**UNITED STATES**

**SECURITIES AND EXCHANGE COMMISSION**

**Washington,D.C. 20549**

**FORM 10-Q**

**xQUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d)**

**OF THE SECURITIES EXCHANGE ACT OF 1934**

**FOR THE QUARTERLY PERIOD ENDED MARCH 31, 2006**

Commission File Number **0-9314**

**ACCESS PHARMACEUTICALS, INC.**

(Exact name of registrantas specified in its charter)

| **Delaware**              | ** ** | **83-0221517**                   |
|---------------------------|------------|----------------------------------|
| (State of  Incorporation) |       | (I.R.S. Employer  I.D. No.) |

 

**2600 Stemmons Frwy, Suite 176,Dallas, TX 75207**

(Address of principalexecutive offices)

TelephoneNumber  (214) 905-5100

Indicate by check markwhether the registrant (1) has filed all reports required to be filed by Section 13or 15(d) of the Securities Exchange Act of 1934 during the preceding 12months (or for such shorter period that the registrant was required to filesuch reports) and (2) has been subject to such filing requirement for thepast 90 days.

Yes  x                   No  o

Indicate by check mark whether the registrant is a largeaccelerated filer, an accelerated filer, or a non-accelerated filer. Seedefinition of “accelerated filer and large accelerated filer” in Rule 12b-2of the Exchange Act.

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

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

Yes  o                   No  x

The number of shares outstanding of the issuer’s commonstock, as of June 6, 2006, was 3,530,908 shares, $0.01 par value pershare.

Total No. of Pages * *34

 

 

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**ACCESS PHARMACEUTICALS, INC.**

**INDEX**
|                                      |   |                                                                                                                     |   | ** ** |
|--------------------------------------|--------|--------------------------------------------------------------------------------------------------------------------------|--------|------------|
| PART I -  FINANCIAL INFORMATION |   | ** **                                                                                                               |
| Item 1.                              |   | Condensed Consolidated Financial  Statements:                                                                            |   |       |
|                                 |   | Condensed Consolidated Balance Sheets at  March 31, 2006 and December 31, 2005                                 |   |       |
|                                 |   | Condensed Consolidated Statements of Operations for  the  three months ended March 31, 2006 and March 31, 2005 |   |       |
|                                 |   | Condensed Consolidated Statements of Cash Flows for  the  three months ended March 31, 2006 and March 31, 2005 |   |       |
|                                 |   | Notes to Unaudited Condensed Consolidated Financial  Statements                                                          |   |       |
| Item 2.                              |   | Management’s Discussion and  Analysis of Financial Condition  and Results of Operations                             |   |       |
| Item 3.                              |   | Quantitative and Qualitative  Disclosures About Market Risk                                                              |   |       |
| Item 4.                              |   | Controls and Procedures                                                                                                  |   |       |
| PART II -  OTHER INFORMATION    |   |                                                                                                                     |
| Item 1                               |   | Legal Proceedings                                                                                                        |   |       |
| Item 1A                              |   | Risk Factors                                                                                                             |   |       |
| Item 2                               |   | Sales of  Unregistered Equity Securities and Use of Proceeds                                                             |   |       |
| Item 3                               |   | Defaults Upon  Senior Securities                                                                                         |   |       |
| Item 4                               |   | Submission of  Matters to a Vote of Security Holders                                                                     |   |       |
| Item 5                               |   | Other Information                                                                                                        |   |       |
| Item 6.                              |   | Exhibits and  Reports on Form 8-K                                                                                   |   |       |
| SIGNATURES                           |   |                                                                                                                     |

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**PART I—FINANCIAL INFORMATION**

*This Quarterly Report (including the informationincorporated by reference) contains forward-looking statements within themeaning of Section 27A of the Securities Act of 1933, as amended, and Section 21Eof the Securities Exchange Act of 1934, as amended, that involve risks anduncertainties. These statements include, without limitation, statementsrelating to uncertainties associated with research and development activities,clinical trials, our ability to raise capital, the timing of and our ability toachieve regulatory approvals, dependence on others to market our licensedproducts, collaborations, future cash flow, the timing and receipt of licensingand milestone revenues, the future success of our marketed products andproducts in development, our sales projections, and the sales projections ofour licensing partners, our ability to achieve licensing milestones, ourability to continue as a going concern, anticipated payments to be receivedfrom Uluru, Inc., anticipated product approvals and timing thereof,product opportunities, clinical trials and U.S. Food and Drug Administration (“FDA”)applications, as well as our drug development strategy, our clinicaldevelopment organization expectations regarding our rate of technologicaldevelopments and competition, our plan not to establish an internal marketingorganization, our expectations regarding minimizing development risk anddeveloping and introducing technology, the terms of future licensingarrangements, our ability to secure additional financing for our operations andour expected cash burn rate. These statements relate to future events or ourfuture financial performance. In some cases, you can identify forward-lookingstatements by terminology such as “may,” “will,” “should,” “expects,” “plans,” “could,”“anticipates,” “believes,” “estimates,” “predicts,” “potential” or “continue”or the negative of such terms or other comparable terminology. These statementsare only predictions and involve known and unknown risks, uncertainties andother factors, including the risks outlined In Item 1A “Risk Factors,” that maycause our or our industry’s actual results, levels of activity, performance orachievements to be materially different from any future results, levels or activity,performance or achievements expressed or implied by such forward-lookingstatements.*

*Although we believe that the expectations reflectedin the forward-looking statements are reasonable, we cannot guarantee futureresults, levels of activity, performance or achievements. We are under no dutyto update any of the forward-looking statements after the date of filing this Form 10-Qto conform such statements to actual results.*

**ITEM 1**                       FINANCIALSTATEMENTS

The response to this Item is submitted as a separatesection of this report.

**ITEM2**                       MANAGEMENT’SDISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

**OVERVIEW**

Access Pharmaceuticals, Inc. (“Access” or the “Company”)is an emerging pharmaceutical company focused on developing both novel productcandidates based upon our technologies in oncology and vitamin targeted drugdelivery.

All share and per share information reflect a one forfive reverse stock split effected on June 5, 2006.

Together with our subsidiaries, we have proprietary patentsor rights to four drug delivery technology platforms:

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·                  syntheticpolymer targeted delivery,

·                  vitamin mediatedtargeted delivery,

·                  vitamin mediatedoral delivery, and

·                  mucoadhesiveliquid technology.

Since our inception, we have devoted our resourcesprimarily to fund our research and development programs. We have beenunprofitable since inception and to date have received limited revenues fromthe sale of products. We cannot assure you that we will be able to generatesufficient product revenues to attain profitability on a sustained basis or atall. We expect to incur losses for the next several years as we continue toinvest in product research and development, preclinical studies, clinicaltrials and regulatory compliance. As of March 31, 2006, our accumulateddeficit was $71,021,000.

On February 16, 2006, we entered into a note and warrant purchase agreementpursuant to which we sold and issued an aggregate of $5,000,000 of 7.5%convertible notes due March 31, 2007 and warrants to purchase an aggregateof 3,863,636 shares of common stock of Access. Net proceeds to Access were $4.5million. The notes and warrants were sold in a private placement to a group ofaccredited investors led by SCO (see further discussion under “Liquidityand Capital Resources”).

On October 12, 2005, we sold our oral care anddermatology business unit to Uluru, Inc., a private Delaware corporation,for up to $20.6 million to allow us to focus on our technologies in oncologyand vitamin targeted drug delivery. The products and technologies sold to Uluruinclude amlexanox 5% paste (marketed under the trade names Aphthasol® andAptheal®), OraDiscTM,Zindaclin® and Residerm® and all of our assets related to these products. Inaddition, we have licensed to Uluru our nanoparticle hydrogel aggregatetechnology which could be used for applications such as local drug delivery andtissue filler in dental and soft tissue applications. The CEO of Uluru is KerryP. Gray, the former CEO of the Company. In conjunction with the saletransaction, we received a fairness opinion from a nationally recognizedinvestment banking firm (see further discussion under “Liquidity and CapitalResources”).

In March 2005 we finalized an agreement withCornell Capital Partners and Highgate House Funds providing  funding in the form of a Secured ConvertibleDebenture for net proceeds of approximately $2,360,000 (which was paid in October 2005),and a Secured Equity Distribution Agreement (“SEDA”) under which Access candraw up to $15,000,000 in working capital over a 2-year period (seefurther discussion under “Liquidity and Capital Resources”).

**LIQUIDITY ANDCAPITAL RESOURCES**

We have funded our operations primarily throughprivate sales of common stock and convertible notes and our principal source ofliquidity is cash and cash equivalents. Contract research payments, licensingfees and milestone payments from corporate alliances and mergers have alsoprovided funding for operations. As of March 31, 2006 our cash and cashequivalents and short-term investments were $3,622,000 and our working capitalwas ($3,230,000). Our working capital at March 31, 2006 represented a decreaseof $4,575,000 as compared to our working capital as of December 31, 2005of $1,345,000. The decrease in working capital was due mainly to the $4.5million received from SCO and affiliates offset by losses from operations andthe payment of payables.

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SCOCapital Partners LLC - Notes and Warrants

On February 16, 2006, we entered into a note and warrant purchase agreementpursuant to which we sold and issued an aggregate of $5,000,000 of 7.5%convertible notes due March 31, 2007 and warrants to purchase an aggregateof 3,863,636 shares of common stock of Access. Net proceeds to Access were $4.5million. The notes and warrants were sold in a private placement to a group ofaccredited investors led by SCO and its affiliates.

The notes matureon March 31, 2007, are convertible into Access common stock at a fixedconversion rate of $1.10 per share, bear interest of 7.5% per annum and aresecured by certain assets of Access. Each note may be converted at the optionof the noteholder or Access under certain circumstances as set forth in thenotes.

Each noteholderreceived a warrant to purchase a number of shares of common stock of Accessequal to 75% of the total number shares of Access common stock into which suchholder’s note is convertible. Each warrant has an exercise price of $1.32 pershare and is exercisable at any time prior to February 16, 2012. In theevent SCO and its affiliates were to convert all of their notes and exerciseall of their warrants, it would own approximately 70.4% of the votingsecurities of Access.

In connection withthe sale and issuance of notes and warrants, Access entered into an investorsrights agreement  whereby it granted SCOthe right to designate two individuals to serve on the Board of Directors ofAccess while the notes are outstanding, and also granted registration rightswith respect to the shares of common stock of Access underlying the notes andwarrants. SCO designated Jeffrey B. Davis and Mark J. Alvino to the Board ofDirectors, and on March 13, 2006 Messrs, Davis and Alvino were appointedto the Board of Directors.

Uluru, Inc.— Sale of Oral/Topical Care Asset*s*

On October 12, 2005, we sold our oral care anddermatology business unit to Uluru, Inc., a private Delaware corporation,for up to $20.6 million to focus on our technologies in oncology and vitamintargeted drug delivery. The products and technologies sold to Uluru includeamlexanox 5% paste (marketed under the trade names Aphthasol® and Aptheal®),OraDiscTM,Zindaclin® and Residerm® and all of our assets related to these products. Inaddition, we have licensed to Uluru our nanoparticle hydrogel aggregatetechnology which could be used for applications such as local drug delivery andtissue filler in dental and soft tissue applications. The CEO of Uluru is KerryP. Gray, the former CEO of the Company. In conjunction with the saletransaction, we received a fairness opinion from a nationally recognizedinvestment banking firm.

Uluru assumed eight employees from the Company, andfive employees remained with Access after the sale transaction. Throughout thetransition period agreed to by the parties, Uluru leased space from the Companyat its Dallas, TX headquarters.

At the closing of this agreement we received $8.7million. In addition, at the one year anniversary of the agreement we willreceive $3.7 million and we will receive an additional $1 million within 24months after closing or earlier upon the achievement of a milestone. Anycontingent liabilities which arise in the future relating to our formerbusiness could reduce the $3.7 million receipt. Additional payments of up to$7.2 million may be made upon the achievement of certain

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additional milestones.

The upfront payment of this transaction allowed Accessto immediately retire our $2.6 million of Secured Convertible Notes held byCornell Capital Partners and its affiliate and the various agreements relatingto these notes. Such notes were secured by all of our assets. In addition, theelimination of the manufacturing and regulatory costs associated with the oralcare business, as well as required employees for these marketed products andproduct candidates are expected to reduce our burn rate substantially.

RestructuringConvertible Notes

On November 9, 2005 we announced therestructuring and partial repayment of our 7.0% convertible promissory notesdue September 13, 2005.

One holder of $4 million worth of convertible notes(Oracle Partners LP and related funds) agreed to amend their notes to a newmaturity date, April  28, 2007, with the conversion price being reducedfrom $27.50 per share to $5.00 per share. In addition, the Company may cause amandatory conversion of the notes into common stock if the common stock tradesat a price of at least 1.5 times the conversion price for a minimum number oftrading days. There is also a provision to allow for a minimum price forconversion  in the event of a change ofcontrol of the Company. This modification resulted in us recording additionaldebt discount of $2.1 million, which will be accreted to interest expense tothe revised maturity date.

Access was unable to reach a conversion agreement withthe second holder of $4 million worth of notes (Philip D. Kaltenbacher), sosettled his claim by paying him this amount plus expenses and interest asoutlined in the terms of the note.

The third noteholder, holding $5.5 million worth ofconvertible notes agreed to amend its notes to a new maturity date, September 13,2010 and elected to have the 2005 interest of $423,000 to be paid on September 13,2006. The delayed interest will earn interest at a rate of 7.7%.

We do not have sufficient funds to repay ourconvertible notes at their maturity. We may not be able to restructure theconvertible notes or obtain additional financing to repay them on termsacceptable to us, if at all. If we raise additional funds by selling equitysecurities, the relative equity ownership of our existing investors would bediluted and the new investors could obtain terms more favorable than previousinvestors. A failure to restructure our convertible notes or obtain additionalfunding to repay the convertible notes and support our working capital andoperating requirements, could cause us to be in default of our convertiblenotes and prevent us from making expenditures that are needed to allow us tomaintain our operations. A failure to restructure our existing convertiblenotes or obtain necessary additional capital in the future could jeopardize ouroperations.

CornellCapital Partners Standby Equity Distribution Agreement and Securities PurchaseAgreement

On March 30, 2005 the Company executed a StandbyEquity Distribution Agreement (SEDA) with Cornell Capital Partners. Under theSEDA, the Company may issue and sell to Cornell Capital Partners common stockfor a total purchase price of up to $15,000,000. The purchase price for theshares is equal to their market price, which is defined in the SEDA as 98% ofthe lowest volume weighted average price of the common stock during a specifiedperiod of trading days following the date notice is given by the Company thatit desires to access the SEDA. 

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Further, we agreed to pay Cornell Capital Partners3.5% of the proceeds that we receive under the Equity Line of Credit. Theamount of each draw down is subject to a maximum amount of $1,000,000. Theterms of the SEDA do not allow us to make draw downs should they cause CornellCapital to own in excess of 9.9% of our outstanding shares of common stock.Upon closing of the transaction, Cornell Capital Partners received a one-timecommitment fee of 29,300 shares of the our common stock. On the same date, theCompany entered into a Placement Agent Agreement with Newbridge SecuritiesCorporation, a registered broker-dealer. Pursuant to the Placement AgentAgreement, upon closing of the transaction the Company paid a one-timeplacement agent fee of 700 shares of common stock. The shares issued werevalued at $500,000 and recorded as issuance costs and such costs are amortizedas the SEDA is accessed. As of March 31, 2006 we have accessed $600,000 ofthe SEDA and $116,000 of the issuance costs were charged to additional paid-incapital. The Company currently cannot access the SEDA until a post-effectiveamendment to our registration statement is filed with, and declared effectiveby, the SEC. The SEDA can be accessed through March 30, 2007.

In addition, on March 30, 2005, the Companyexecuted a Securities Purchase Agreement with Cornell Capital Partners andHighgate House Funds. Under the Securities Purchase Agreement, Cornell CapitalPartners and Highgate House Funds purchased an aggregate of $2,633,000 principalamount of Secured Convertible Debentures from the Company (net proceeds to theCompany of $2,360,000). The Secured Convertible Debentures accrued interest ata rate of 7% per year and were to mature 12 months from the issuance date withscheduled monthly repayment commencing on November 1, 2005 to the extentthat the Secured Convertible Debenture had not been converted to common stock.The Secured Convertible Debenture was convertible into the Company’s commonstock at the holder’s option any time up to maturity at a conversion priceequal to $20.00. The Secured Convertible Debentures were secured by all of theassets of the Company. The Company had the right to redeem the SecuredConvertible Debentures upon 3 business days notice for 110% of the amount redeemed.Pursuant to the Securities Purchase Agreement, the Company issued to theholders an aggregate of 10,000 shares of common stock of the Company. TheSecured Convertible Notes were paid in full on October 12, 2005 inconjunction with the sale of our oral care assets.

We have generally incurred negative cash flows fromoperations since inception, and have expended, and expect to continue to expendin the future, substantial funds to complete our planned product developmentefforts. Since inception, our expenses havesignificantly exceeded revenues, resulting in an accumulated deficit as of March 31,2006 of $71,021,000. Weexpect that the receivables due from Uluru, Inc. will be adequate to fundour current level of operations for twelve months excluding any obligation torepay the convertible notes and the debt service on the convertible notes***.*******Wecannot assure you****thatwe will ever be able to generate significant product revenue or achieve orsustain profitability. We currently do not have the cash resources to repay ourConvertible Notes due in March and April 2007. Our financing planthrough the sales of equity or use of the SEDA are expected to provide theresources to repay such notes. At this time the Company will not be ableto access the SEDA until a post-effective amendment to our registrationstatement is filed with, and declared effective by, the SEC.

**FIRST QUARTER 2006COMPARED TO FIRST QUARTER 2005**

Total research spending for the first quarter of 2006was $756,000, as compared to $541,000 for the same period in 2005, an increaseof $215,000. The increase in expenses was primarily the result of higher costsfor product manufacturing and clinical trials for ProLindacTM.

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Total general and administrative expenses were $666,000for the first quarter of 2006, a decrease of $23,000 as compared to the sameperiod in 2005. The decrease in spending was due primarily to the following:

·     lower license fees ($67,000), due to us notbeing listed on the American Stock Exchange;

·     lower business consulting expenses($44,000); and

·     lower rent expense and equipment rentalexpense ($44,000).

The decrease in general and administrative expenses ispartially offset by:

·     higher salary related expenses due torecognizing option expenses ($53,000)

·     higher patent fees ($42,000); and

·     by other net increases ($37,000).

Depreciation and amortization was $77,000 for thefirst quarter of 2006 as compared to $83,000 for the same period in 2005reflecting a decrease of $6,000. The decrease in depreciation and amortizationwas due to assets becoming fully depreciated.

Total operating expenses in the first quarter of 2006were $1,498,000 as compared to total operating expenses of $1,313,000 for thesame period in 2005, an increase of $185,000.

Interest and miscellaneous income was $92,000 for thefirst quarter of 2006 as compared to $10,000 for the same period in 2005, anincrease of $82,000. The increase in interest income was due to accretion ofthe receivable due from Uluru.

Interest and other expense was $1,299,000 for thefirst quarter of 2006 as compared to $313,000 for the same period in 2005, anincrease of $986,000. The increase in interest and other expense was due toamortization of the discount on the extension of convertible notes.

In 2006 there was an unrealized loss on fair value ofwarrants of $2,150,000 due to the warrants issued to SCO and affiliates.

Loss from continuing operations in the first quarter of2006 was $4,856,000 as compared to loss from continuing operations of$1,616,000 for the same period in 2005, an increase of $1,009,000.

Discontinued operations in 2005 is the result of thesale of our oral/topical care business to Uluru, Inc. and the closure ofour Australian laboratory. The loss from our discontinued operations was$814,000 or $0.26 per common share for the first quarter of 2005.

Net loss in the first quarter of 2006 was $4,856,000,or a $1.38 basic and diluted loss per common share, compared with a loss of$2,430,000, or a $0.78 basic and diluted loss per common share for the sameperiod in 2005.

**ITEM3**                       QUANTITATIVEAND QUALITATIVE DISCLOSURES ABOUT MARKETRISK

We invest our excess cash and short-term investmentsin certificates of deposit, corporate securities with high quality ratings, andU.S. government securities. These investments are not held for trading or otherspeculative purposes. These financial investment securities all mature in 2006and their estimated fair value approximates cost. Changes in interest ratesaffect the

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investment income we earn on our investments and,therefore, impact our cash flows and results of operations. A hypothetical 50basis point decrease in interest rates would result in a decrease in annualinterest income and a corresponding increase in net loss of approximately$3,000. This estimated effect assumes no changes in our short-term investmentsat March 31, 2006. We do not believe that we are exposed to any othermarket risks, as defined under applicable SEC regulations. We are not exposedto risks for changes in commodity prices, or any other market risks.

**ITEM 4**                       CONTROLSAND PROCEDURES

(a)            *Evaluation of disclosure controls and procedures.*Our chief executive officer and our chief financial officer, after evaluatingthe effectiveness of our “disclosure controls and procedures” (as defined in Rules 13a-15(e) and15d-(e) of the Securities and Exchange Act of 1934, as amended (the “ExchangeAct”)) as of the end of the period covered by this quarterly report, concludedthat the Company’s disclosure controls and procedures were (1) designed toensure that material information relating to the Company, including itsconsolidated subsidiaries, is made known to the Company’s chief executiveofficer and chief financial officer by others within those entities,particularly during the period in which this report was being prepared, and (2) werenot effective for the reasons discussed below, in Item 4(c), to ensure that informationrequired to be disclosed by the Company in the reports that it files or submitsunder the Exchange Act is recorded, processed, summarized and reported withinthe time periods specified in the SEC’s rules and forms.

(b)           *Changes in internal controls.* Except asset forth below, there were no changes in our internal controls over financialreporting during the quarter ended March 31, 2006 that have materiallyaffected, or are reasonably likely to material affect, our internal controlsover financial reporting.

(c)            Aspreviously reported in our Annual Report on Form 10-K for the fiscalyear ended December 31, 2005 (the “Form 10-K”), two materialweaknesses were reported, a material weakness with respect to the inadequacy ofstaffing and a material weakness relating to the lack of segregation of duties.

(d)           Managementis taking the necessary steps to correct the two material weaknesses discussedabove. Management is hiring a staff accountant to assist in the preparation offinancial statements and add a level to the segregation of duties. We believethat these actions will make our disclosure controls and procedures effective.

**PART II—OTHERINFORMATION**

**ITEM 1**                       LEGALPROCEEDINGS

None

**ITEM 1A**              RISK FACTORS

The risk factors set forth below, other than the risksunder the heading “Additional Risks”, were previously discussed in our Form 10-Kfor the fiscal year ended December 31, 2005. There have not been anymaterial changes from the risk factors previously disclosed in our Form 10-K,other 

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than the risks under the heading “Additional Risks”.These risk factors are not the only ones facing the Company. Additional risksand uncertainties not currently deemed to be material may also materially oradversely affect our financial condition and/or operating results.

**Additional RiskFactors**

**Risks associated with the effectuation of theproposed reverse stock split.**

The Company amended its Certificate of Incorporationto effect a one-for-five reverse stock split (the “Reverse Stock Split”) afterobtaining the requisite shareholder approval at its 2006 annual meeting ofshareholders. The Board is optimistic that the reduction in the number ofshares of Common Stock outstanding as a consequence of the proposed ReverseStock Split and the resulting anticipated increased price level will result ingreater interest in the Common Stock by the financial community and theinvesting public. There can be no assurances, however, that the market price ofthe Common Stock immediately after implementation of the proposed Reverse StockSplit will increase, and if it increases, no assurance that such increase canbe maintained for any period of time, or that such market price willapproximate five times the market price before the proposed Reverse StockSplit. In some cases, the total market capitalization of a company following areverse stock split is lower, and may be substantially lower, than the totalmarket capitalization before the reverse stock split. In addition, the fewernumber of shares that will be available to trade will possibly cause thetrading market of the Common Stock to become less liquid, which could have anadverse effect on the price of the Common Stock. The market price of our CommonStock is based on our performance and other factors, some of which may beunrelated to the number of our shares outstanding.

In addition, there can be no assurance that theReverse Stock Split will result in a per share price that will attract brokersand investors who do not trade in lower priced stock or that it will increasethe Company’s ability to attract and retain employees and other serviceproviders.

**Risk FactorsPreviously Disclosed**

**Without obtaining adequate capital funding, we maynot be able to continue as a going concern.**

The report of our independent registered public accountingfirm, Grant Thornton LLP, for the fiscal year ended December 31, 2005contained a fourth explanatory paragraph to reflect its significant doubt aboutour ability to continue a going concern as a result of our history of lossesand our liquidity position, as discussed in our Form 10-K. If we areunable to obtain adequate capital funding in the future, we may not be able tocontinue as a going concern, which would have an adverse effect on our businessand operations, and investors’ investment in us may decline.

**We have experienced a history of losses, we expectto incur future losses and we may be unable to obtain necessary additional capital to fundoperations in the future.**

We have recorded minimal revenue to date and we haveincurred a cumulative operating loss of approximately $71.0 million through March 31,2006. Net losses for the years ended 2005, 2004 and 2003 were $1,700,000,$10,238,000 and $6,935,000, respectively. Our losses have resulted 

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principally from costs incurred in research anddevelopment activities related to our efforts to develop clinical drugcandidates and from the associated administrative costs. We expect to incuradditional operating losses over the next several years. We also expectcumulative losses to increase if we expand research and development efforts andpreclinical and clinical trials. Our net cash burn rate for the twelve monthswas approximately $700,000 per month. We project our net cash burn rate for thenext nine months to be approximately $675,000 per month. Capital expendituresare forecasted to be minor for the next nine months.

We require substantial capital for our developmentprograms and operating expenses, to pursue regulatory clearances and toprosecute and defend our intellectual property rights. We believe that ourexisting capital resources, interest income, and revenue from possiblelicensing agreements and collaborative agreements will be sufficient to fundour currently expected operating expenses for nine months (other than debt andinterest obligations including the approximately $5.0 million of SeniorConvertible notes due March 31, 2007, and approximately $4.0million of convertible notes which are required to be repaid in April 2007and interest of $1,189,000 due September 2006). We will need to raisesubstantial additional capital to support our ongoing operations and debtobligations.

If we do raise additional funds by issuing equitysecurities, further dilution to existing stockholders would result and futureinvestors may be granted rights superior to those of existing stockholders. Ifadequate funds are not available to us through additional equity offerings, wemay be required to delay, reduce the scope of or eliminate one or more of ourresearch and development programs or to obtain funds by entering intoarrangements with collaborative partners or others that require us to issueadditional equity securities or to relinquish rights to certain technologies ordrug candidates that we would not otherwise issue or relinquish in order tocontinue independent operations. As a result of our history of losses and ourliquidity position, our auditors have issued an audit report expressingsignificant doubt about our ability to remain a going concern.

**We do not have operating revenue and we may neverattain profitability.**

Todate, we have funded our operations primarily through private sales of commonstock and convertible notes. Contract research payments and licensing fees fromcorporate alliances and mergers have also provided funding for our operations.Our ability to achieve significant revenue or profitability depends upon ourability to successfully complete the development of drug candidates, to developand obtain patent protection and regulatory approvals for our drug candidatesand to manufacture and commercialize the resulting drugs. We sold our onlyrevenue producing assets to Uluru, Inc. in October 2005. We are notexpecting any revenues in the short-term from our remaining assets.Furthermore, we may not be able to ever successfully identify, develop, patent,manufacture, commercialize, obtain required regulatory approvals and market anyadditional products. Moreover, even if we do identify, develop, patent,manufacture, commercialize, and obtain required regulatory approvals to marketadditional products, we may not generate revenues or royalties from commercialsales of these products for a significant number of years, if at all.Therefore, our proposed operations are subject to all the risks inherent in theestablishment of a new business enterprise. In the next few years, our revenuesmay be limited to minimal product sales and royalties, any amounts that wereceive under strategic partnerships and research or drug developmentcollaborations that we may establish and, as a result, we may be unable toachieve or maintain profitability in the future or to achieve significantrevenues in order to fund our operations.

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**Our StandbyEquity Distribution Agreement may have a dilutive impact on our stockholders.**

We aredependent on external financing to fund our operations. Our financial needs maybe partially provided from the SEDA. The issuance of shares of our common stockunder the SEDA would have a dilutive impact on our other stockholders and theissuance, or even potential issuance of such shares could have a negativeeffect on the market price of our common stock. In addition, if we access theSEDA, we will issue shares of our common stock to Cornell Capital Partners at adiscount to the lowest daily volume weighted average of our common stock duringa specified period of trading days after we access the SEDA. Issuing shares ata discount will further dilute the interests of other stockholders and maynegatively affect the market price of our Common Stock.

To theextent that Cornell Capital Partners sells shares of our common stock issuedunder the SEDA to third parties, our stock price may decrease due to theadditional selling pressure in the market. The perceived risk of dilution fromsales of stock to or by Cornell Capital Partners may cause holders of ourcommon stock to sell their shares, or it may encourage short sales of ourcommon stock or other similar transactions. This could contribute to a declinein the stock price of our common stock.

At this time we are not be able to draw funds from theSEDA until an amendment to our registration statement relating to the SEDA isfiled and declared effective by the SEC.

**We may not beable to pay our debt and other obligations and our assets may be seized as aresult.**

We may notgenerate the cash flow required to pay our liabilities as they become due. Ouroutstanding debt includes approximately $5.0 million of Senior Convertiblenotes due March 31, 2007, and approximately $9.5 million of ourConvertible Subordinated Notes of which $4.0 million is due in April 2007and $5.5 million is due in September 2010.

If our cash flow is inadequate to meet theseobligations, we will default on the notes. Any default on the notes could allowour note holders to foreclose upon our assets, force us into bankruptcy. We may be unable to repay orrepurchase or restructure the convertible subordinated notes due in April 2007and September 2010 and be forced into bankruptcy. In the event of adefault, the holders of our secured convertible notes have the right toforeclose on all of our assets, which could force us to curtail or cease ourbusiness operations.

The holdersof our Convertible Notes may require us to repurchase or prepay all of theoutstanding Convertible Notes under certain circumstances. We may not havesufficient cash reserves to repurchase the Convertible Notes at such time,which would cause an event of default under the Convertible Notes and may forceus to declare bankruptcy.

**We may not successfully commercialize our drugcandidates.**

Our drug candidates are subject to the risks offailure inherent in the development of pharmaceutical products based on newtechnologies and our failure to develop safe, commercially 

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viable drugs would severely limit our ability tobecome profitable or to achieve significant revenues. We may be unable tosuccessfully commercialize our drug candidates because:

·                    someor all of our drug candidates may be found to be unsafe or ineffective orotherwise fail to meet applicable regulatory standards or receive necessaryregulatory clearances;

·                    ourdrug candidates, if safe and effective, may be too difficult to develop intocommercially viable drugs;

·                    itmay be difficult to manufacture or market our drug candidates on a large scale;

·                    proprietaryrights of third parties may preclude us from marketing our drug candidates; and

·                    thirdparties may market superior or equivalent drugs.

**The success of our research and developmentactivities, upon which we primarily focus, is uncertain.**

Our primary focus is on our research and developmentactivities and the commercialization of compounds covered by proprietarybiopharmaceutical patents and patent applications. Research and developmentactivities, by their nature, preclude definitive statements as to the timerequired and costs involved in reaching certain objectives. Actual research anddevelopment costs, therefore, could exceed budgeted amounts and estimated time framesmay require extension. Cost overruns, unanticipated regulatory delays ordemands, unexpected adverse side effects or insufficient therapeutic efficacywill prevent or substantially slow our research and development effort and ourbusiness could ultimately suffer. We anticipate that we will remain principallyengaged in research and development activities for an indeterminate, butsubstantial, period of time.

**We may be unable to successfully develop, market,or commercialize our products or our product candidates without establishingnew relationships and maintaining current relationships.**

Our strategy for the research, development andcommercialization of our potential pharmaceutical products may require us toenter into various arrangements with corporate and academic collaborators,licensors, licensees and others, in addition to our existing relationships withother parties. Specifically, we may seek to joint venture, sublicense or enterother marketing arrangements with parties that have an established marketingcapability or we may choose to pursue the commercialization of such products onour own. We may, however, be unable to establish such additional collaborativearrangements, license agreements, or marketing agreements as we may deemnecessary to develop, commercialize and market our potential pharmaceuticalproducts on acceptable terms. Furthermore, if we maintain and establisharrangements or relationships with third parties, our business may depend uponthe successful performance by these third parties of their responsibilitiesunder those arrangements and relationships.

Our ability to successfully commercialize, and marketour product candidates could be limited if a number of these existingrelationships were terminated.

Furthermore, we may enter into a strategic licensingagreement with a pharmaceutical company for our polymer platinate program wherethe costs of developing a product would be shared. Although we have haddiscussions with potential licensing partners with respect to our polymer 

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platinate program, to date we have not entered intoany licensing arrangement. We may be unable to execute our licensing strategyfor polymer platinate.

**We may be unable to successfully manufacture ourproducts and our product candidates in clinical quantities or for commercialpurposes without the assistance of contract manufacturers, which may be difficult for us to obtain andmaintain.**

We have limited experience in the manufacture ofpharmaceutical products in clinical quantities or for commercial purposes andwe may not be able to manufacture any new pharmaceutical products that we maydevelop. As a result, we have established, and in the future intend toestablish arrangements with contract manufacturers to supply sufficientquantities of products to conduct clinical trials and for the manufacture,packaging, labeling and distribution of finished pharmaceutical products if anyof our potential products are approved for commercialization. If we are unableto contract for a sufficient supply of our potential pharmaceutical products onacceptable terms, our preclinical and human clinical testing schedule may bedelayed, resulting in the delay of our clinical programs and submission ofproduct candidates for regulatory approval, which could cause our business tosuffer. Our business could suffer if there are delays or difficulties inestablishing relationships with manufacturers to produce, package, label anddistribute our finished pharmaceutical or other medical products, if any,market introduction and subsequent sales of such products. Moreover, contractmanufacturers that we may use must adhere to current Good ManufacturingPractices, as required by the FDA. In this regard, the FDA will not issue apre-market approval or product and establishment licenses, where applicable, toa manufacturing facility for the products until the manufacturing facilitypasses a pre-approval plant inspection. If we are unable to obtain or retainthird party manufacturing on commercially acceptable terms, we may not be ableto commercialize our products as planned. Our potential dependence upon thirdparties for the manufacture of our products may adversely affect our ability togenerate profits or acceptable profit margins and our ability to develop anddeliver such products on a timely and competitive basis.

ProLindacTM is manufactured by third parties for ourPhase I/II clinical trials. Manufacturing is ongoing for the current clinicaltrials. Certain manufacturing steps are conducted by the Company to enablesignificant cost savings to be realized.

**We are subject to extensive governmentalregulation which increases our cost of doing business and may affect ourability to commercialize any new products that we may develop.**

The FDA and comparable agencies in foreign countriesimpose substantial requirements upon the introduction of pharmaceuticalproducts through lengthy and detailed laboratory, preclinical and clinicaltesting procedures and other costly and time-consuming procedures to establishtheir safety and efficacy. All of our drugs and drug candidates require receiptand maintenance of governmental approvals for commercialization. Preclinicaland clinical trials and manufacturing of our drug candidates will be subject tothe rigorous testing and approval processes of the FDA and correspondingforeign regulatory authorities. Satisfaction of these requirements typicallytakes a significant number of years and can vary substantially based upon thetype, complexity and novelty of the product. The status of our principal productsis as follows:

·                    ProLindacTM iscurrently commencing a Phase II trial in Europe and has commenced a Phase IItrial in the US.

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·                    ProLindacTM hasbeen approved for an additional Phase I trial in the US by the FDA.

·                    A mucoadhesiveliquid technology product, MuGardTM, will be the subject of a 510(k) deviceapproval application in 2006.

·                    Vitaminmediated delivery technology is currently in the pre-clinical phase.

·                    Wealso have other products in the preclinical phase.

Due to the time consuming and uncertain nature of thedrug candidate development process and the governmental approval processdescribed above, we cannot assure you when we, independently or with ourcollaborative partners, might submit a NDA, for FDA or other regulatory review.

Government regulation also affects the manufacturingand marketing of pharmaceutical products. Government regulations may delaymarketing of our potential drugs for a considerable or indefinite period oftime, impose costly procedural requirements upon our activities and furnish acompetitive advantage to larger companies or companies more experienced inregulatory affairs. Delays in obtaining governmental regulatory approval couldadversely affect our marketing as well as our ability to generate significantrevenues from commercial sales. Our drug candidates may not receive FDA orother regulatory approvals on a timely basis or at all. Moreover, if regulatoryapproval of a drug candidate is granted, such approval may impose limitationson the indicated use for which such drug may be marketed. Even if we obtaininitial regulatory approvals for our drug candidates, Access, our drugs and ourmanufacturing facilities would be subject to continual review and periodicinspection, and later discovery of previously unknown problems with a drug,manufacturer or facility may result in restrictions on the marketing ormanufacture of such drug, including withdrawal of the drug from the market. TheFDA and other regulatory authorities stringently apply regulatory standards andfailure to comply with regulatory standards can, among other things, result infines, denial or withdrawal of regulatory approvals, product recalls orseizures, operating restrictions and criminal prosecution.

**The uncertainty associated with preclinical andclinical testing may affect our ability to successfully commercialize newproducts.**

Before we can obtain regulatory approvals for thecommercial sale of any of our potential drugs, the drug candidates will besubject to extensive preclinical and clinical trials to demonstrate theirsafety and efficacy in humans. Preclinical or clinical trials of any of ourfuture drug candidates may not demonstrate the safety and efficacy of such drugcandidates at all or to the extent necessary to obtain regulatory approvals. Inthis regard, for example, adverse side effects can occur during the clinicaltesting of a new drug on humans which may delay ultimate FDA approval or evenlead us to terminate our efforts to develop the drug for commercial use.Companies in the biotechnology industry have suffered significant setbacks inadvanced clinical trials, even after demonstrating promising results in earliertrials. In particular, polymer platinate has taken longer to progress throughclinical trials than originally planned. This extra time has not been relatedto concerns of the formulations but rather due to the lengthy regulatoryprocess. The failure to adequately demonstrate the safety and efficacy of adrug candidate under development could delay or prevent regulatory approval ofthe drug candidate. A delay or failure to receive regulatory approval for anyof our drug candidates could prevent us from successfully commercializing suchcandidates and we could incur substantial additional expenses in our attemptsto further develop such candidates and obtain future regulatory approval.

**We may incur substantial product liabilityexpenses due to the use or misuse of our**

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**products for which we may be unable to obtaininsurance coverage.**

Our business exposes us to potential liability risksthat are inherent in the testing, manufacturing and marketing of pharmaceuticalproducts. These risks will expand with respect to our drug candidates, if any,that receive regulatory approval for commercial sale and we may facesubstantial liability for damages in the event of adverse side effects orproduct defects identified with any of our products that are used in clinicaltests or marketed to the public. We generally procure product liabilityinsurance for drug candidates that are undergoing human clinical trials.Product liability insurance for the biotechnology industry is generallyexpensive, if available at all, and as a result, we may be unable to obtaininsurance coverage at acceptable costs or in a sufficient amount in the future,if at all. We may be unable to satisfy any claims for which we may be heldliable as a result of the use or misuse of products which we have developed,manufactured or sold and any such product liability claim could adverselyaffect our business, operating results or financial condition.

**We may incur significant liabilities if we fail tocomply with stringent environmental regulations or if we did not comply withthese regulations in the past.**

Our research and development processes involve thecontrolled use of hazardous materials. We are subject to a variety of federal,state and local governmental laws and regulations related to the use,manufacture, storage, handling and disposal of such material and certain wasteproducts. Although we believe that our activities and our safety procedures forstoring, using, handling and disposing of such materials comply with thestandards prescribed by such laws and regulations, the risk of accidentalcontamination or injury from these materials cannot be completely eliminated. Inthe event of such accident, we could be held liable for any damages that resultand any such liability could exceed our resources.

**Intense competition may limit our ability tosuccessfully develop and market commercial products.**

The biotechnology and pharmaceutical industries areintensely competitive and subject to rapid and significant technologicalchange. Our competitors in the United States and elsewhere are numerous andinclude, among others, major multinational pharmaceutical and chemical companies,specialized biotechnology firms and universities and other researchinstitutions.

The following products may compete with polymerplatinate:

·                    Cisplatin,marketed by Bristol-Myers-Squibb, the originator of the drug, and severalgeneric manufacturers;

·                    Carboplatin,marketed by Bristol-Myers-Squibb in the US; and

·                    Oxaliplatin,marketed exclusively by Sanofi-Synthelabo.

The following companies are working on therapies andformulations that may be competitive with our polymer platinate:

·                    Antigenics andRegulon are developing liposomal formulations; and

·                    AmericanPharmaceutical Partners, Cell Therapeutics, Daiichi, Enzon and Debio aredeveloping alternate drugs in combination with polymers and other drug deliverysystems.

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Companies working on therapies and formulations thatmay be competitive with our vitamin mediated drug delivery system areBristol-Myers-Squibb, Centocor (acquired by Johnson & Johnson),GlaxoSmithKline, Imclone and Xoma which are developing targeted monoclonalantibody therapy.

Amgen commercializes PaliferminTM. CuraGen, McNeil, MGIPharma and OSI Pharmaceuticals are developing products to treat mucositis thatmay compete with our mucoadhesive liquid technology.

BioDelivery, Biovail Corporation, Cellgate, CIMA Labs, Inc.,Depomed Inc., Emisphere Technologies, Inc., Eurand, Flamel Technologies,Nobex and Xenoport are developing products which compete with our oral drugdelivery system.

Many of these competitors have and employ greaterfinancial and other resources, including larger research and development, marketingand manufacturing organizations. As a result, our competitors may successfullydevelop  technologies and drugs that aremore effective or less costly than any that we are developing or which wouldrender our technology and future products obsolete and noncompetitive.

In addition, some of our competitors have greaterexperience than we do in conducting preclinical and clinical trials andobtaining FDA and other regulatory approvals. Accordingly, our competitors maysucceed in obtaining FDA or other regulatory approvals for drug candidates morerapidly than we do. Companies that complete clinical trials, obtain requiredregulatory agency approvals and commence commercial sale of their drugs beforetheir competitors may achieve a significant competitive advantage. Drugsresulting from our research and development efforts or from our joint effortswith collaborative partners therefore may not be commercially competitive withour competitors’ existing products or products under development.

**Our ability to successfully develop andcommercialize our drug candidates will substantially depend upon theavailability of reimbursement funds for the costs of the resulting drugs andrelated treatments.**

The successful commercialization of, and the interestof potential collaborative partners to invest in the development of our drugcandidates, may depend substantially upon reimbursement of the costs of theresulting drugs and related treatments at acceptable levels from governmentauthorities, private health insurers and other organizations, including healthmaintenance organizations, or HMOs. Limited reimbursement for the cost of anydrugs that we develop may reduce the demand for, or price of such drugs, whichwould hamper our ability to obtain collaborative partners to commercialize ourdrugs, or to obtain a sufficient financial return on our own manufacture andcommercialization of any future drugs.

**The market may not accept any pharmaceuticalproducts that we successfully develop.**

The drugs that we are attempting to develop maycompete with a number of well-established drugs manufactured and marketed bymajor pharmaceutical companies. The degree of market acceptance of any drugsdeveloped by us will depend on a number of factors, including the establishmentand demonstration of the clinical efficacy and safety of our drug candidates,the potential advantage of our drug candidates over existing therapies and thereimbursement policies of government and third-party payers. Physicians,patients or the medical community in 

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general may not accept or use any drugs that we maydevelop independently or with our collaborative partners and if they do not,our business could suffer.

**Trends toward managed health care and downwardprice pressures on medical products and services may limit our ability toprofitably sell any drugs that we may develop.**

Lower prices for pharmaceutical products may resultfrom:

·                  third-partypayers’ increasing challenges to the prices charged for medical products andservices;

·                  the trend towardmanaged health care in the United States and the concurrent growth of HMOs andsimilar organizations that can control or significantly influence the purchaseof healthcare services and products; and

·                  legislativeproposals to reform healthcare or reduce government insurance programs.

The cost containment measures that healthcareproviders are instituting, including practice protocols and guidelines andclinical pathways, and the effect of any healthcare reform, could limit ourability to profitably sell any drugs that we may successfully develop.Moreover, any future legislation or regulation, if any, relating to thehealthcare industry or third-party coverage and reimbursement, may cause ourbusiness to suffer.

**We may not be successful in protecting ourintellectual property and proprietary rights.**

Our success depends, in part, on our ability to obtainU.S. and foreign patent protection for our drug candidates and processes,preserve our trade secrets and operate our business without infringing theproprietary rights of third parties. Legal standards relating to the validityof patents covering pharmaceutical and biotechnological inventions and thescope of claims made under such patents are still developing and there is noconsistent policy regarding the breadth of claims allowed in biotechnologypatents. The patent position of a biotechnology firm is highly uncertain andinvolves complex legal and factual questions. We cannot assure you that anyexisting or future patents issued to, or licensed by, us will not subsequentlybe challenged, infringed upon, invalidated or circumvented by others. As aresult, although we, together with our subsidiaries, are either the owner orlicensee to 11 U.S. patents and to 11 U.S. patent applications now pending, and4 European patents and 12 European patent applications, we cannot assure youthat any additional patents will issue from any of the patent applicationsowned by, or licensed to, us. Furthermore, any rights that we may have underissued patents may not provide us with significant protection againstcompetitive products or otherwise be commercially viable.

Our patents for the following technologies expire inthe years and during the date ranges indicated below:

·                  ProLindacTM in2021

·                  Mucoadhesivetechnology, patents are pending

·                  Vitaminmediated technology between 2006 and 2019

In addition, patents may have been granted to thirdparties or may be granted covering products or processes that are necessary oruseful to the development of our drug candidates. If our drug 

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candidates or processes are found to infringe upon thepatents or otherwise impermissibly utilize the intellectual property of others,our development, manufacture and sale of such drug candidates could be severelyrestricted or prohibited. In such event, we may be required to obtain licensesfrom third parties to utilize the patents or proprietary rights of others. Wecannot assure you that we will be able to obtain such licenses on acceptableterms, if at all. If we become involved in litigation regarding ourintellectual property rights or the intellectual property rights of others, thepotential cost of such litigation, regardless of the strength of our legalposition, and the potential damages that we could be required to pay could besubstantial.

**Our business could suffer if we lose the servicesof, or fail to attract, key personnel.**

We are dependent upon the efforts of our seniormanagement and scientific team. The loss of the services of one or more ofthese individuals could delay or prevent the achievement of our research,development, marketing, or product commercialization objectives. While we haveemployment agreements with David Nowotnik, PhD our Senior Vice PresidentResearch and Development, and Stephen Thompson, our Vice President and ChiefFinancial Officer, their employment may be terminated by them or us at anytime. Mr. Thompson’s and Dr. Nowotnik’s agreements expire within oneyear and are extendable each year on the anniversary date. Dr. Mazanet,our acting CEO is currently an employee at will. We do not have employmentcontracts with our other key personnel. We do not maintain any “key-man”insurance policies on any of our key employees and we do not intend to obtainsuch insurance. In addition, due to the specialized scientific nature of ourbusiness, we are highly dependent upon our ability to attract and retainqualified scientific and technical personnel. In view of the stage of ourdevelopment and our research and development programs, we have restricted ourhiring to research scientists and a small administrative staff and we have madeonly limited investments in manufacturing, production, sales or regulatorycompliance resources. There is intense competition among major pharmaceuticaland chemical companies, specialized biotechnology firms and universities andother research institutions for qualified personnel in the areas of ouractivities, however, and we may be unsuccessful in attracting and retainingthese personnel.

**An investment in our common stock may be lessattractive because it is not traded on a recognized public market.**

In February, 2006, our common stock was de-listed fromtrading on American Stock Exchange, and traded on the “Pink Sheets” until May18, 2006.  Our common stock is currentlytraded on the OTC Bulletin Board.  Thisis viewed by most investors as a less desirable, and less liquid, marketplace. Asa result, an investor may find it more difficult to purchase, dispose of orobtain accurate quotations as to the value of our common stock.

Our common stock is subject to Rules 15g-1through 15g-9 under the Exchange Act, which imposes certain salespractice requirements on broker-dealers who sell our common stock to personsother than established customers and “accredited investors” (as defined in Rule 501(c) ofthe Securities Act). For transactions covered by this rule, a broker-dealermust make a special suitability determination for the purchaser and havereceived the purchaser’s written consent to the transaction prior to the sale. Thisrule adversely affects the ability of broker-dealers to sell our commonstock and purchasers of our common stock to sell their shares of our commonstock.

Additionally, our common stockis subject to SEC regulations applicable to “penny stock.” Penny stock includesany non-Nasdaq equity security that has a market price of less than $5.00 pershare, subject to certain exceptions. The regulations require that prior to anynon-exempt buy/sell transaction in a penny stock, a disclosure scheduleproscribed by the SEC relating to the 

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penny stock market must bedelivered by a broker-dealer to the purchaser of such penny stock. Thisdisclosure must include the amount of commissions payable to both thebroker-dealer and the registered representative and current price quotationsfor our common stock. The regulations also require that monthly statements besent to holders of penny stock that disclose recent price information for thepenny stock and information of the limited market for penny stocks. Theserequirements adversely affect the market liquidity of our common stock.

**Ownership of our shares is concentrated, to someextent, in the hands of a few investors which could limit the ability of ourother stockholders to influence the direction of the company.**

SCO Capital Partners LLC and its affiliates, Larry N.Feinberg (Oracle Partners LP, Oracle Institutional Partners LP and OracleInvestment Management Inc.), and Heartland Advisors, Inc. eachbeneficially owned, as determined under the SEC’s beneficial ownership rules,approximately 70.4%, 26.4% and 9.0%, respectively, of our common stock as of May 31,2006. Accordingly, they collectively mayhave the ability to significantly influence or determine the election of all ofour directors or the outcome of most corporate actions requiring stockholderapproval. They may exercise this ability in a manner that advances their bestinterests and not necessarily those of our other stockholders.

**Provisions of our charter documents coulddiscourage an acquisition of our company that would benefit our stockholdersand may have the effect of entrenching, and making it difficult to remove,management.**

Provisions of our Certificate of Incorporation,By-laws and Stockholders Rights Plan may make it more difficult for a thirdparty to acquire control of the Company, even if a change in control wouldbenefit our stockholders. In particular, shares of our preferred stock may beissued in the future without further stockholder approval and upon such termsand conditions, and having such rights, privileges and preferences, as ourBoard of Directors may determine, including, for example, rights to convertinto our common stock. The rights of the holders of our common stock will besubject to, and may be adversely affected by, the rights of the holders of anyof our preferred stock that may be issued in the future. The issuance of ourpreferred stock, while providing desirable flexibility in connection withpossible acquisitions and other corporate purposes, could have the effect ofmaking it more difficult for a third party to acquire control of us. This couldlimit the price that certain investors might be willing to pay in the futurefor shares of our common stock and discourage these investors from acquiring a majorityof our common stock. Further, the existence of these corporate governanceprovisions could have the effect of entrenching management and making it moredifficult to change our management.

**Substantial sales of our common stock could lowerour stock price.**

The market price for our common stock could drop as aresult of sales of a large number of our presently outstanding shares or shares that we may issue orbe obligated to issue in the future. All of the 3,530,908 shares of ourcommon stock that are outstanding as of June 6, 2006, are unrestricted andfreely tradable or tradable pursuant to a resale registration statement orunder Rule 144 of the Securities Act or are covered by a registrationrights agreement.

**Failure to achieve and maintain effective internalcontrols could have a material adverse effect on our business.**

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Effective internal controls are necessary for us toprovide reliable financial reports. If we cannot provide reliable financialreports, our operating results could be harmed. All internal control systems,no matter how well designed, have inherent limitations. Therefore, even thosesystems determined to be effective can provide only reasonable assurance withrespect to financial statement preparation and presentation.

While we continue to evaluate and improve our internalcontrols, we cannot be certain that these measures will ensure that weimplement and maintain adequate controls over our financial processes andreporting in the future. Any failure to implement required new or improvedcontrols, or difficulties encountered in their implementation, could harm ouroperating results or cause us to fail to meet our reporting obligations.

Failure to achieve and maintain an effective internalcontrol environment could cause investors to lose confidence in our reportedfinancial information, which could have a material adverse effect on our stockprice.

**ITEM 2**                       SALES OFUNREGISTERED EQUITY SECURITIES AND USE OF PROCEEDS

On February 16, 2006, we entered into a note and warrant purchase agreementpursuant to which we sold and issued an aggregate of $5,000,000 of 7.5%convertible notes due March 31, 2007 and warrants to purchase an aggregateof 3,863,636 shares of common stock of Access. Net proceeds to Access were $4.5million. The notes and warrants were sold in a private placement to a group ofaccredited investors led by SCO and its affiliates.

The notes matureon March 31, 2007, are convertible into Access common stock at a fixedconversion rate of $1.10 per share, bear interest of 7.5% per annum and aresecured by certain assets of Access. Each note may be converted at the optionof the noteholder or Access under certain circumstances as set forth in thenotes.

Each noteholderreceived a warrant to purchase a number of shares of common stock of Accessequal to 75% of the total number shares of Access common stock into which suchholder’s note is convertible. Each warrant has an exercise price of $1.32 pershare and is exercisable at any time prior to February 16, 2012. In theevent SCO and its affiliates were to convert all of their notes and exerciseall of their warrants, it would own approximately 70.4% of the votingsecurities of Access.

In connection withthe sale and issuance of notes and warrants, Access entered into an investorsrights agreement whereby it granted SCO the right to designate two individualsto serve on the Board of Directors of Access while the notes are outstanding,and also granted registration rights with respect to the shares of common stockof Access underlying the notes and warrants. SCO designated Jeffrey B. Davisand Mark J. Alvino to the Board of Directors, and on March 13, 2006Messrs, Davis and Alvino were appointed to the Board of Directors.

In connection with the Separation Agreement with KerryP. Gray, former President, CEO and Director of the Company, Mr. Gray isentitled to receive 700 shares of Access common stock per month for a total of 12,600shares from May 30, 2005 until October 30, 2006.

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**ITEM 3**                       DEFAULTSUPON SENIOR SECURITIES

None

**ITEM 4**                       SUBMISSIONOF MATTERS TO A VOTE OF SECURITY HOLDERS

None

**ITEM 5**                       OTHERINFORMATION

None

**ITEM 6**                       EXHIBITSAND REPORTS ON FORM 8-K

Exhibits:
| 10.29 |   | Security Agreement dated February 16, 2006  between us and certain Secured Parties                                                                                        |
|-------|--------|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| 10.30 |   | Form of 7.5% Secured Promissory Notes dated  February 16, 2006 between us and SCO Capital Partners LLC, Beach Capital  LLC and Lake End Capital LLC                  |
| 10.31 |   | Form of Warrant Agreement dated  February 16, 2006 between us and SCO Capital Partners LLC, Beach Capital  LLC, Lake End Capital LLC, Howard Fischer and Mark Alvino |
| 10.32 |   | Investment Agreement dated February 16, 2006  between us and SCO Capital Partners, LLC.                                                                                   |
| 10.33 |   | Rights Agreement, as amended, dated as of  February 16, 2006 between us and American Stock Transfer &  Trust Company, as Rights Agent                            |
| 31.1  |   | Certification of Chief Executive Officer of Access  Pharmaceuticals, Inc. pursuant to Rule 13a-14(a)/15d-14(a)                                                       |
| 31.2  |   | Certification of Chief Financial Officer of Access  Pharmaceuticals, Inc. pursuant to Rule 13a-14(a)/15d-14(a)                                                       |
| 32.1* |   | Certification of Chief Executive Officer of Access  Pharmaceuticals, Inc. pursuant to 18 U.S.C. Section 1350                                                         |
| 32.2* |   | Certification of Chief Financial Officer of Access  Pharmaceuticals, Inc. pursuant to 18 U.S.C. Section 1350                                                         |

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* This exhibit shall notbe deemed “filed” for purposes of Section 18 of the Securities ExchangeAct of 1934 or otherwise subject to the liabilities of that Section, nor shallit be deemed incorporated by reference in any filings under the Securities Actof 1933 or the Securities and Exchange Act of 1934, whether made before orafter the date hereof and irrespective of any general incorporation language inany filings.

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**SIGNATURES**

Pursuant to the requirements of the SecuritiesExchange Act of 1934, the registrant has duly caused this report to be signedon its behalf by the undersigned, thereunto duly authorized.
|                           | ACCESS PHARMACEUTICALS, INC. |
|---------------------------|------------------------------|
| Date: June 15,  2006 | By:                          |   | /s/ Rosemary Mazanet |
|                      |                         |   | Rosemary Mazanet |
|                      |                         |   | Acting Chief Executive Officer |
|                      |                         |   | (Principal Executive Officer) |
| Date: June 15,  2006 | By:                          |   | /s/ Stephen B. Thompson |
|                      |                         |   | Stephen B. Thompson |
|                      |                         |   | Vice President  and Chief Financial Officer |
|                      |                         |   | (Principal  Financial and Accounting Officer) |

 

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**AccessPharmaceuticals, Inc. and Subsidiaries**

CondensedConsolidated Balance Sheets
| ** **                                                                                                                                       | ** ** | **March 31, 2006** | ** ** | **December 31, 2005** | ** ** |
|--------------------------------------------------------------------------------------------------------------------------------------------------|------------|------------------------------|------------|---------------------------------|------------|
| ** **                                                                                                                                       | ** ** | **(unaudited)**              | ** ** | ** **                      | ** ** |
| ASSETS                                                                                                                                           |       |                         |       |                            |       |
| Current assets                                                                                                                                   |       |                         |       |                            |       |
| Cash and cash  equivalents                                                                                                                       |       | $                            | 3,463,000  |                            | $          | 349,000 |   |
| Short term  investments, at cost                                                                                                                 |       | 159,000                      |       | 125,000                         |       |
| Receivables                                                                                                                                      |       | 4,565,000                    |       | 4,488,000                       |       |
| Prepaid expenses  and other current assets                                                                                                       |       | 139,000                      |       | 197,000                         |       |
| Total current  assets                                                                                                                            |       | 8,326,000                    |       | 5,159,000                       |       |
| Property and  equipment, net                                                                                                                     |       | 278,000                      |       | 300,000                         |       |
| Debt issuance  costs, net                                                                                                                        |       | 402,000                      |       | —                          |       |
| Patents, net                                                                                                                                     |       | 1,004,000                    |       | 1,046,000                       |       |
| Licenses, net                                                                                                                                    |       | 62,000                       |       | 75,000                          |       |
| Restricted cash  and other assets                                                                                                                |       | 502,000                      |       | 633,000                         |       |
| Total assets                                                                                                                                     |       | $                            | 10,574,000 |                            | $          | 7,213,000 |   |
| LIABILITIES AND STOCKHOLDERS’ DEFICIT                                                                                                       |       |                         |       |                            |       |
| Current  liabilities                                                                                                                             |       |                         |       |                            |       |
| Accounts payable  and accrued expenses                                                                                                           |       | $                            | 2,733,000  |                            | $          | 2,883,000 |   |
| Accrued interest  payable                                                                                                                        |       | 887,000                      |       | 652,000                         |       |
| Deferred  revenues                                                                                                                               |       | 173,000                      |       | 173,000                         |       |
| Current portion  of long-term debt                                                                                                               |       | 7,763,000                    |       | 106,000                         |       |
| Total current  liabilities                                                                                                                       |       | 11,556,000                   |       | 3,814,000                       |       |
| Long-term debt                                                                                                                                   |       | 7,992,000                    |       | 7,636,000                       |       |
| Total  liabilities                                                                                                                               |       | 19,548,000                   |       | 11,450,000                      |       |
| Commitments and  contingencies                                                                                                                   |       |                         |       |                            |       |
| Stockholders’  deficit                                                                                                                      |       |                         |       |                            |       |
| Preferred stock  - $.01 par value; authorized 2,000,000 shares; none issued or outstanding                                                       |       | —                       |       | —                          |       |
| Common stock -  $.01 par value; authorized 100,000,000 shares; issued, 3,530,208 at  March 31, 2006 and 3,528,108 at December 31, 2005 |       | 35,000                       |       | 35,000                          |       |
| Additional  paid-in capital                                                                                                                      |       | 63,061,000                   |       | 62,942,000                      |       |
| Notes receivable  from stockholders                                                                                                              |       | (1,045,000                   | )          | (1,045,000                      | )          |
| Treasury stock,  at cost — 163 shares                                                                                                       |       | (4,000                       | )          | (4,000                          | )          |
| Accumulated  deficit                                                                                                                             |       | (71,021,000                  | )          | (66,165,000                     | )          |
| Total  stockholders’ deficit                                                                                                                |       | (8,974,000                   | )          | (4,237,000                      | )          |
| Total liabilities and stockholders’ deficit                                                                                                 |       | $                            | 10,574,000 |                            | $          | 7,213,000 |   |

 

The accompanying notes are an integral part of these statements.

23

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**Access Pharmaceuticals, Inc. and Subsidiaries**

CondensedConsolidated Statements of Operations(unaudited)
| ** **                                                        | ** ** | **Three Months ended March 31,** | ** ** |
|-------------------------------------------------------------------|------------|------------------------------------------------------|------------|
| ** **                                                        | ** ** | **2006**                                             | ** ** | **2005** | ** ** |
| Expenses                                                          |       |                                                 |       |   |   |
| Research and development                                          |       | $                                                    | 756,000    |   | $ | 541,000 |   |
| General and administrative                                        |       | 666,000                                              |       | 689,000 |   |
| Depreciation and amortization                                     |       | 77,000                                               |       | 83,000 |   |
| Total expenses                                                    |       | 1,499,000                                            |       | 1,313,000 |   |
| Loss from operations                                              |       | (1,499,000                                           | )          | (1,313,000 | ) |
| Interest and miscellaneous income                                 |       | 92,000                                               |       | 10,000 |   |
| Interest and  other expense                                       |       | (1,299,000                                           | )          | (313,000 | ) |
| Unrealized loss  on fair value of warrants                        |       | (2,150,000                                           | )          | — |   |
|                                                              |       | (3,357,000                                           | )          | (303,000 | ) |
| Loss before  discontinued operations                              |       | (4,856,000                                           | )          | (1,616,000 | ) |
| Discontinued  operations                                          |       | —                                               |       | (814,000 | ) |
| Net loss                                                          |       | $                                                    | (4,856,000 | ) | $ | (2,430,000 | ) |
| Basic and diluted loss per common share                           |       |                                                 |       |   |   |
| Loss from continuing operations allocable to common  stockholders |       | $                                                    | (1.38      | ) | $ | (0.52 | ) |
| Discontinued operations                                           |       | —                                               |       | (0.26 | ) |
| Net loss allocable to common stockholders                         |       | $                                                    | (1.38      | ) | $ | (0.78 | ) |
| Weighted average  basic and diluted common shares outstanding     |       | 3,528,831                                            |       | 3,104,947 |   |

 

The accompanying notes are an integral part of these statements.

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**Access Pharmaceuticals, Inc. and Subsidiaries**

CondensedConsolidated Statements of Cash Flows(unaudited)
| ** **                                                                                                                                    | ** ** | **Three Months ended March 31,** | ** ** |
|-----------------------------------------------------------------------------------------------------------------------------------------------|------------|------------------------------------------------------|------------|
| ** **                                                                                                                                    | ** ** | **2006**                                             | ** ** | **2005** | ** ** |
| Cash flows from  operating activities:                                                                                                        |       |                                                 |       |   |   |
| Net loss                                                                                                                                      |       | $                                                    | (4,856,000 | ) | $ | (2,430,000 | ) |
| Adjustments to reconcile net loss to cash used in  operating activities:                                                                      |       |                                                 |       |   |   |
| Amortization of restricted stock grants                                                                                                       |       | —                                               |       | 32,000 |   |
| Depreciation and amortization                                                                                                                 |       | 77,000                                               |       | 164,000 |   |
| Stock option expense                                                                                                                          |       | 95,000                                               |       | — |   |
| Stock expense                                                                                                                                 |       | 23,000                                               |       | — |   |
| Amortization of debt costs and discounts                                                                                                      |       | 986,000                                              |       | 46,000 |   |
| Unrealized loss on fair value of warrants                                                                                                     |       | 2,150,000                                            |       | — |   |
| Change in operating assets and liabilities:                                                                                                   |       |                                                 |       |   |   |
| Receivables                                                                                                                                   |       | —                                               |       | 27,000 |   |
| Inventory                                                                                                                                     |       | —                                               |       | 12,000 |   |
| Prepaid expenses and other current assets                                                                                                     |       | 58,000                                               |       | 136,000 |   |
| Restricted cash and other assets                                                                                                              |       | 35,000                                               |       | 553,000 |   |
| Accounts payable and accrued expenses                                                                                                         |       | (150,000                                             | )          | (331,000 | ) |
| Accrued interest payable                                                                                                                      |       | 235,000                                              |       | 261,000 |   |
| Deferred revenues                                                                                                                             |       | —                                               |       | 229,000 |   |
| Net cash used in operating activities                                                                                                         |       | (1,347,000                                           | )          | (1,301,000 | ) |
| Cash flows from investing activities:                                                                                                         |       |                                                 |       |   |   |
| Capital expenditures                                                                                                                          |       | —                                               |       | (10,000 | ) |
| (Purchases) redemptions of short term investments  and certificates of deposit                                                                |       | (34,000                                              | )          | 14,000 |   |
| Net cash (used in) provided by investing activities                                                                                           |       | (34,000                                              | )          | 4,000 |   |
| Cash flows from financing activities:                                                                                                         |       |                                                 |       |   |   |
| Payments of notes payable                                                                                                                     |       | (37,000                                              | )          | (223,000 | ) |
| Proceeds from secured convertible notes payable                                                                                               |       | 4,532,000                                            |       | 2,633,000 |   |
| Net cash provided by financing activities                                                                                                     |       | 4,495,000                                            |       | 2,410,000 |   |
| Net increase in cash and cash equivalents                                                                                                     |       | 3,114,000                                            |       | 1,113,000 |   |
| Cash and cash  equivalents at beginning of period                                                                                             |       | 349,000                                              |       | 1,775,000 |   |
| Cash and cash  equivalents at end of period                                                                                                   |       | $                                                    | 3,463,000  |   | $ | 2,888,000 |   |
| *Cash paid for interest*                                                                                                                      |       | $                                                    | 2,000      |   | $ | 7,000 |   |
| *Supplemental  disclosure of non-cash transactions 200,000 shares of common stock issued  pursuant to the SEDA and Secured Convertible Notes* |       | $                                                    | —     |   | $ | 500,000 |   |

 

The accompanying notes are an integral part ofthese statements.

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**Access Pharmaceuticals, Inc. and Subsidiaries**

Notes to Condensed Consolidated Financial StatementsThree Months Ended March 31, 2006 and2005(unaudited)

**(1)**                                  InterimFinancial Statements

The consolidated balancesheet as of March 31, 2006 and the consolidated statements of operationsand cash flows for the three months ended March 31, 2006 and 2005 wereprepared by management without audit. In the opinion of management, alladjustments, consisting only of normal recurring adjustments, except asotherwise disclosed, necessary for the fair presentation of the financialposition, results of operations, and changes in financial position for suchperiods, have been made. All share and per share information reflect a one forfive reverse stock split effected on June 5, 2006.

Certain information andfootnote disclosures normally included in financial statements prepared inaccordance with accounting principles generally accepted in the United Statesof America have been condensed or omitted. It is suggested that these interimfinancial statements be read in conjunction with the financial statements andnotes thereto included in our Annual Report on Form 10-K for theyear ended December 31, 2005. The results of operations for the periodended March 31, 2006 are not necessarily indicative of the operatingresults which may be expected for a full year. The consolidated balance sheetas of December 31, 2005 contains financial information taken from theaudited financial statements as of that date.

**(2)**                                  IntangibleAssets

Intangible assets consistof the following (in thousands):
| ** **                     | ** ** | **March 31, 2006** | ** ** | **December 31, 2005** | ** ** |
|--------------------------------|------------|------------------------------|------------|---------------------------------|------------|
| ** **                     | ** ** | **Gross  carrying  value**   | ** ** | **Accumulated  amortization**   | ** ** | **Gross  carrying  value** | ** ** | **Accumulated  amortization** | ** ** |
| Amortizable intangible  assets |       |                         |       |                            |       |   |   |   |   |
| Patents                        |       | $                            | 1,680      |                            | $          | 676 |   | $ | 1,680 |   | $ | 634 |   |
| Licenses                       |       | 500                          |       | 438                             |       | 500 |   | 425 |   |
| Total                          |       | $                            | 2,180      |                            | $          | 1,114 |   | $ | 2,180 |   | $ | 1,059 |   |

 

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Amortization expenserelated to intangible assets totaled $55,000 and $96,000****foreach of the three months ended March 31, 2006 and 2005, respectively. Theaggregate estimated amortization expense for intangible assets remaining as of March 31is as follows (in thousands):

| 2006       |   | $   | 163    |   |
|------------|--------|-----|--------|--------|
| 2007       |   | 193 |   |
| 2008       |   | 168 |   |
| 2009       |   | 168 |   |
| 2010       |   | 168 |   |
| Thereafter |   | 206 |   |
| Total      |   | $   | 1,066  |   |

 

**(3)**                                  Liquidity

The Company incurred significant losses from continuingoperations of $4.86 million for the quarter ending March 31, 2006, $7.6million for the year ended December 31, 2005 and $7.2 million for the yearended December 31, 2004. Additionally, at March 31, 2006, we haveworking capital of ($3,230,000). As of March 31, 2006, we did nothave sufficient funds to repay our convertible notes at their maturity andsupport our working capital and operating requirements. As described below thefunds raised from SCO and affiliates together with amounts due to us in October fromthe sale of our oral/topical care business to Uluru, Inc. we believe thatthese funds will allow us to support our working capital and operatingrequirements for nine months. We do not have funds to pay the obligations whichare due in March and April 2007 and will have to raise more funds orattempt to restructure the convertible notes.

SCO Capital Partners LLC Note and Warrant Purchase Agreement

On February 16, 2006, we entered into a note and warrant purchase agreementpursuant to which we sold and issued an aggregate of $5.0 million of 7.5%convertible notes due March 31, 2007 and warrants to purchase an aggregateof 3,863,636 shares of common stock of Access. Net proceeds to Access were$4.557 million. The notes and warrants were sold in a private placement to agroup of accredited investors led by SCO Capital Partners LLC (“SCO”).

The notes matureon March 31, 2007, are convertible into Access common stock at a fixedconversion rate of $1.10 per share, bear interest of 7.5% per annum and aresecured by certain assets of Access. Each note may be converted at the optionof the noteholder or Access under certain circumstances as set forth in thenotes.

Each noteholderreceived a warrant to purchase a number of shares of common stock of Accessequal to 75% of the total number shares of Access common stock into which suchholder’s note is convertible. Each warrant has an exercise price of $1.32 pershare and is exercisable at any time prior to February 16, 2012. In theevent SCO and its affiliates were to convert all of their notes and exerciseall of their warrants, they would own approximately 70% of the votingsecurities of Access.

The Company considers the warrantagreement and the conversion feature of the notes to be derivatives and hasclassified the warrants and the conversion feature as liabilities at fair valuein the balance sheet. Information regarding the valuation of the warrants andthe conversion feature is as follows:

|                                                    | ** ** | **2006**              | ** ** |
|----------------------------------------------------|------------|-----------------------|------------|
| ** **                                         | ** ** | **February 16,** | ** ** | **March 31,** | ** ** |
| Weighted-average  fair value of warrants           |       | $                     | 0.93       |   | $ | 1.11 |   |
| Black-Scholes  Assumptions:                        |       |                  |       |   |   |
| Dividend rate                                      |       | —                |       | — |   |
| Average risk-free interest rate                    |       | 5.08                  | %          | 5.08 | % |
| Average volatility                                 |       | 113                   | %          | 142 | % |
| Contractual life in years                          |       | 6.0                   |       | 5.9 |   |
|                                               |       |                  |       |   |   |
| Weighted-average  fair value of conversion feature |       | $                     | 0.50       |   | $ | 0.63 |   |
| Black-Scholes  Assumptions:                        |       |                  |       |   |   |
| Dividend rate                                      |       | —                |       | — |   |
| Average risk-free interest rate                    |       | 3.50                  | %          | 3.50 | % |
| Average volatility                                 |       | 113                   | %          | 142 | % |
| Contractual life in years                          |       | 1.1                   |       | 1.0 |   |

 

The change in fairvalue of the warrant between February 16, 2006 and March 31, 2006, has beenreflected as an unrealized loss on fair value in the accompanying statement ofoperations.

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In connection withits sale and issuance of notes and warrants, Access entered into an investorsrights agreement whereby it granted SCO the right to designate two individualsto serve on the Board of Directors of Access while the notes are outstanding,and also granted registration rights with respect to the shares of common stockof Access underlying the notes and warrants. SCO designated Jeffrey B. Davisand Mark J. Alvino to the Board of Directors, and on March 13, 2006Messrs, Davis and Alvino were appointed to the Board of Directors.

Standby EquityDistribution Agreement (SEDA) with Cornell Capital Partners

On March 30, 2005, the Company executed a StandbyEquity Distribution Agreement (SEDA) with Cornell Capital Partners. Under theSEDA, the Company may issue and sell to Cornell Capital Partners common stockfor a total purchase price of up to $15,000,000. The purchase price for theshares is equal to their market price, which is defined in the SEDA as 98% ofthe lowest volume weighted average price of the common stock during a specifiedperiod of trading days following the date notice is given by the Company thatit desires to access the SEDA. Further, we have agreed to pay Cornell CapitalPartners, L.P. 3.5% of the proceeds that we receive under the Equity Line ofCredit. The amount of each draw down is subject to a maximum amount of$1,000,000. The terms of the SEDA do not allow us to make draw downs shouldthey cause Cornell Capital to own in excess of 9.9% of our outstanding sharesof common stock. Upon closing of the transaction, Cornell Capital Partnersreceived a one-time commitment fee of 29,300 shares of the Company’s commonstock. On the same date, the Company entered into a Placement Agent Agreementwith Newbridge Securities Corporation, a registered broker-dealer. Pursuant tothe Placement Agent Agreement, upon closing of the transaction the Company paida one-time placement agent fee of 700 shares of common stock. The shares issuedwere valued at $500,000 and recorded as issuance costs and such costs areamortized as the SEDA is accessed. As of March 31, 2006 we have accessed$600,000 of the SEDA and $116,000 of the issuance costs were charged toadditional paid-in capital. At this time the Company will not be able to accessthe SEDA until a post-effective amendment to our registration statement isfiled with, and declared effective by, the SEC. The SEDA can be accessedthrough March 30, 2007.

**(4)**                                 DiscontinuedOperations

In October 2005, wesold our oral/topical care business to Uluru, Inc. for up to $20.6million. At the closing of this agreement we received $8.7 million. Inaddition, at the one year anniversary of the agreement we will receive $3.7million and we will receive an additional $1 million within 24 months afterclosing or earlier upon the achievement of a milestone. Any contingentliabilities that arise in the future relating to our former business couldreduce the $3.7 million receipt. Additional payments of up to $7.2 million maybe made upon the achievement of certain additional milestones.

In September 2005 weclosed our Australian laboratory and office, keeping the vitamin B12technology.

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In accordance withStatement of Financial Accounting Standards (“SFAS”) No. 144, “Accountingfor the Impairment or Disposal of Long-Lived Assets” operating results forassets sold or held for sale are presented as discontinued operations forcurrent and all prior years presented. In accordance with SFAS No. 144 theoperating results of these assets, along with the gain on sale, have beenpresented in discontinued operations for all periods presented.

|                                    | ** ** | **March 31, 2006** | ** ** | **March 31, 2005** | ** ** |
|------------------------------------|------------|------------------------------|------------|------------------------------|------------|
| Revenue                            |       | $                            | —     |                         | $          | 155,000 |   |
| Operating  expenses                |       | —                       |       | 969,000                      |       |
| Loss from  discontinued operations |       | —                       |       | $                            | (814,000   | ) |
|                                    |            |                              |            |                              |            |  |  |

 

We previously hadlicenses for the oral/topical assets. These licenses were sold to Uluru, Inc.in October 2005. In the Asset Sale Agreement between us and Uluru certainrefunds and receipts were incurred before the date of sale and were assigned toeither us or to Uluru. We have $173,000 recorded as a deferred gain on the saleuntil such time as marketing approvals are received.

**(5)**                                 Stock BasedCompensation

The Company has variousstock-based employee compensation plans, which are described more fully in Note10 of the Notes to Consolidated Financial Statements in the Company’s AnnualReport on Form 10-K for the fiscal year ended December 31,2005.

On January 1, 2006,the Company adopted SFAS No. 123 (revised 2004), “*Share-Based Payment*,” (“SFAS 123(R)”),which requires the measurement and recognition of all share-based paymentawards made to employees and directors including stock options based onestimated fair values. SFAS 123(R) supersedes the Company’s previousaccounting under Accounting Principles Board (“APB”) Opinion No. 25, “*Accounting for Stock Issued to Employees*”(“APB 25”), for periods beginning in fiscal year 2006. In March 2005, theSecurities and Exchange Commission issued Staff Accounting Bulletin No. 107(“SAB 107”) relating to SFAS 123(R). The Company has applied the provisions ofSAB 107 in its adoption of SFAS 123(R).

The Company adopted SFAS123(R) using the modified prospective transition method, which requiresthe application of the accounting standard as of January 1, 2006, thefirst day of the Company’s 2006 fiscal year. The Company’s consolidatedfinancial statements for the three months ended March 31, 2006, reflectthe impact of SFAS 123(R). In accordance with the modified prospectivetransition method, the Company’s consolidated financial statements for priorperiods have not been restated to include the impact of SFAS 123(R).Stock-based compensation expense recognized under SFAS 123(R) for thethree months ended March 31, 2006 was approximately $95,000. Stock-basedcompensation expense which would have been recognized under the fair valuebased method would have been approximately $155,000 during the three monthsended March 31, 2005.

SFAS 123(R) requirescompanies to estimate the fair value of share-based payment awards on the dateof grant using an option-pricing model. The value of the portion of the awardthat is ultimately expected to vest is recognized as expense over the requisiteservice period in the Company’s Statement of Operations. Prior to the adoptionof SFAS 123(R), the Company 

29

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accounted for stock-basedawards to employees and directors using the intrinsic value method inaccordance with APB No. 25 as allowed under SFAS No. 123, “*Accounting for Stock-Based Compensation*” (“SFAS123”). Under the intrinsic value method, no stock-based compensation expensefor stock option grants is recognized because the exercise price of the Company’sstock options granted to employees and directors equaled the fair market valueof the underlying stock at the date of grant. In 2005, the Company didrecognize stock compensation expense for restricted stock awards based on thefair value of the underlying stock on date of grant and this expense wasamortized over the requisite service period. There are no restricted stockawards granted in 2006 as yet and therefore no stock compensation expense isrecognized in 2006.

Stock-based compensationexpense recognized in the Company’s Statement of Operations for the firstquarter of fiscal year 2006 includes compensation expense for share-basedpayment awards granted prior to, but not yet vested as of December 31,2005, based on the grant date fair value estimated in accordance with the proforma provisions of SFAS 123 and compensation expense for the share-basedpayment awards granted subsequent to December 31, 2005, based on the grantdate fair value estimated in accordance with the provisions of SFAS 123(R).Stock-based compensation expense recognized in the Company’s Statement ofOperations for the first quarter of fiscal year 2006 is based on awardsultimately expected to vest and has been reduced for estimated forfeitures,which currently is nil. SFAS 123(R) requires forfeitures to be estimatedat the time of grant and revised, if necessary, in subsequent periods if actualforfeitures differ from those estimates. In the Company’s pro forma informationrequired under SFAS 123 for periods prior to fiscal year 2006, forfeitures havebeen accounted for as they occurred.

The Company used theBlack-Scholes option-pricing model (“Black-Scholes”) as its method of valuationunder SFAS 123(R) in fiscal year 2006 and a single option award approach.This fair value is then amortized on a straight-line basis over the requisiteservice periods of the awards, which is generally the vesting period.Black-Scholes was also previously used for the Company’s pro forma informationrequired under SFAS 123 for periods prior to fiscal year 2006. The fair valueof share-based payment awards on the date of grant as determined by theBlack-Scholes model is affected by the Company’s stock price as well as otherassumptions. These assumptions include, but are not limited to the expectedstock price volatility over the term of the awards, and actual and projectedemployee stock option exercise behaviors.

The weighted-averageestimated value of employee stock options granted during the three months endedMarch 31, 2006 was estimated using the Black-Scholes model with thefollowing assumptions:

30

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|                           | ** ** | **Three Months Ended  March 31, 2006** | ** ** |
|---------------------------|------------|------------------------------------------------------------|------------|
| Expected  volatility      |       | 113                                                        | %          |
| Risk-free  interest rate  |       | 4.72                                                       | %          |
| Expected  dividends       |       | 0.0                                                        | %          |
| Expected  forfeiture rate |       | 0.0                                                        | %          |
| Expected term in years    |       | 2.0                                                        |       |

 

No stock options weregranted in the first quarter of 2005.

The expected volatilityassumption was based upon a combination of historical stock price volatilitymeasured on a twice a month basis and is a reasonable indicator of expectedvolatility. The risk-free interest rate assumption is based upon U.S. Treasurybond interest rates appropriate for the term of the Company’s employee stockoptions. The dividend yield assumption is based on the Company’s history andexpectation of dividend payments. The estimated expected term is based on employeeexercise behavior.

During the first quarterof 2006, the Board of Directors granted the following awards to certaindirectors, executives, and new employees. 

|                                   | ** ** | **Quantity** | ** ** | **Weighted Average  Fair Value Per Share** | ** ** | **Fair Value** | ** ** |
|-----------------------------------|------------|--------------|------------|----------------------------------------------------------------|------------|---------------------|------------|
| Options to  Purchase Common Stock |       | 36,873       |       | $                                                              | 0.45       |                | $          | 17,094 |   |
|                                   |            |              |            |                                                                |            |                     |            |  |  |

 

Options to purchase 29,673shares of common stock vested immediately and options to purchase 7,200 sharesof common stock vest six months after grant.

At March 31, 2006,the balance of unearned stock-based compensation to be expensed in futureperiods related to unvested share-based awards, as adjusted for expectedforfeitures, is approximately $263,000. The period over which the unearnedstock-based compensation is expected to be recognized is approximately threeand 3/4 years. The Company anticipates that it will grant additionalshare-based awards to employees in the future, which will increase the Company’sstock-based compensation expense by the additional unearned compensation resultingfrom these grants. The fair value of these grants is not included in the amountabove, because the impact of these grants cannot be predicted at this time dueto the dependence on the number of share-based payments granted. In addition,if factors change and different assumptions are used in the application ofSFAS 123(R) in future periods, stock-based compensation expenserecorded under SFAS 123(R) may differ significantly from what hasbeen recorded in the current period.

The Company’s EmployeeStock Purchase Plan has been deemed compensatory in accordance with SFAS123(R). Stock-based compensation relating to this plan was computed using theBlack-Scholes model option-pricing formula with interest rates, volatility anddividend assumptions as of the respective grant dates of the purchase rightsprovided to employees under the plan. The weighted-average fair value of options

31

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existing under this planduring the first quarter of 2006 was $0.09.

The following tablesummarizes stock-based compensation in accordance with SFAS 123(R) for thethree months ended March 31, 2006, which was allocated as follows (inthousands):

|                                                                  | ** ** | **Three months ended  March 31, 2006** | ** ** |
|------------------------------------------------------------------|------------|------------------------------------------------------------|------------|
| Research and  development                                        |       | $                                                          | 22         |   |
| General and  administrative                                      |       | 73                                                         |       |
| Stock-based compensation expense included in  operating expenses |       | 95                                                         |       |
| Total stock-based compensation expense                           |       | 95                                                         |       |
| Tax benefit                                                      |       | —                                                     |       |
| Stock-based compensation expense, net of tax                     |       | $                                                          | 95         |   |

 

The following tablereflects net income and diluted earnings per share for the three months ended March 31,2006, compared with proforma information for the three months ended March 31,2005, had compensation cost been determined in accordance with the fairvalue-based method prescribed by SFAS 123(R). 
| ** **                                                                                                                               | ** ** | **Three Months Ended March 31,**               | ** ** |
|------------------------------------------------------------------------------------------------------------------------------------------|------------|--------------------------------------------------------------------|------------|
| ** **                                                                                                                               | ** ** | **2006 Actuals**                                              | ** ** | **2005 Proforma** | ** ** |
| ** **                                                                                                                               | ** ** | **(In thousands, except per share data)** | ** ** |
| Net loss, as reported under APB 25 for the prior  period (1)                                                                             |       | $                                                                  | N/A        |   | $ | (2,430 | ) |
| Add back stock  based employee compensation expense in reported net loss, net of related tax  effects                                    |       | —                                                             |       | — |   |
| Subtract total stock-based compensation expense  determined under fair value-based method for all awards, net of related tax  effects(2) |       | (95                                                                | )          | (155 | ) |
| Net loss including the effect of stock-based  compensation expense(3)                                                                    |       | $                                                                  | (4,856     | ) | $ | (2,585 | ) |
| Loss per share:                                                                                                                          |       |                                                               |       |   |   |
| Basic and diluted, as reported for the prior  period(1)                                                                                  |       | $                                                                  | (1.38      | ) | $ | (0.78 | ) |
| Basic and  diluted, including the effect of stock-based compensation expense(3)                                                          |       | $                                                                  | (1.38      | ) | $ | (0.83 | ) |

 

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(1)             Net loss and loss pershare for periods prior to year 2006 does not include stock-based compensationexpense under SFAS 123 because the Company did not adopt the recognitionprovisions of SFAS 123. 

(2)             Stock-basedcompensation expense for periods prior to year 2006 was calculated based on thepro forma application of SFAS 123. 

(3)             Net loss and loss pershare for periods prior to year 2006 represent pro forma information based onSFAS 123. 

Summary of Plans

During May 2005, theCompany adopted a stock awards plan, as amended, (the “2005 Equity IncentivePlan”) which covers 1,000,000 shares of common stock. Under its terms,employees, officers and directors of the Company and its subsidiaries arecurrently eligible to receive non-qualified stock options, restricted stockawards and incentive stock options within the meaning of Section 422 ofthe Internal Revenue Code of 1986 (the “Code”). In addition, advisors andconsultants who perform services for the Company or its subsidiaries areeligible to receive non-qualified stock options under the Stock Incentive Plan.The Stock Incentive Plan is administered by the Board of Directors or acommittee designated by the Board of Directors. 36,873 options were granted inthe first quarter of 2006 at a weighted average exercise price of $3.10 pershare and with 118 months remaining on its contractual life.

Under the 1995 StockAwards Plan, as amended, 500,000 shares of our authorized but unissued commonstock were reserved for issuance to optionees including officers, employees,and other individuals performing services for us. At December 31, 2005,there were no additional shares available for grant under the 1995 Stock AwardsPlan. A total of 474,044 options were issued under this plan.

All stock options grantedunder the 2005 Equity Incentive Plan and 1995 Stock Awards Plan are exercisablefor a period of up to ten years from the date of grant. The Company may notgrant incentive stock options pursuant to either plan at exercise prices whichare less than the fair market value of the common stock on the date of grant.

In addition to the stockoptions covered by the above plans, the Company has outstanding options topurchase 100,000 shares of common stock under the 2000 Special Stock OptionPlan. All options under this plan are vested and there were no additionalshares available for grant under the Plan. All of the options in the 2000Special Stock Option Plan were exercisable at December 31, 2005. All ofthe options expire on March 1, 2010 and have an exercise price of $12.50per share.

33

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Summarized informationfor the 1995 Stock Awards Plan is as follows:
| ** **                                       | ** ** | **Shares** | ** ** | **Weighted-  average  exercise  price** | ** ** |
|--------------------------------------------------|------------|------------|------------|-----------------------------------------|------------|
| Outstanding options at  December 31, 2005   |       | 430,276    |       | 18.20                                   |       |
| Options granted,  forfeited or exercised in 2006 |       | —     |       | —                                  |       |
| Outstanding options at  March 31, 2006      |       | 430,276    |       | 18.20                                   |       |

 

**(6)           Debt**
|                                        | ** ** | **March 31,  2006** | ** ** | **December 31,  2005** | ** ** |
|----------------------------------------|------------|--------------------------|------------|-----------------------------|------------|
| Convertible note                       |       | $                        | 4,015,000  |                        | $          | 4,015,000 |   |
| Convertible note                       |       | 5,500,000                |       | 5,500,000                   |       |
|                                   |       | 9,515,000                |       | 9,515,000                   |       |
| Discount                               |       | (1,523,000               | )          | (1,879,000                  | )          |
|                                   |       | 7,992,000                |       | 7,636,000                   |       |
|                                   |       |                     |       |                        |       |
| SCO and  affiliates                    |       | 5,000,000                |       | —                      |       |
| Fair value –  warrants            |       | 4,280,000                |       | —                      |       |
| Fair value –  convertible feature |       | 2,871,000                |       | —                      |       |
|                                   |       | 12,151,000               |       | —                      |       |
| Discount                               |       | (4,457,000               | )          | —                      |       |
|                                   |       | 7,694,000                |       | —                      |       |
|                                   |       |                     |       |                        |       |
| Bank note                              |       | 69,000                   |       | 106,000                     |       |
| Total                                  |       | $                        | 15,755,000 |                        | $          | 7,742,000 |   |
|                                   |       |                     |       |                        |       |
| Short term                             |       | $                        | 7,763,000  |                        | $          | 106,000 |   |
|                                   |       |                     |       |                        |       |
| Long term                              |       | 7,992,000                |       | 7,636,000                   |       |
| Total                                  |       | $                        | 15,755,000 |                        | $          | 7,742,000 |   |

 

34

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