** **Commitments
      and Contingencies, continued**





Watson
      Pharmaceuticals, Inc .


On
      October 3, 2006, the Company entered into a termination and release agreement
      (the “Termination Agreement”) with Watson Laboratories, Inc. (“Watson”)
      terminating the Manufacturing and Supply Agreement dated October 14, 2003 (the
      “Supply Agreement”) pursuant to which the Company manufactured and supplied and
      Watson distributed and sold generic Vicoprofen® (7.5 mg hydrocodone
      bitartrate/200 mg ibuprofen) tablets, (the “Product”). Watson
      was required to return all rights and agreements to the Company thereby enabling
      it to market the Product. Further, Watson was required to turn over to the
      Company its current customer list for this Product and agreed that, for a period
      of six months from closing, neither Watson nor any of its affiliates is to
      solicit sales for this product from its twenty largest customers. In
      accordance with the Termination Agreement, Watson returned approximately $141
      of
      the Product and the Company in turn invoiced Watson $42 for
      repacking.  The net
      affect was a reduction of $99 to the Company’s net sales during the three months
      ended September 30, 2007.  In
      consideration of the termination of Watson’s rights under the Supply Agreement,
      the Company is to pay Watson $2,000 payable at the rate of $500 per year over
      four years from the first anniversary of the effective date of the termination
      agreement. The Company determined the net present value of the obligation and
      accordingly increased Accounts payable, accrued expenses and other liabilities
      and Contract termination liability by $367 and $1,288, respectively. At
      September 30, 2007, contract termination liability of $394 and $1,382 are
      included in Accounts payable, accrued expenses and other liabilities and
      Contract termination liability, respectively. The imputed interest of $345
      will
      be amortized over the remaining life of the obligation using the effective
      interest rate method. Non-cash interest of $34 was recognized during the three
      months ended September 30, 2007.





On
      November 2, 2007, the Company commenced an action against Watson in the U.S.
      District Court, Eastern District of New York (Index No. 02-4600). The Company
      is
      seeking rescission of the Termination Agreement and a declaratory judgment
      relieving the Company of its obligations under the Termination Agreement.





In
      February 2007 the Company entered into a termination and release agreement
      with
      Watson terminating the Manufacturing and Supply Agreement dated as of July
      1, 2003 pursuant to which the Company manufactured and supplied and Watson
      distributed and sold Reprexain® (5.0 mg hydrocodone bitartrate/200 mg ibuprofen)
      tablets. Further, in February 2007 the Company entered into an intellectual
      property purchase agreement with Watson whereby the Company acquired the
      registered trademark, domain name, and website content relating to the
      pharmaceutical product Reprexain® (5.0 mg hydrocodone bitartrate/200 mg
      ibuprofen) tablets as described in the agreement.  As consideration
      the Company shall pay Watson, on a quarterly basis, 1.5% of net sales derived
      from sales of 5.0 mg hydrocodone bitartrate/200 mg ibuprofen tablets
      sold under the Reprexain® trademark.


31
 INTERPHARM
          HOLDINGS, INC. AND SUBSIDIARIES
 NOTES
          TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
 (In
          thousands, except per share data)


**NOTE
      17 –** **Commitments
      and Contingencies, continued**





At
      September 30, 2007, contract termination liability of $394 and $1,382 are
      included in Accounts payable, accrued expenses and other liabilities and
      Contract termination liability, respectively. In February 2007 the Company
      entered into a termination and release agreement with Watson terminating
      the Manufacturing and Supply Agreement dated as of July 1, 2003 pursuant to
      which the Company manufactured and supplied and Watson distributed and sold
      Reprexain® (5.0 mg hydrocodone bitartrate/200 mg ibuprofen) tablets. Further, in
      February 2007 the Company entered into an intellectual property purchase
      agreement with Watson whereby the Company acquired the
      registered trademark, domain name, and website content relating to the
      pharmaceutical product Reprexain® (5.0 mg hydrocodone bitartrate/200 mg
      ibuprofen) tablets as described in the agreement.  As consideration
      the Company shall pay Watson, on a quarterly basis, 1.5% of net sales derived
      from sales of 5.0 mg hydrocodone bitartrate/200 mg ibuprofen tablets
      sold under the Reprexain® trademark.





Centrix
      Pharmaceutical, Inc.


On
      October 27, 2006, the Company amended its agreement with Centrix
      Pharmaceuticals, Inc., (“Centrix”) wherein Centrix has agreed to purchase over a
      twelve month period, 40% more bottles of the Company’s female hormone therapy
      products than the initial year of the agreement, commencing November 2006. 
The parties will share net profits, as defined in the agreement, with the
      Company’s share being paid within 45 days of the end of each calendar month.
 The amendment has a one year term, after which time the original Centrix
      agreement shall again be in full force and effect.





Applied
      Pharma, LLC


In
      October 2006 the Company entered into a consulting agreement with Applied
      Pharma, LLC in which the consultant agreed to provide the Company with, among
      other things, analytical method development services relating to the Company’s
      oral contraceptive products. The Agreement is for thirty six months and may
      be
      terminated by either party with 90 days written notice. The agreement calls for
      monthly payments of $25, which aggregate to a maximum of $900 along with a
      $75
      payment which was issued upon the execution of the agreement. The principal
      of
      Applied Pharma, LLC holds a minority interest in APR, LLC.


32
 INTERPHARM
          HOLDINGS, INC. AND SUBSIDIARIES
 NOTES
          TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
 (In
          thousands, except per share data)





**NOTE
      18 –** **Subsequent
      Events**





On
      October 26, 2007, the Company and Wells Fargo Business Credit finalized a
      Forbearance Agreement that terminates on December 31, 2007, which was
      subsequently amended on November 12, 2007. As of June 30, 2007, the Company
      had
      defaulted under the Senior Credit Agreement with respect to (i) financial
      reporting obligations, including the submission of its annual audited financial
      statements for the fiscal year ending June 30, 2007, and (ii) financial
      covenants related to minimum net cash flow, maximum allowable leverage ratio,
      maximum allowable total capital expenditures and unfinanced capital expenditures
      for the fiscal year ended June 30, 2007 (collectively, the “Existing Defaults”).
      In accordance with the Forbearance Agreement, WFBC has waived the Defaults
      based
      upon the Borrower’s consummation and receipt of $8,000 related to the issuance
      of subordinated debt described below. The parties have agreed to establish
      financial covenants for fiscal year 2008 prior to the conclusion of the
      Forbearance Period.




On
      November 7, 2007 and November 14, 2007, as required by the Forbearance
      Agreement, the Company received a total of $8,000 in gross proceeds from the
      issuance and sale of subordinated debt.





On
      November 7, 2007, Dr. Maganlal K. Sutaria, the Chairman of the Company’s Board
      of Directors, and Vimla M. Sutaria, his wife, loaned $3,000 to the Company
      pursuant to a Junior Subordinated Secured 12% Promissory Note due 2010 (the
      “Sutaria Note”). Interest of 12% per annum on the Sutaria Note is payable
      quarterly in arrears, and for the first 12 months of the note’s term, may be
      paid in cash, or additional notes (“PIK Notes”), at the option of the Company.
      Thereafter, the Company is required to pay at least 8% interest in cash, and
      the
      balance, at its option, in cash or PIK Notes.





Repayment
      of the Sutaria Notes is secured by liens on substantially all of the Company’s
      property and real estate. Pursuant to intercreditor agreements, the Sutaria
      Notes are subordinated to the liens held by WFBC and the holders of the STAR
      Notes described below.





On
      November 14, 2007, the Company issued and sold an aggregate of $5,000 of Secured
      12% Promissory Notes Due 2009 (the “STAR Notes”) in the following amounts to the
      following parties:





Tullis-Dickerson
                Capital Focus III, L.P. (“Tullis”)
            
            $
            833Aisling
                Capital II, L.P. (“Aisling”)
            
            $
            833Cameron
                Reid (“Reid”)
            
            $
            833Sutaria
                Family Realty, LLC (“SFR”)
            
            $
            2,500





The
      $5,000 proceeds were deposited in escrow on November 14, 2007 and will be
      released from escrow upon the Company receiving the waiver of the Existing
      Defaults from WFBC in writing in accordance with the terms of the Forbearance
      Agreement.





Tullis
      is
      an investor in the Company and the holder of its Series B-1 Convertible
      Preferred Stock. Aisling is also an investor in the Company and the holder
      of
      its Series C-1 Convertible Preferred Stock. Reid is the Company’s Chief
      Executive Officer and SFR is owned by Company shareholders who control
      approximately 54% of the Company’s voting stock (the “Major Shareholders”),
      including Raj Sutaria, who is a Company Executive Vice
      President.


33
 INTERPHARM
          HOLDINGS, INC. AND SUBSIDIARIES
 NOTES
          TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
 (In
          thousands, except per share data)


**NOTE
      18 –** **Subsequent
      Events, continued**





Interest
      of 12% per annum on the STAR Notes is payable quarterly in arrears, and may
      be
      paid, at the option of the Company, in cash or PIK Notes. Upon the Company
      obtaining stockholder approval and ratification of the issuance of the STAR
      Note
      financing and making the necessary filings with the SEC in connection therewith
      (the “Stockholder Approval”), which is to occur no earlier than January 18, 2008
      and no later than the later of February 28, 2008 or such later date as may
      be
      necessary to address SEC comments on the Company’s Information Statement on
      Schedule 14C, the STAR Notes shall be exchanged for:




·
            Secured
                Convertible 12% Promissory Notes due 2009 (the “Convertible Notes”) in the
                original principal amount equal to the principal and accrued interest
                on
                the STAR Notes through the date of exchange. The conversion price
                of the
                Convertible Notes is to be $0.95 per share and interest is to be
                payable
                quarterly, in arrears, in either cash or PIK Notes, at the option
                of the
                Company;





·
            Warrants
                to acquire an aggregate of 1,842 shares of Common Stock (the “Warrants”)
                with an exercise price of $0.95 per
                share.





Each
      of
      the Convertible Notes and Warrants are to have anti-dilution protection with
      respect to issuances of Common Stock, or common stock equivalents at less than
      $0.95 per share such that their conversion or exercise price shall be reset
      to a
      price equal to 90% of the price at which shares of Common Stock or equivalents
      are deemed to have been issued.





The
      repayment of the STAR and Convertible Notes is secured by a second priority
      lien
      on substantially all of the Company’s property and real estate. Pursuant to
      intercreditor agreements, the STAR Note financing liens are subordinate to
      those
      of WFBC, but ahead, in priority, of the Sutaria Notes.





Also,
      upon the Company obtaining the Stockholder Approval, the Series B-1 and Series
      C-1 Convertible Preferred Stock held by Tullis and Aisling shall be exchangeable
      for shares of a new Series D-1 Convertible Preferred Stock, which shall be
      substantially similar to the B-1 and C-1 Convertible Preferred Stock other
      than
      the Conversion price which is to be $0.95 per share instead of $1.5338 per
      share.




Pursuant
      to the terms of the Securities Purchase Agreements for the Company’s Series B-1
      and C-1 Convertible Preferred Stock, the consent of Tullis and Aisling was
      required for the issuance of the Sutaria Notes and for the STAR Note financing.
      In consideration for that consent, the Company has agreed to exchange 2,282
      warrants to purchase Company Common Stock held by each of Tullis and Aisling
      with an exercise price of $1.639 per share for new warrants with an exercise
      price of $0.95 per share. In addition, the Major Shareholders have agreed to
      give Tullis and Aisling tag along rights on certain sales of Company common
      stock.




34
 Interpharm
          Holdings, Inc. and Subsidiaries
 (In
          thousands, except per share data)




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





**FORWARD-LOOKING
      STATEMENTS AND ASSOCIATED RISK**





Certain
      statements in this document may constitute “forward-looking statements” within
      the meaning of the Private Securities Litigation Reform Act of 1995, including
      those concerning Management’s expectations with respect to future financial
      performance, trends and future events, particularly relating to sales of current
      products and the introduction of new products. Such statements involve known
      and
      unknown risks, uncertainties and contingencies, many of which are beyond the
      control of the Company, which could cause actual results and outcomes to differ
      materially from those expressed herein. These statements are often, but not
      always, made typically by use of words or phrases such as “estimate,” “plans,”
“projects,” “anticipates,” “continuing,” “ongoing,” “expects,” “intends,”
“believes,” or similar words and phrases. Factors that might affect such
      forward-looking statements set forth in this document include (i) increased
      competition from new and existing competitors, and pricing practices from such
      competitors, (ii) pricing pressures, (iii) the amount of funds available for
      research and development, (iv) research and development project delays or delays
      and unanticipated costs in obtaining regulatory approvals, (v) the continued
      ability of distributed product suppliers to meet future demand, (vi) the costs,
      delays involved in and outcome of any threatened or pending litigations, (vii)
      and general industry and economic conditions. Any forward-looking statements
      included in this document are made as of the date hereof only, based on
      information available to us as of the date hereof, and, subject to applicable
      law to the contrary, we assume no obligation to update any forward-looking
      statements.





Investing
      in our securities involves substantial risks and uncertainties. Therefore,
      we
      encourage you to review the “Risk Factors” contained in Item 1A of our Form 10-K
      filed with the SEC on November 15, 2007.


35
 INTERPHARM
          HOLDINGS, INC. AND SUBSIDIARIES
 (In
          thousands, except per share data)





**Overview**





Interpharm
      Holdings, Inc., (the "Company" or "Interpharm"), through its operating
      wholly-owned subsidiary, Interpharm, Inc., ("Interpharm, Inc." and collectively
      with Interpharm, "we" or "us") is engaged in the business of developing,
      manufacturing and marketing generic prescription strength and over-the-counter
      pharmaceutical products.





As
      previously reported, as a result of increased expenses and losses we incurred
      during the fiscal year ended June 30, 2007, we defaulted on our credit facility
      with Wells Fargo Business Credit (“WFBC”) and, in November 2007, had to raise an
      additional $8,000 in debt financing. A complete description of the debt
      financing and a Forbearance Agreement with WFBC may be found below under the
      heading “Liquidity and Capital Resources.”





Net
      sales
      for the three months ended September 30, 2007 were $17,715, which represented
      a
      22.4% decrease from sales of $22,827 for the three months ended September 30,
      2006. The decrease was primarily due to lower sales of our female hormone
      product and naproxen product, which is discussed below. During the three months
      ended September 30, 2007, we re-launched seven strengths of our
      hydrocodone/acetaminophen products and launched naproxen sodium. We increased
      our sales in the three months ended September 30, 2007 by $2,343 as compared
      to
      the three months ended June 30, 2007, and now believe we have stabilized sales
      of our existing products going forward.





During
      the fiscal year ended June 30, 2007, we had lower than expected sales levels,
      an
      inefficient planning process and inefficient manufacturing operations. This
      was
      reflected in significantly increased inventory levels at June 30, 2007. During
      the three months ended September 30, 2007, we took steps to bring inventory
      to
      levels that are consistent with current sales expectations by reducing purchases
      of raw materials and reducing the level of production. In addition, we
      recognized an adjustment of $975 to reduce the carrying value of certain
      inventory items on hand at September 30, 2007 to their market value and to
      recognize any obsolescence in inventory as of that date. The combination of
      the
      rapid decrease in inventory from June 30, 2007 to September 30, 2007 and the
      $975 in inventory adjustments resulted in higher costs of goods sold as a
      percentage of net sales being reflected in the three months ended September
      30,
      2007. While there can be no assurance of improved financial performance, we
      anticipate that forwarding the future, the stabilization of inventory levels
      and
      improvement in the sales forecasting and planning process may result in
      improving gross margins.





We
      are
      currently making an effort to bring our cost structure in line with expected
      sales. To date, we have taken steps to reduce compensation costs in
      manufacturing, research and development (“R&D”) and administration on an
      annualized basis by approximately $2,000, the benefit of which we will realize
      in coming quarters.





The
      objectives and scope of our generic pharmaceutical R&D program have been
      scaled back to levels which allow us to execute a majority of our overall
      business plan while managing the financial implications. We have focused our
      R&D efforts primarily on oral contraceptives and a decreased number of
      products in each of the other product areas: soft gels, high potency products,
      products coming off patent and special release products. As a result, we
      decreased the number of R&D staff, reduced overall operating costs and
      reduced the number of planned bio-studies, all of which led to reduced R&D
      expense for the three months ended September 30, 2007 and which will result
      in
      further reduced R&D expense in the future.


36
 INTERPHARM
          HOLDINGS, INC. AND SUBSIDIARIES
 (In
          thousands, except per share data)





**Results
      of Operations —**


**Summary**





As
      indicated in the tables below, our net sales decreased $4,787, or 21%, when
      comparing the three month periods ended September 30, 2007 and 2006.




Three
                  Month Periods Ended September2007
              
              2006%
                  of
              
              
              
              %
                  ofSales
              
              Sales
              
              Sales
              
              SalesIbuprofen
              
              $
              9,366
              
              
              53
              %
              $
              8,622
              
              
              38
              %Bactrim®
              
              
              3,460
              
              
              19
              
              
              4,748
              
              
              21Naproxen
              
              
              2,115
              
              
              12
              
              
              3,099
              
              
              14Female
                  hormone product
              
              
              1,275
              
              
              7
              
              
              5,025
              
              
              22Hydrocodone/Ibuprofen
              
              
              673
              
              
              4
              
              
              927
              
              
              4Hydrocodone/Acetaminophen
              
              
              675
              
              
              4
              
              
              —
              
              
              0All
                  Other Products
              
              
              151
              
              
              1
              
              
              406
              
              
              1Total
              
              $
              17,715
              
              
              100
              %
              $
              22,827
              
              
              100
              %





·  Net
      sales
      of Ibuprofen for the three month period ended September 30, 2007 increased
      $744,
      or 8.6%, as compared to sales for the three months ended September 30, 2006.
      We
      continue to expand distribution of our prescription strength ibuprofen products
      in major retail and wholesaler channels. We had previously reported that demand
      for our OTC Ibuprofen product had decreased as of March 31, 2007 due to one
      of
      our customer’s voluntary suspension of sales of over-the-counter pharmaceuticals
      as a result of the FDA inspection, which was unrelated to our product. We have
      since been able to increase sales of this product to another customer, which
      enabled total sales of our OTC Ibuprofen product to increase for the three
      months ended September 30, 2007 as compared to sales for the three months ended
      June 30, 2007, and which partially offset the loss of sales to the first
      customer.




·  Net
      sales
      of our Bactrim products for the three months ended September 30, 2007 decreased
      $1,288, or 27.1%, as compared to sales for the three month period ended
      September 30, 2006. (We market our Sulfamethoxazole – Trimethoprim products
      in two strengths: 400mg / 80mg, commonly referred to as generic Bactrim®, and
      800mg / 160mg, commonly referred to as Bactrim-DS® (both, “Bactrim”)). The
      decrease in sales primarily relates to lower selling prices in September 2007
      quarter as compared to the prior year.




·  Net
      sales
      of our Naproxen products for the three month period ended September 30, 2007
      decreased $984, or 31.8%, as compared to sales for the three month period ended
      September 30, 2006. Sales decreased due to increased competitive pressure and
      due to losing private label distributor business to a large wholesaler and
      retailer in July 2007.




·  Net
      sales
      of our female hormone products for the three months ended September 30, 2007
      decreased $3,750, or 74.6%, as compared to sales for the three month period
      ended September 30, 2006. The significant sales decrease was due to two
      additional competitors entering the market for these products, resulting in
      decreased selling prices, lower sales and lower margins.




·  On
      October 3, 2006, we entered into a termination and release agreement (the
“Termination Agreement”) with Watson terminating the Manufacturing and Supply
      Agreement dated as of October 14, 2003 pursuant to which we manufactured and
      supplied and Watson distributed and sold generic Vicoprofen® (7.5 mg hydrocodone
      bitartrate/200 mg ibuprofen) tablets.  As
      a
      result of the Termination Agreement we obtained all rights to market this
      product. Net sales of this product for the three month periods ended September
      30, 2007 and September 30, 2006 were unchanged.


37
 INTERPHARM
          HOLDINGS, INC. AND SUBSIDIARIES
 (In
          thousands, except per share data)







·  During
      the three months ended September 30, 2007, we re-launched seven strengths of
      our
      hydrocodone bitartrate/acetaminophen tablet products though retail and wholesale
      channels of distribution.





For
      the
      three month period ended September 30, 2007, two significant customers accounted
      for 27.0% of our total sales, compared to four significant customers accounting
      for 65% of total sales for the three month period ended September
      2006.





**Cost
      of sales / Gross Margins**





Our
      gross
      profit percentage for the three months ended September 30, 2007 was 6.1%, a
      decrease of 33.2  percentage
      points as compared to 39.3% for the three months ended September 30, 2006.
      The
      significant decrease was due to several factors. As discussed above, we had
      lower than expected sales levels, an inefficient planning process and
      inefficient manufacturing operations. This was reflected in significantly
      increased inventory levels at June 30, 2007. During the three months ended
      September 30, 2007, inventory levels were reduced by decreasing purchases of
      raw
      materials and reducing the level of production. In addition, we recognized
      an
      adjustment of $975 to reduce the carrying value of certain inventory items
      on
      hand at September 2007 to their market value. The combination of the rapid
      decrease in inventory from June 30, 2007 to September 30, 2007 and the $975
      inventory adjustment resulted in higher costs of goods sold as a percentage
      of
      sales being reflected in the September 2007 quarter. In addition, the
      competition for certain of our existing products has increased which has
      resulted in lower selling prices and lost volume in certain cases. We are making
      efforts to mitigate the downward pressure on our gross margin by seeking
      improvements in manufacturing efficiency to reduce cost of goods sold, and
      by
      continuing to introduce new products. While there can be no assurance of
      improved financial performance, we believe that our efforts can achieve an
      improvement in overall gross margin in the coming quarters.





**Selling
      and General and Administrative Expenses**





Selling,
      general and administrative (“SG&A”) expenses include salaries and related
      costs, commissions, travel, administrative facilities, communications costs
      and
      promotional expenses for our direct sales and marketing staff, administrative
      and executive salaries and related benefits, legal, accounting and other
      professional fees as well as general corporate overhead.





SG&A
      expenses were $3,772 for the three month period ended September 30, 2007, which
      represented an increase of $1,135, or 43.0%, above $2,637 incurred in the three
      month period ended September 30, 2006.  When stated as a percentage of net
      sales, SG&A expenses increased to 21.3% for the three months ended September
      30, 2007 as compared to 11.6% for the same period in the prior
      year.





The
      dollar increase in SG&A expenses during the three months ended September 30,
      2007 was primarily attributable to the following: an increase of $337 in
      compensation, related taxes and benefits, and travel and entertainment expenses
      of sales and administrative staff; an increase of $176 in sales contract
      administrative fees; an increase of $185 in professional and consulting fees
      consisting of management advisory services and information technology consulting
      related to our ERP system implementation; an increase of $39 in computer-related
      expenses related due to a higher number of employees; an increase of $66 in
      depreciation; and an increase of $72 in freight-out costs related to the higher
      proportion of distribution through major retail and wholesaler
      channels.


38
 INTERPHARM
          HOLDINGS, INC. AND SUBSIDIARIES
 (In
          thousands, except per share data)





The
      expense related to the SARs are recorded at fair value and is marked to market
      each reporting period with changes recorded as income or expense in the period
      will be marked to market.  Accordingly we recorded $3 of income during the
      three months ended September 30, 2007, resulting from increase in the price
      of
      our stock as of September 30, 2007 when compared to June 30, 2007.





SFAS
      123(R) requires us to report a non-cash expense for the ratable portion of
      the
      fair value of employee stock option awards of unvested stock options over the
      remaining vesting period.  We reported non-cash expenses of $343 and $211
      during the three month periods ended September 30, 2007 and September 2006,
      respectively.





**Research
      and Development Expenses**





We
      incurred R&D expenses of $3,458 during the three month period ended
      September 30, 2007, which represented an increase of $39, or 1.2%, above $3,419
      incurred in the three month period ended September 30, 2006.  R&D
      compensation expenses, primarily related to the expansion of analytical chemist
      and product formulation staff increased $532, the costs of materials used in
      the
      bio-study and product development processes increased $325, and outside
      consulting and other product development costs increased $354.  These
      increases were offset by reduced costs of $806 related to bioequivalence studies
      for new generic pharmaceutical products currently in development, and a
      reduction of $365 in costs related to our development agreement with Tris
      Pharma.





As
      previously reported, during October 2006, we entered into a new agreement (“New
      Liquids Agreement”) with Tris Pharma, Inc. (“Tris”), which terminated the
      agreement entered into February 2005, which in turn was for the development
      and
      licensing of up to twenty-five liquid generic products (“Liquids Agreement”).
      According to the terms of the New Liquids Agreement, Tris will, among other
      things, be required to develop and deliver the properties, specifications and
      formulations (“Product Details”) for fourteen generic liquid pharmaceutical
      products (“Liquid Products”). We will then utilize this information to obtain
      all necessary approvals. Tris will manufacture, package and label each product
      for a fee. In conjunction with this new liquids agreement we were required
      to
      pay Tris $1,000, whether or not regulatory approval is obtained for any of
      the
      liquid products. As of September 30, 2007, all payments associated to this
      agreement were made. In addition, Tris is to receive forty percent of the net
      profits, as defined, in accordance with the terms in the New Liquids
      Agreement.





During
      February 2005, we entered into a second agreement (“Solids Agreement”), for
      solid dosage products (“solids”) with Tris. In July 2005, the Solids Agreement
      was amended.  According to the terms of the Solids Agreement, as amended,
      we are to collaborate with Tris on the development, manufacture and marketing
      of
      eight solid oral dosage generic products. The amendment to this agreement
      requires Tris to deliver Technical Packages for two soft-gel products and one
      additional solid dosage product. Some of the products included in this
      agreement, as amended, may require us to challenge the patents for the
      equivalent branded products.  This agreement, as amended, provides for
      payments of an aggregate of $4,500 to Tris, whether or not regulatory approval
      is obtained for any of the solids products.  The Solids Agreement also
      provides for an equal sharing of net profits for each product, except for one
      product, that is successfully sold and marketed, after the deduction and
      reimbursement of all litigation-related and certain other costs. The excluded
      product provides for a profit split of 60% for the Company and 40% for
      Tris.  Further, this agreement provides us with a perpetual royalty-free
      license to use all technology necessary for the solid products in the United
      States, its territories and possessions.





In
      April
      2006, we further amended the Solids Agreement. This second amendment requires
      Tris to deliver a Technical Package for one additional solid dosage
      product.  Further, terms of this second amendment will require us to pay to
      Tris an additional $300 after we have paid the initial aggregate amounts
      associated with the original agreement.


39
 INTERPHARM
          HOLDINGS, INC. AND SUBSIDIARIES
 (In
          thousands, except per share data)





We
      further amended the Solids Agreement in October 2006, modifying the manner
      in
      which certain costs will be shared as well as clarifying respective audit
      rights.





**Interest
      Expense, net**





Our
      net
      interest expense increased approximately $455 when comparing the three months
      ended September 30, 2007 with the three month period ended September 30, 2006.
      The increase is primarily a result of an increase in borrowings from our line
      of
      credit. As of September 30, 2006, we had not drawn from our line of credit
      as
      compared to $15,447 outstanding against the line of credit as of September
      30,
      2007. In addition to these borrowings being in place, we also borrowed
      additional funds for new equipment.





In
      order
      to hedge against rising interest rates, we entered into two interest rate swap
      arrangements. Fair value of the interest rate swaps at September 30, 2007 and
      2006 was approximately ($208) and $10 and is included in Other Liabilities
      and
      Other Assets, respectively. However, it is likely that, as a result of
      additional borrowings we will incur increases in our interest expense in the
      future.





**Income
      Taxes**





At
      September 30, 2007, we have remaining Federal net operating losses (“NOLs”) of
      $39,009 available through 2027. Pursuant to Section 382 of the Internal Revenue
      Code regarding substantial changes in Company ownership, utilization of the
      Federal NOLs is limited. As a result of losses incurred in fiscal years 2005,
      2006 and 2007, which indicate uncertainty as to our ability to generate future
      taxable income, the “more-likely-than-not” standard has not been met and
      therefore some amount of our deferred tax asset may not be realized. As such,
      we
      recorded a full valuation allowance against deferred tax assets generated in
      the
      three months ended September 30, 2007.





In
      calculating our tax provision for the three month periods ended September 30,
      2007 and 2006, we applied aggregate effective tax rates of approximately 0%
      and
      38%, respectively, thereby creating income tax benefit of $0 and $1,668,
      respectively, and adjusted our deferred tax assets by like amounts. The decrease
      in effective tax rates is the result of us recording a valuation allowance
      for
      100% of the income tax benefit generated during the three months ended September
      30, 2007.


40
 INTERPHARM
          HOLDINGS, INC. AND SUBSIDIARIES
 (In
          thousands, except per share data)




**Liquidity
      and Capital Resources**





At
      September 30, 2007 we had an accumulated deficit of $25,727 and operating
      activities used $3,481 of cash for the three months then ended. In order to
      address our operating loss position and our lack of liquidity, (i) we have
      completed a series of banking and financing activities in October and November
      2007, which are outlined below in “Subsequent Events – Banking and
      Financing Transactions”, and (ii) we are taking various actions to improve
      profitability and cash flows generated from operations, including:





o
            Reducing
                headcount and other operating expenses in different functional areas
                where
                possible while still carrying out our future growth
                plan;





o
            Increasing
                revenue through the launch of new products, identifying new customers
                and
                expanding relationships with existing customers;
                and





o
            Scaling
                back our R&D activities to levels where we can execute a majority of
                our overall business plan while managing the financial
                implications.




On
      October 26, 2007, the Company and WFBC finalized a Forbearance Agreement that
      terminates on December 31, 2007, which was subsequently amended on November
      12,
      2007. As of June 30, 2007, we had defaulted under the Senior Credit Agreement
      with respect to (i) financial reporting obligations, including the submission
      of
      its annual audited financial statements for the fiscal year ending June 30,
      2007, and (ii) financial covenants related to minimum net cash flow, maximum
      allowable leverage ratio, maximum allowable total capital expenditures and
      unfinanced capital expenditures for the fiscal year ended June 30, 2007
      (collectively, the “Defaults”). WFBC has waived the Defaults based upon the
      Borrower’s consummation and receipt of $8,000 related to the issuance of
      subordinated debt described below. The parties have agreed to establish
      financial covenants for fiscal year 2008 prior to the conclusion of the
      Forbearance Period. There were no covenants in place at September 30,
      2007.




On
      November 7, 2007 and November 14, 2007, as required by the Forbearance
      Agreement, we received a total of $8,000 in gross proceeds from the issuance
      and
      sale of subordinated debt.





On
      November 7, 2007, Dr. Maganlal K. Sutaria, the Chairman of the Company’s Board
      of Directors, and Vimla M. Sutaria, his wife, loaned $3,000 to us pursuant
      to a
      Junior Subordinated Secured 12% Promissory Note due November 7, 2010 (the
“Sutaria Note”). Interest of 12% per annum on the Sutaria Note is payable
      quarterly in arrears, and for the first 12 months of the note’s term, may be
      paid in cash, or additional notes (“PIK Notes”), at the option of the Company.
      Thereafter, we are required to pay at least 8% interest in cash, and the
      balance, at its option, in cash or PIK Notes.





Repayment
      of the Sutaria Notes is secured by liens on substantially all of our property
      and real estate. Pursuant to intercreditor agreements, the Sutaria Notes are
      subordinated to the liens held by WFBC and the holders of the STAR Notes
      described below.





On
      November 14, 2007, we issued and sold an aggregate of $5,000 of Secured 12%
      Promissory Notes due October 1, 2009 (the “STAR Notes”) in the following amounts
      to the following parties:


41
 INTERPHARM
          HOLDINGS, INC. AND SUBSIDIARIES
 (In
          thousands, except per share data)




Tullis-Dickerson
                Capital Focus III, L.P. (“TD III”)
            
            $
            833Aisling
                Capital II, L.P. (“Aisling”)
            
            $
            833Cameron
                Reid (“Reid”)
            
            $
            833Sutaria
                Family Realty, LLC (“SFR”)
            
            $
            2,500





TD
      III is
      an investor in the Company and the holder of its Series B-1 Convertible
      Preferred Stock. Aisling is also an investor in the Company and the holder
      of
      its Series C-1 Convertible Preferred Stock. Reid is the Company’s Chief
      Executive Officer and SFR is owned by Company shareholders who control
      approximately 54% of the Company’s voting stock (the “Major Shareholders”),
      including Raj Sutaria, who is a Company Executive Vice President.





Interest
      of 12% per annum on the STAR Notes is payable quarterly in arrears, and may
      be
      paid, at the option of the Company, in cash or PIK Notes. Upon the Company
      obtaining stockholder approval and ratification of the issuance of the STAR
      Note
      financing and making the necessary filings with the SEC in connection therewith
      (the “Stockholder Approval”), which is to occur no earlier than January 18, 2008
      and no later than the later of February 28, 2008 or such later date as may
      be
      necessary to address SEC comments on the Company’s Information Statement on
      Schedule 14C, the STAR Notes shall be exchanged for:




·
            Secured
                Convertible 12% Promissory Notes due 2009 (the “Convertible Notes”) in the
                original principal amount equal to the principal and accrued interest
                on
                the STAR Notes through the date of exchange. The conversion price
                of the
                Convertible Notes is to be $0.95 per share and interest is to be
                payable
                quarterly, in arrears, in either cash or PIK Notes, at the option
                of the
                Company;





·
            Warrants
                to acquire an aggregate of 1,842 shares of Common Stock (the “Warrants”)
                with an exercise price of $0.95 per
                share.





Each
      of
      the Convertible Notes and Warrants are to have anti-dilution protection with
      respect to issuances of Common Stock, or common stock equivalents at less than
      $0.95 per share such that their conversion or exercise price shall be reset
      to a
      price equal to 90% of the price at which shares of Common Stock or equivalents
      are deemed to have been issued.





The
      repayment of the STAR and Convertible Notes is secured by a second priority
      lien
      on substantially all of the Company’s property and real estate. Pursuant to
      intercreditor agreements, the STAR Note financing liens are subordinate to
      those
      of WFBC, but ahead, in priority, of the Sutaria Notes.





Also,
      upon the Company obtaining the Stockholder Approval, the Series B-1 and Series
      C-1 Convertible Preferred Stock held by TD III and Aisling shall be exchangeable
      for shares of a new Series D-1 Convertible Preferred Stock, which shall be
      substantially similar to the B-1 and C-1 Convertible Preferred Stock other
      than
      the Conversion price which is to be $0.95 per share instead of $1.5338 per
      share.





Pursuant
      to the terms of the Securities Purchase Agreements for the Company’s Series B-1
      and C-1 Convertible Preferred Stock, the consent of TD III and Aisling was
      required for the issuance of the Sutaria Notes and for the STAR Note financing.
      In consideration for that consent, the Company has agreed to exchange 2,282
      warrants to purchase Company Common Stock held by each of TD III and Aisling
      with an exercise price of $1.639 per share for new warrants with an exercise
      price of $0.95 per share. In addition, the Major Shareholders have agreed to
      give TD III and Aisling tag along rights on certain sales of Company common
      stock.


42
 INTERPHARM
          HOLDINGS, INC. AND SUBSIDIARIES
 (In
          thousands, except per share data)





Our
      operations and capital expenditures have been financed through the WFBC Credit
      Facility. For the three months ended September 30, 2007, net cash used in
      operating activities was $3,481 as compared to cash provided by operating
      activities of $1,044 for the three months ended September 30, 2006. Significant
      factors comprising the net cash used in operating activities for the three
      months ended September 30, 2007 include: net loss of $6,896, increase in
      accounts receivable of $3,377, partially offset by a decrease in inventory
      of
      $3,436 and an increase in accounts payable, accrued expenses and other
      liabilities of $1,894. Inventory levels decreased significantly due the factors
      discussed above. Accounts payable, accrued expenses and other payables increased
      temporarily while we worked through a period of tight liquidity in the September
      30, 2007 quarter. These balances have been brought into line subsequent to
      September 30, 2007 in connection with the completion of the banking and
      financing activities outlined above. We also recognized several non-cash
      charges: depreciation and amortization of $904, stock-based compensation expense
      (in accordance with SFAS 123 (R)) amounting to $343, and a lower of cost or
      market write down of inventory of $975.





For
      the
      three months ended September 30, 2007, we used funds in investing activities
      of
      $1,558 compared to $930 used in investing activities during the three months
      ended September 30, 2006. These amounts primarily related to capital
      expenditures for new machinery, equipment and building renovations.





Our
      investing activities provided cash of $5,035 for the three months ended
      September 30, 2007 compared to $9,951 of cash provided by investing activities
      for the same period in the prior year. For the three months ended September
      30,
      2007, we increased borrowings by $5,581 under the WFBC revolving credit
      facility. During the September 2006 quarter, net cash of $9,993 was provided
      by
      the sale of $10,000 of our Series C-1 redeemable convertible preferred stock,
      which generated $9,993 of cash.





At
      September 30, 2007, we had $68 in cash and cash equivalents, compared to $72
      at
      June 30, 2007.





While
      we
      believe that the initiatives described above will result in positive cash flows
      and profitability, there can be no assurance that we will achieve our cash
      flow
      and profitability goals, or that we will be able, if necessary, to raise
      additional capital sufficient to implement our plans, or, if additional capital
      is available, that it will be available on terms acceptable to the Company.
      In
      such event, we may have to revise our plans and significantly reduce our
      operating expenses, which could have a material adverse effect on revenue and
      operations in the short term.





Bank
      Financing





During
      February, 2006, we entered into a four-year financing arrangement with Wells
      Fargo Business Credit (“WFBC”). This financing agreement provided an original
      maximum credit facility of $41,500 comprised of:





·  $22,500
      revolving credit facility (the “facility”)


·  $12,000
      real estate term loan


·  $
      3,500
      machinery and equipment (“M&E”) term loan


·  $
      3,500
      additional / future capital expenditure facility





Complete
      details regarding the WFBC credit facility may be found in Note 8 of the
      accompanying condensed consolidated financial statements for the quarter ended
      September 30, 2007 and in our Form 10-K filed with the SEC on November 15,
      2007.


43
 INTERPHARM
          HOLDINGS, INC. AND SUBSIDIARIES
 (In
          thousands, except per share data)





Watson
      Termination Agreement





On
      October 3, 2006, we entered into a termination and release agreement (the
“Termination Agreement”) with Watson terminating the Manufacturing and Supply
      Agreement dated October 14, 2003 (the “Supply Agreement”) pursuant to which we
      manufactured and supplied and Watson distributed and sold generic Vicoprofen®
(7.5 mg hydrocodone bitartrate/200 mg ibuprofen) tablets, (the “Product”). Watson
      was required to return all rights and agreements to us thereby enabling us
      to
      market the Product ourselves. Further, Watson was required to turn over to
      us
      its then current customer list for this product and agreed that, for a period
      of six
      months from closing, neither Watson nor any of its affiliates is to solicit
      sales for this Product from its twenty largest customers. In accordance with
      the
      Termination Agreement, Watson returned approximately $141 of the Product and
      we
      in turn invoiced Watson $42 for repacking. The net effect was a reduction of
      $99
      to our net sales during the three month ended December 2006. In consideration
      of
      the termination of Watson’s rights under the Supply Agreement, we are to pay
      Watson $2,000 payable at the rate of $500 per year over four years from the
      first anniversary of the effective date of the agreement. We determined the
      net
      present value of the obligation and accordingly included in Accounts payable,
      accrued expenses and other liabilities and Contract termination liability $367
      and $1,288, respectively. The imputed interest of $324 will be amortized over
      the four year life of the obligation using the effective interest rate method.
      At September 30, 2007, contract termination liability of $394 and $1,382 are
      included in Accounts payable, accrued expenses and other liabilities and
      Contract termination liability, respectively. The imputed interest of $345
      will
      be amortized over the remaining life of the obligation using the effective
      interest rate method. Non-cash interest of $34 was recognized during the three
      months ended September 30, 2007.





**Accounts
      Receivable**





Our
      accounts receivable at September 30, 2007 was $16,322 as compared to $12,945
      at
      June 30, 2007. The average annual turnover ratio of accounts receivable to
      net
      sales for the three months ended September 30, 2007 was 3.49. Our turns are
      calculated on an annual average. Our accounts receivable continue to have
      minimal risk with respect to bad debts; however this trend cannot be
      assured.





**Inventories**





At
      September 30, 2007, our inventory was $12,884 as compared to $17,295 at June
      30,
      2007. Our turnover of inventory for the three months ended September 30, 2007
      was 4.43.





We
      reduce
      the carrying value of inventories to a lower of cost or market basis for
      inventory whose net book value is in excess of market. Aggregate reductions
      in
      the carrying value with respect to inventories still on hand at September 30,
      2007 that were determined to have a carrying value in excess of market was
      $745.





In
      addition, we perform a quarterly review of inventory items to determine if
      an
      obsolescence reserve adjustment is necessary. The allowance not only considers
      specific items and expiration dates, but also takes into consideration the
      overall value of the inventory as of the balance sheet date. The inventory
      obsolescence reserve value at September 30, 2007 was $230.


44
 INTERPHARM
          HOLDINGS, INC. AND SUBSIDIARIES
 (In
          thousands, except per share data)




**Accounts
      Payable, Accrued Expenses and Other Liabilities**





Accounts
      payable, accrued expenses and other current liabilities increased $1,334 from
      June 30, 2007 to September 30, 2007 temporarily while we worked through a period
      of tight liquidity in the September 30, 2007 quarter. These balances have been
      brought into line subsequent to September 30, 2007 in connection with the
      completion of the banking and financing activities outlined above.





**Cash**





Cash
      decreased approximately $4 to $68 at September 30, 2007 from $72 at June 30,
      2007 as more fully described in Liquidity and Capital Resources
      above.





**Critical
      Accounting Policies**





Management's
      discussion and analysis of financial condition and results of operations
      discusses our financial statements, which have been prepared in accordance
      with
      accounting principles generally accepted in the United States of America. The
      preparation of these financial statements requires that we make estimates and
      assumptions that affect the reported amounts of assets and liabilities, the
      disclosure of contingent assets and liabilities at the date of the financial
      statements, and the reported amounts of revenues and expenses during the
      reporting period. On an on-going basis, we evaluate judgments and estimates
      made, including those related to revenue recognition, inventories, income taxes
      and contingencies including litigation. We base our judgments and estimates
      on
      historical experience and on various other factors that it believes to be
      reasonable under the circumstances, the results of which form the basis for
      making judgments about the carrying value of assets and liabilities that are
      not
      readily apparent from other sources. Actual results may differ from these
      estimates under different assumptions or conditions.





We
      consider the following accounting policies to be most critical in understanding
      the more complex judgments that are involved in preparing our financial
      statements and the uncertainties that could impact results of operations,
      financial condition and cash flows.





**Revenue
      Recognition**





We
      recognize product sales revenue upon the shipment of product, when estimated
      provisions for chargebacks and other sales allowances are reasonably
      determinable, and when collectibility is reasonably assured. Accruals for these
      provisions are presented in the consolidated financial statements as reductions
      to revenues. Accounts receivable are presented net of allowances relating to
      the
      above provisions.





In
      addition, we are party to supply agreements with certain pharmaceutical
      companies under which, in addition to the selling price of the product, we
      receive payments based on sales or profits associated with these products
      realized by our customer. We recognize revenue related to the initial selling
      price upon shipment of the products as the selling price is fixed and
      determinable and no right of return exists. We recognize the additional revenue
      component of these agreements at the time our customers record their sales
      and
      is based on pre-defined formulas contained in the agreements.


45
 INTERPHARM
          HOLDINGS, INC. AND SUBSIDIARIES
 (In
          thousands, except per share data)





We
      purchase raw materials from two suppliers, which are manufactured into finished
      goods and sold back to such suppliers as well as to other customers. We can
      and
      do purchase raw materials from other suppliers. Pursuant to Emerging Issues
      Task
      Force, (“EITF”) No. 99-19, “Reporting Revenue Gross as a Principal Versus Net as
      an Agent,” we recorded sales to, and purchases from, these suppliers on a gross
      basis. Sales and purchases were recorded on a gross basis since we (i) have
      a
      risk of loss associated with the raw materials purchased, (ii) convert the
      raw
      material into a finished product based upon our specifications, (iii) have
      other
      sources of supply of the raw material, and (iv) have credit risk related to
      the
      sale of such product to the suppliers. These factors among others, qualify
      us as
      the principal under the indicators set forth in EITF 99-19, “Reporting Revenue
      Gross as a Principal vs. Net as an Agent.” If the terms and substance of the
      arrangement change, such that we no longer qualify to report these transactions
      on a gross reporting basis, our net income and cash flows would not be affected.
      However, our sales and cost of sales would both be reduced by a similar amount.
      These purchase and sales transactions are recorded at fair value in accordance
      with EITF Issue 04-13 “Accounting for Purchase and Sales of Inventory with the
      Same Counterparty”.





**Inventories**





Our
      inventories are valued at the lower of cost or market determined on a first-in,
      first-out basis, and includes the cost of raw materials, labor and manufacturing
      overhead. We continually evaluate the carrying value of our inventories and
      when
      factors such as expiration dates and spoilage indicate that impairment has
      occurred, either a reserve is established against the inventories' carrying
      value or the inventories are disposed of and completely written off in the
      period incurred.





**Research
      and Development**





Pursuant
      to SFAS No. 2 “Accounting for Research and Development Costs,” research and
      development costs are expensed as incurred or at the date payment of
      non-refundable amounts become due, whichever occurs first. Research and
      development costs, which consist of salaries and related costs of research
      and
      development personnel, fees paid to consultants and outside service providers,
      raw materials used specifically in the development of its new products and
      bioequivalence studies. Pre-approved milestone payments due under contract
      research and development arrangements are expensed when the milestone is
      achieved.


46
 INTERPHARM
          HOLDINGS, INC. AND SUBSIDIARIES
 (In
          thousands, except per share data)




**Issues
      And Uncertainties**


**Risk
      of Product Liability Claims**





The
      testing, manufacturing and marketing of pharmaceutical products subject us
      to
      the risk of product liability claims. We believe that we maintain an adequate
      amount of product liability insurance, but no assurance can be given that such
      insurance will cover all existing and future claims or that we will be able
      to
      maintain existing coverage or obtain additional coverage at reasonable rates.





**ITEM
      3 - Quantitative and Qualitative Disclosures About Market
      Risk**




At
      September 30, 2007, total obligations to our bank pertaining to the credit
      facility described above were: (i) $15,447 related to the WFBC line of credit;
      (ii) approximately $10,734 real property term loan; and (ii) $5,257 owing on
      the
      machinery and equipment lines (see Note 8 of the accompanying condensed
      consolidated financial statements).





With
      respect to the real estate term loan and the $3,500 M&E loan, we entered
      into interest rate swap contracts (the “swaps”), whereby the Company pays a
      fixed rate of 7.56% and 8.00% per annum, respectively. The swaps contracts
      mature in 2010. The swaps are a cash flow hedge (i.e. a hedge against interest
      rates increasing). As all of the critical terms of the swaps and loans match,
      they are structured for short-cut accounting under SFAS No. 133, “Accounting For
      Derivative Instruments and Hedging Activities” and by definition, there is no
      hedge ineffectiveness or a need to reassess effectiveness. Fair value of the
      interest rate swaps at September 30, 2007 was approximately ($208) and is
      included in Other Liabilities.


47
 INTERPHARM
          HOLDINGS, INC. AND SUBSIDIARIES
 (In
          thousands, except per share data)




**ITEM
      4 – CONTROLS AND PROCEDURES**





**E** **valuation** **** **of
      Controls and Procedures** ****





We
      maintain disclosure controls and procedures that are designed to ensure that
      information required to be disclosed in our Exchange Act reports is recorded,
      processed, summarized and reported within the time periods specified in the
      SEC's rules and forms, and that such information is accumulated and communicated
      to our management to allow timely decisions regarding required disclosure.
      Management necessarily applied its judgment in assessing the costs and benefits
      of such controls and procedures, which, by their nature, can provide only
      reasonable assurance regarding management's control objectives.





At
      the
      conclusion of the three month period ended September 30, 2007, we carried out
      an
      evaluation, under the supervision and with the participation of our management,
      including our Chief Executive Officer and Chief Financial Officer, of the
      effectiveness of the design and operation of our disclosure controls and
      procedures. Based upon that evaluation, the Chief Executive Officer and Chief
      Financial Officer concluded that our disclosure controls and procedures were
      effective in alerting them in a timely manner to information relating to the
      Company, required to be disclosed in this report.





In
      July
      2007, the Company implemented an enterprise resource planning (“ERP”) system.
      The implementation involves enhancements in business processes and significant
      improvements to the Company’s internal controls over financial reporting. In
      addition to expanding and improving access to information, we believe the new
      ERP system will provide a standard scalable information platform to accommodate
      our current business growth plan.




48
 INTERPHARM
          HOLDINGS, INC. AND SUBSIDIARIES
 (In
          thousands, except per share data)





**PART
      II –  OTHER INFORMATION**





**Item
      1.**   **Legal
      Proceedings**





On
      October 8, 2007, Leiner Health Products LLC and the Company entered into a
      Settlement Agreement and Release (“Settlement”) in connection with an October
      2005 manufacturing and supply agreement for ibuprofen tablets. As part of the
      Settlement, Leiner executed a Promissory Note for $477 for the amount it owed
      the Company. On October 12, 2007, the Company notified Leiner that one lot
      of
      this product was subject to a voluntary recall. Leiner subsequently held any
      additional payments under the Settlement until they received reasonable
      assurances from the Company that the additional lots in their possession would
      not be subject to the recall as well. If all lots were recalled, Leiner would
      be
      entitled to a reimbursement by the Company of approximately $256. However,
      the
      Company does not believe any further lots will be recalled.




On
      November 8, 2007, Leiner failed to make its initial principal payment under
      the
      Promissory Note, and indicated that it did not intend to make future payments
      under the Note.  In response, the Company declared Leiner in default under
      the Promissory Note and accelerated the unpaid principal obligations.  On
      November 26, 2007, the Company commenced litigation, via a motion for summary
      judgment in lieu of complaint, in New York Supreme Court, Suffolk County
      entitled *Interpharm
      Holdings, Inc. v. Leiner Health Products LLC,* 36642/2007,
      seeking to recover the full principal amount of the promissory note plus costs
      and interest.  Leiner’s answer is due on or around December 28, 2007, and a
      decision on the Company’s motion for summary judgment is expected by early
      spring.





We
      are
      unaware of any other material pending or threatened legal action or proceeding
      against us.


49




Interpharm
      Holdings, Inc. and Subsidiaries






**Item
      6.**   **Exhibits**




Exhibits21.1
            List
                of Subsidiaries.31.1
            Certification
                of Chief Executive Officer pursuant to Rules 13a-14(a) as adopted,
                pursuant to Section 302 of the Sarbanes-Oxley Act of
                2002.31.2
            Certification
                of the Chief Financial Officer pursuant to Rules 13a-14(a) as adopted,
                pursuant to Section 302 of the Sarbanes-Oxley Act of
                2002.32.1
            Certifications
                of the Chief Executive Officer and the Chief Financial Officer pursuant
                to
                18 U.S.C. Section 1350 as adopted, pursuant to Section 906 of the
                Sarbanes-Oxley Act of 2002.




50


Interpharm
      Holdings, Inc. and
      Subsidiaries






Signatures





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








INTERPHARM
                HOLDINGS, INC.(Registrant)Date:
                December 19, 2007By:
            /s/
                Peter GiallorenzoPeter
                Giallorenzo,Chief
                Financial Officer(Duly
                authorized to sign on behalf of
                registrant)




51