**UNITED STATES**

**SECURITIES AND EXCHANGE COMMISSION**

 

**WASHINGTON,D.C.  20549**

 

**FORM 10-Q**

 

**(MarkOne)**

 

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

 

**For thequarterly period ended****September 30, 2005**

 

**or**

 

**o****             ****TRANSITION REPORT PURSUANT TO SECTION 13 OR15(d) OF THE SECURITIES EXCHANGE ACT OF 1934**

 

**For thetransition period from                                        to**

 

**Commission File Number****  1-10581**

 

**BENTLEY PHARMACEUTICALS, INC.**

(Exact name of registrant as specified in its charter)

 
| **DELAWARE**                                                    | ** ** | **No. 59-1513162**               |
|-----------------------------------------------------------------|------------|---------------------------------------|
| (State or other jurisdiction of  incorporation or organization) |       | (I.R.S. Employer  Identification No.) |

 

**Bentley Park, 2 Holland Way, Exeter, NewHampshire  03833**

(Current Address of Principal Executive Offices)

 

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

 

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

 

Indicateby check mark whether the registrant is an accelerated filer (as defined in rule 12b-2of the Exchange Act).       YES  ý     NO  o

 

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

 

Thenumber of shares of the registrant’s common stock outstanding as of November 8,2005 was 21,841,564.

 

 

----

 

**Bentley Pharmaceuticals, Inc. and Subsidiaries**

**Form 10-Q for the Quarter Ended September 30,2005**

 

**Index**

 
| ** **        | ** **                                                                                          | ** **                                                                                                                                               |
|-------------------|-----------------------------------------------------------------------------------------------------|----------------------------------------------------------------------------------------------------------------------------------------------------------|
| **Part I.**  | **Unaudited  Financial Information**                                                                | **Page**                                                                                                                                                 |
|              |                                                                                                |                                                                                                                                                     |
|              | Item  1. Condensed Consolidated Financial Statements:                                               |                                                                                                                                                     |
|              |                                                                                                |                                                                                                                                                     |   |
|              |                                                                                                | Consolidated Balance  Sheets as of September 30, 2005 and December 31, 2004                                                                    | 3 |
|              |                                                                                                |                                                                                                                                                     |   |
|              |                                                                                                | Consolidated Income Statements  for the three months ended September 30, 2005 and 2004, and the nine  months ended September 30, 2005 and 2004 | 4 |
|              |                                                                                                |                                                                                                                                                     |   |
|              |                                                                                                | Consolidated Statement of  Changes in Stockholders’ Equity for the nine months ended September 30,  2005                                       | 5 |
|              |                                                                                                |                                                                                                                                                     |   |
|              |                                                                                                | Consolidated  Statements of Cash Flows for the nine months ended September 30, 2005  and 2004                                                       | 6 |
|              |                                                                                                |                                                                                                                                                     |   |
|              |                                                                                                | Notes to  Condensed Consolidated Financial Statements                                                                                                    | 8 |
|              |                                                                                                |                                                                                                                                                     |   |
|              | Item 2. Management’s  Discussion and Analysis of Financial Condition and Results of Operations | 16                                                                                                                                                       |
|              |                                                                                                |                                                                                                                                                     |   |
|              | Item 3.  Quantitative and Qualitative Disclosures About Market Risk                                 | 30                                                                                                                                                       |
|              |                                                                                                |                                                                                                                                                     |   |
|              | Item 4. Controls  and Procedures                                                                    | 31                                                                                                                                                       |
|              |                                                                                                |                                                                                                                                                     |   |
| **Part II.** | **Other Information**                                                                               |                                                                                                                                                     |
|              |                                                                                                |                                                                                                                                                     |   |
|              | Item 1. Legal Proceedings                                                                           | 32                                                                                                                                                       |
|              |                                                                                                |                                                                                                                                                     |   |
|              | Item 2.  Unregistered Sales of Equity Securities and Use of Proceeds                                | 32                                                                                                                                                       |
|              |                                                                                                |                                                                                                                                                     |   |
|              | Item 6. Exhibits                                                                                    | 33                                                                                                                                                       |

 

2

----

 

**Bentley Pharmaceuticals, Inc. and Subsidiaries**

**Consolidated Balance Sheets**

** **
| **(in  thousands, except per share data)**                                                                  | ** ** | **September 30,  2005** | ** ** | **December 31,  2004** | ** ** |
|-------------------------------------------------------------------------------------------------------------|------------|------------------------------|------------|-----------------------------|------------|
| ** **                                                                                                  | ** ** | ** **                   | ** ** | ** **                  | ** ** |
| **Assets**                                                                                                  |       |                         |       |                        |       |
|                                                                                                        |       |                         |       |                        |       |
| Current assets:                                                                                             |       |                         |       |                        |       |
| Cash and cash  equivalents                                                                                  |       | $                            | 35,813     |                        | $          | 34,230 |   |
| Marketable  securities                                                                                      |       | 469                          |       | 528                         |       |
| Receivables, net                                                                                            |       | 26,856                       |       | 27,860                      |       |
| Inventories, net                                                                                            |       | 12,758                       |       | 10,258                      |       |
| Deferred taxes                                                                                              |       | 613                          |       | 479                         |       |
| Prepaid expenses  and other                                                                                 |       | 1,568                        |       | 1,355                       |       |
| Total current  assets                                                                                       |       | 78,077                       |       | 74,710                      |       |
|                                                                                                        |       |                         |       |                        |       |
| Non-current assets:                                                                                         |       |                         |       |                        |       |
| Fixed assets,  net                                                                                          |       | 30,820                       |       | 30,849                      |       |
| Drug licenses  and related costs, net                                                                       |       | 13,944                       |       | 14,863                      |       |
| Restricted cash                                                                                             |       | 1,000                        |       | 1,000                       |       |
| Other                                                                                                       |       | 976                          |       | 508                         |       |
| Total  non-current assets                                                                                   |       | 46,740                       |       | 47,220                      |       |
|                                                                                                        |       | $                            | 124,817    |                        | $          | 121,930 |   |
|                                                                                                        |       |                         |       |                        |       |
| **Liabilities and Stockholders’ Equity**                                                               |       |                         |       |                        |       |
|                                                                                                        |       |                         |       |                        |       |
| Current liabilities:                                                                                        |       |                         |       |                        |       |
| Accounts payable                                                                                            |       | $                            | 15,608     |                        | $          | 17,048 |   |
| Accrued expenses                                                                                            |       | 9,686                        |       | 6,169                       |       |
| Related party  payable                                                                                      |       | 736                          |       | —                      |       |
| Short-term  borrowings                                                                                      |       | 2,129                        |       | 2,754                       |       |
| Current portion  of long-term debt                                                                          |       | 27                           |       | 31                          |       |
| Deferred income                                                                                             |       | 2,674                        |       | 1,594                       |       |
| Total current  liabilities                                                                                  |       | 30,860                       |       | 27,596                      |       |
|                                                                                                        |       |                         |       |                        |       |
| Non-current liabilities:                                                                                    |       |                         |       |                        |       |
| Deferred taxes                                                                                              |       | 2,047                        |       | 2,319                       |       |
| Long-term debt                                                                                              |       | 319                          |       | 349                         |       |
| Deferred income                                                                                             |       | 2,360                        |       | 1,944                       |       |
| Other                                                                                                       |       | 47                           |       | 65                          |       |
| Total  non-current liabilities                                                                              |       | 4,773                        |       | 4,677                       |       |
|                                                                                                        |       |                         |       |                        |       |
| Commitments and contingencies                                                                               |       |                         |       |                        |       |
|                                                                                                        |       |                         |       |                        |       |
| Stockholders’ equity:                                                                                  |       |                         |       |                        |       |
| Preferred stock,  $1.00 par value, authorized 2,000 shares, issued and outstanding, none                    |       | —                       |       | —                      |       |
| Common stock,  $.02 par value, authorized 100,000 shares, issued and outstanding, 21,840 and  21,312 shares |       | 437                          |       | 426                         |       |
| Additional  paid-in capital                                                                                 |       | 139,677                      |       | 140,418                     |       |
| Accumulated  deficit                                                                                        |       | (53,646                      | )          | (60,909                     | )          |
| Accumulated  other comprehensive income                                                                     |       | 2,716                        |       | 9,722                       |       |
| Total  stockholders’ equity                                                                            |       | 89,184                       |       | 89,657                      |       |
|                                                                                                        |       | $                            | 124,817    |                        | $          | 121,930 |   |

 

*Theaccompanying Notes to Condensed Consolidated Financial Statements are anintegral part of these financial statements.*

 

3

----

 

**Bentley Pharmaceuticals, Inc. and Subsidiaries**

**Consolidated Income Statements**

 
| ** **                                  | ** ** | **For the Three Months Ended  September 30,** | ** ** | **For the Nine Months Ended  September 30,** | ** ** |
|---------------------------------------------|------------|----------------------------------------------------|------------|---------------------------------------------------|------------|
| **(in thousands, except per share  data)**  | ** ** | **2005**                                           | ** ** | **2004**                                          | ** ** | **2005** | ** ** | **2004** | ** ** |
| Revenues:                                   | ** ** | ** **                                         | ** ** | ** **                                        | ** ** | ** ** | ** ** | ** ** | ** ** |
| Net product  sales                          |       | $                                                  | 22,057     |                                              | $          | 17,312 |   | $ | 68,769 |   | $ | 51,325 |   |
| Licensing and  collaboration revenues       |       | 1,455                                              |       | 791                                               |       | 3,751 |   | 2,550 |   |
| Total revenues                              |       | 23,512                                             |       | 18,103                                            |       | 72,520 |   | 53,875 |   |
|                                        |       |                                               |       |                                              |       |   |   |   |   |
| Cost of net product sales                   |       | 11,104                                             |       | 8,662                                             |       | 33,923 |   | 25,383 |   |
|                                        |       |                                               |       |                                              |       |   |   |   |   |
| Gross profit                                |       | 12,408                                             |       | 9,441                                             |       | 38,597 |   | 28,492 |   |
|                                        |       |                                               |       |                                              |       |   |   |   |   |
| Operating expenses:                         |       |                                               |       |                                              |       |   |   |   |   |
| Selling and  marketing                      |       | 3,503                                              |       | 3,199                                             |       | 12,118 |   | 10,919 |   |
| General and  administrative                 |       | 3,036                                              |       | 2,140                                             |       | 9,072 |   | 6,590 |   |
| Research and  development                   |       | 1,775                                              |       | 1,230                                             |       | 4,734 |   | 3,171 |   |
| Depreciation and  amortization              |       | 416                                                |       | 353                                               |       | 1,359 |   | 1,038 |   |
| Total operating  expenses                   |       | 8,730                                              |       | 6,922                                             |       | 27,283 |   | 21,718 |   |
|                                        |       |                                               |       |                                              |       |   |   |   |   |
| Income from operations                      |       | 3,678                                              |       | 2,519                                             |       | 11,314 |   | 6,774 |   |
|                                        |       |                                               |       |                                              |       |   |   |   |   |
| Other income (expenses):                    |       |                                               |       |                                              |       |   |   |   |   |
| Interest income                             |       | 238                                                |       | 157                                               |       | 610 |   | 399 |   |
| Interest expense                            |       | (53                                                | )          | (49                                               | )          | (163 | ) | (160 | ) |
| Other, net                                  |       | (1                                                 | )          | 130                                               |       | 23 |   | 1,405 |   |
|                                        |       |                                               |       |                                              |       |   |   |   |   |
| Income before income taxes                  |       | 3,862                                              |       | 2,757                                             |       | 11,784 |   | 8,418 |   |
|                                        |       |                                               |       |                                              |       |   |   |   |   |
| Provision for income taxes                  |       | 1,377                                              |       | 1,344                                             |       | 4,521 |   | 4,706 |   |
|                                        |       |                                               |       |                                              |       |   |   |   |   |
| Net income                                  |       | $                                                  | 2,485      |                                              | $          | 1,413 |   | $ | 7,263 |   | $ | 3,712 |   |
|                                        |       |                                               |       |                                              |       |   |   |   |   |
| Net income per common share:                |       |                                               |       |                                              |       |   |   |   |   |
| Basic                                       |       | $                                                  | 0.11       |                                              | $          | 0.07 |   | $ | 0.34 |   | $ | 0.18 |   |
| Diluted                                     |       | $                                                  | 0.11       |                                              | $          | 0.06 |   | $ | 0.32 |   | $ | 0.16 |   |
|                                        |       |                                               |       |                                              |       |   |   |   |   |
| Weighted average common shares outstanding: |       |                                               |       |                                              |       |   |   |   |   |
| Basic                                       |       | 21,652                                             |       | 21,049                                            |       | 21,455 |   | 20,764 |   |
| Diluted                                     |       | 22,970                                             |       | 22,746                                            |       | 22,700 |   | 22,772 |   |

 

*Theaccompanying Notes to Condensed Consolidated Financial Statements are anintegral part of these financial statements.*

 

4

----

 

**Bentley Pharmaceuticals, Inc. and Subsidiaries**

**Consolidated Statement of Changes in Stockholders’Equity**

** **
| ** **                               | ** ** | **$.02 Par Value  Common Stock** | ** ** | **Additional  Paid-In** | ** ** | **Accumulated** | ** ** | **Accumulated  Other  Comprehensive** | ** ** | ** **        | ** ** |
|------------------------------------------|------------|----------------------------------|------------|-------------------------|------------|-----------------|------------|---------------------------------------|------------|-------------------|------------|
| **(in thousands)**                       | ** ** | **Shares**                       | ** ** | **Amount**              | ** ** | **Capital**     | ** ** | **Deficit**                           | ** ** | **Income (Loss)** | ** ** | **Total** | ** ** |
|                                     |       |                             |       |                    |       |            |       |                                  |       |              |       |   |   |
| Balance at December 31, 2004        |       | 21,312                           |       | $                       | 426        |            | $          | 140,418                               |       | $                 | (60,909    | ) | $ | 9,722 |   | $ | 89,657 |   |
| Comprehensive  income (loss):            |       |                             |       |                    |       |            |       |                                  |       |              |       |   |   |
| Net income                               |       | —                           |       | —                  |       | —          |       | 7,263                                 |       | —            |       | 7,263 |   |
| Other  comprehensive loss:               |       |                             |       |                    |       |            |       |                                  |       |              |       |   |   |
| Foreign currency  translation adjustment |       | —                           |       | —                  |       | —          |       | —                                |       | (7,006            | )          | (7,006 | ) |
| Comprehensive  income                    |       |                             |       |                    |       |            |       |                                  |       |              |       | $ | 257 |   |
|                                     |       |                             |       |                    |       |            |       |                                  |       |              |       |   |   |
| Exercise of  stock options               |       | 876                              |       | 18                      |       | 3,182           |       | —                                |       | —            |       | 3,200 |   |
| Purchase of  treasury shares             |       | (364                             | )          | (7                      | )          | (4,102          | )          | —                                |       | —            |       | (4,109 | ) |
| Equity-based  compensation               |       | 16                               |       | —                  |       | 179             |       | —                                |       | —            |       | 179 |   |
|                                     |       |                             |       |                    |       |            |       |                                  |       |              |       |   |   |
| Balance at  September 30, 2005      |       | 21,840                           |       | $                       | 437        |            | $          | 139,677                               |       | $                 | (53,646    | ) | $ | 2,716 |   | $ | 89,184 |   |

 

*The accompanying Notes toCondensed Consolidated Financial Statements are an integral part of thesefinancial statements.*

 

5

----

 

**Bentley Pharmaceuticals, Inc. and Subsidiaries**

**Consolidated Statements of Cash Flows**

 

** **
| ** **                                                                         | ** ** | **For the Nine Months Ended  September 30,** | ** ** |
|------------------------------------------------------------------------------------|------------|---------------------------------------------------|------------|
| **(in thousands)**                                                                 | ** ** | **2005**                                          | ** ** | **2004** | ** ** |
|                                                                               |       |                                              |       |   |   |
| Cash flows from operating activities:                                              |       |                                              |       |   |   |
| Net income                                                                         |       | $                                                 | 7,263      |   | $ | 3,712 |   |
| Adjustments to  reconcile net income to net cash provided by operating activities: |       |                                              |       |   |   |
| Depreciation and  amortization                                                     |       | 3,872                                             |       | 2,748 |   |
| Equity-based  compensation expense                                                 |       | 179                                               |       | 167 |   |
| Loss on disposal  of assets                                                        |       | 190                                               |       | — |   |
| Other non-cash  items                                                              |       | 32                                                |       | (80 | ) |
| (Increase)  decrease in assets and increase (decrease) in liabilities:             |       |                                              |       |   |   |
| Receivables                                                                        |       | (2,175                                            | )          | (8,272 | ) |
| Inventories                                                                        |       | (4,193                                            | )          | (1,823 | ) |
| Deferred income  taxes                                                             |       | (192                                              | )          | — |   |
| Prepaid expenses  and other current assets                                         |       | (357                                              | )          | (607 | ) |
| Other assets                                                                       |       | (564                                              | )          | (1 | ) |
| Accounts payable  and accrued expenses                                             |       | 4,423                                             |       | 3,797 |   |
| Deferred income                                                                    |       | 1,880                                             |       | 1,450 |   |
| Other  liabilities                                                                 |       | (14                                               | )          | (279 | ) |
| Net cash  provided by operating activities                                         |       | 10,344                                            |       | 812 |   |
|                                                                               |       |                                              |       |   |   |
| Cash flows from investing activities:                                              |       |                                              |       |   |   |
| Additions to  fixed assets                                                         |       | (6,673                                            | )          | (6,217 | ) |
| Additions to  drug licenses and related costs                                      |       | (1,477                                            | )          | (849 | ) |
| Proceeds from  maturity of investments                                             |       | 158                                               |       | 149,100 |   |
| Purchase of  investments                                                           |       | (158                                              | )          | (148,230 | ) |
| Purchase of API  manufacturing assets                                              |       | —                                            |       | (3,309 | ) |
| Net cash used in  investing activities                                             |       | (8,150                                            | )          | (9,505 | ) |
|                                                                                    |            |                                                   |            |  |  |  |  |

 

(Continued on following page)

 

*The accompanying Notes to Condensed ConsolidatedFinancial Statements are an integral part of these financial statements.*

 

6

----

 
| ** **                                                                                                       | ** ** | **For the Nine Months Ended  September 30,** | ** ** |
|------------------------------------------------------------------------------------------------------------------|------------|---------------------------------------------------|------------|
| **(in thousands)**                                                                                               | ** ** | **2005**                                          | ** ** | **2004** | ** ** |
| Cash flows from financing activities:                                                                            |       |                                              |       |   |   |
| Proceeds from  the exercise of stock options/warrants                                                            |       | $                                                 | 1,800      |   | $ | 3,061 |   |
| Remittance of  employee tax liabilities in exchange for common stock tendered to the Company                     |       | (1,082                                            | )          | — |   |
| Purchases of  treasury stock                                                                                     |       | (305                                              | )          | — |   |
| Proceeds from  borrowings                                                                                        |       | 1,338                                             |       | 3,729 |   |
| Repayment of  borrowings                                                                                         |       | (1,684                                            | )          | (3,728 | ) |
| Net cash  provided by financing activities                                                                       |       | 67                                                |       | 3,062 |   |
|                                                                                                             |       |                                              |       |   |   |
| Effect of exchange rate changes on cash                                                                          |       | (678                                              | )          | 1 |   |
|                                                                                                             |       |                                              |       |   |   |
| Net increase (decrease) in cash and cash equivalents                                                             |       | 1,583                                             |       | (5,630 | ) |
|                                                                                                             |       |                                              |       |   |   |
| Cash and cash equivalents at beginning of period                                                                 |       | 34,230                                            |       | 39,393 |   |
|                                                                                                             |       |                                              |       |   |   |
| Cash and cash equivalents at end of period                                                                       |       | $                                                 | 35,813     |   | $ | 33,763 |   |
|                                                                                                             |       |                                              |       |   |   |
| **Supplemental Disclosures of Cash Flow  Information**                                                           |       |                                              |       |   |   |
| The Company paid cash during the period for:                                                                     |       |                                              |       |   |   |
| Interest                                                                                                         |       | $                                                 | 153        |   | $ | 270 |   |
| Foreign income  taxes                                                                                            |       | $                                                 | 3,209      |   | $ | 3,711 |   |
|                                                                                                             |       |                                              |       |   |   |
| **Supplemental Disclosures of Non-Cash Financing  and Investing Activities**                                     |       |                                              |       |   |   |
| The Company has  issued Common Stock as equity-based compensation in lieu of cash during the  period as follows: |       |                                              |       |   |   |
| Shares                                                                                                           |       | 16                                                |       | 12 |   |
| Amount                                                                                                           |       | $                                                 | 161        |   | $ | 151 |   |
|                                                                                                             |       |                                              |       |   |   |
| Amounts included in accounts payable at end of  period for fixed asset and drug license purchases                |       | $                                                 | 1,836      |   | $ | 1,951 |   |

 

*The accompanying Notes toCondensed Consolidated Financial Statements are an integral part of thesefinancial statements.*

 

7

----

 

**Bentley Pharmaceuticals, Inc. and Subsidiaries**

**Notes to Condensed Consolidated Financial Statements**

 

**History and Operations**

 

BentleyPharmaceuticals, Inc. and Subsidiaries (which may be referred to individually andcollectively asBentley Pharmaceuticals, Bentley, or the Company), headquartered in the U.S.,is an international specialty pharmaceutical company, incorporated in the Stateof Delaware, focused on:

 

•                  development, licensing and sales of generic andbranded pharmaceutical products and active pharmaceutical ingredients (API) andthe manufacturing of pharmaceuticals for others; and

 

•                  research, development andlicensing/commercialization of advanced drug delivery technologies andpharmaceutical products.

 

Bentley’spharmaceutical product sales and licensing activities are based primarily inSpain, where it has a significant commercial presence and manufactures andmarkets approximately 35 products through three wholly-owned Spanishsubsidiaries; Laboratorios Belmac, Laboratorios Davur and Laboratorios Rimafar.Bentley’s products include approximately 135 product formulations of variousdosages and strengths in four primary therapeutic areas: cardiovascular,gastrointestinal, neurological and infectious diseases. The Company continuallyadds to its product portfolio in response to increasing market demand forgeneric and branded therapeutic agents and, when appropriate, divests portfolioproducts considered to be redundant or that have become non-strategic.  Although most of the Company’s sales of theseproducts are currently in the Spanish market, it has recently focused onincreasing sales in other European countries and other geographic regionsthrough strategic alliances with companies in these territories.  In April 2004, the Company purchased amanufacturing facility located in Zaragoza, Spain that specializes in themanufacture of active pharmaceutical ingredients. The facility has beenapproved by the U.S. Food and Drug Administration for the manufacture of oneingredient for marketing and sale in the U.S. The Company manufactures andmarkets active pharmaceutical ingredients through its subsidiary, Bentley API.

 

TheCompany has U.S. and international patents and other proprietary rights totechnologies that facilitate the absorption of drugs. Bentley is developingproducts that incorporate its drug delivery technologies and has licensedapplications of its proprietary CPE-215® drug delivery technology to AuxiliumPharmaceuticals, Inc., which launched Testim® in the U.S. market, in February 2003.Testim, which incorporates Bentley’s CPE-215 drug delivery technology, is a gelindicated for low testosterone levels. Bentley continues to seek otherpharmaceutical and biotechnology companies to form additional strategicalliances to facilitate the development and commercialization of other productsusing its drug delivery technologies, including product formulations thatdeliver insulin to diabetic patients intranasally and that treat nail fungusinfections topically.

 

**Basisof Condensed Consolidated Financial Statements**

 

Thecondensed consolidated financial statements of Bentley Pharmaceuticals as of September 30,2005 and for the three and nine months ended September 30, 2005 and 2004,included herein, have been prepared by the Company, without audit, pursuant tothe rules and regulations of the Securities and Exchange Commission.Certain information and footnote disclosures normally included in financialstatements prepared in accordance with accounting principles generally acceptedin the United States of America have been condensed or omitted insofar as suchinformation was disclosed in the Company’s consolidated financial statementsfor the year ended December 31, 2004. These condensed consolidatedfinancial statements should be read in conjunction with the auditedconsolidated financial statements and notes thereto, including the summary ofsignificant accounting policies, included in Bentley’s Annual Report on Form 10-Kfor the year ended December 31, 2004.

 

8

----

 

Inthe opinion of management, the accompanying unaudited condensed consolidatedfinancial statements as of September 30, 2005 and for the three and ninemonths ended September 30, 2005 and 2004 are presented on a basisconsistent with the audited consolidated financial statements for the yearended December 31, 2004 and contain all adjustments, consisting only ofnormal recurring adjustments, necessary to present fairly Bentley’s financialposition as of September 30, 2005 and the results of its operations forthe three and nine months ended September 30, 2005 and 2004 and cash flowsfor the nine months ended September 30, 2005 and 2004.  The results of operations for the three andnine months ended September 30, 2005 should not necessarily be consideredindicative of the results to be expected for the full year ending December 31,2005 or any other interim period.

 

**Cashand cash equivalents**

 

The Company considers allhighly liquid investments with remaining maturities of three months or lesswhen purchased to be cash equivalents for purposes of classification in theConsolidated Balance Sheets and the Consolidated Statements of Cash Flows.Investments in securities that do not meet the definition of cash equivalentsare classified as *marketable securities*in the Consolidated Balance Sheets.

 

Included in *cash and cash equivalents* at September 30, 2005 and December 31,2004 are approximately $11,062,000 and $3,684,000, respectively, of short-terminvestments considered to be cash equivalents, as the original maturity datesof such investments were three months or less when purchased.

 

**Marketable securities**

 

The Company hasinvestments in securities, with maturities of greater than three months whenpurchased, which are classified as available-for-sale, totaling $469,000 as of September 30,2005, compared to $528,000 as of December 31, 2004. The Company’s investments are carried atamortized cost which approximates fair value due to the short-term nature ofthese investments.  Accordingly, nounrealized gains or losses have been recognized on these investments. Shouldthe fair values differ significantly from the amortized costs, unrealized gainsor losses would be included as a component of *othercomprehensive income (loss)*.

 

**Receivables**

 

Receivables consist of thefollowing (in thousands):

 
| ** **                                                                                                                              | ** ** | **September 30, 2005** | ** **   | **December 31, 2004** | ** ** |
|-----------------------------------------------------------------------------------------------------------------------------------------|------------|-----------------------------|--------------|----------------------------|------------|
| Trade  receivables (of which $2,129 and $2,754, respectively, collateralize  short-term borrowings with Spanish financial institutions) |       | $                           |  22,675 |                       | $          |  23,586 |   |
| VAT receivable                                                                                                                          |       | 1,457                       |         | 2,428                      |       |
| Royalties receivable                                                                                                                    |       | 2,944                       |         | 1,882                      |       |
| Other                                                                                                                                   |       | 230                         |         | 339                        |       |
|                                                                                                                                    |       | 27,306                      |         | 28,235                     |       |
| Less allowance for doubtful accounts                                                                                                    |       | (450                        | )            | (375                       | )          |
|                                                                                                                                    |       | $                           | 26,856       |                       | $          | 27,860 |   |

 

**Inventories**

 

Inventories are stated atthe lower of cost or market, cost being determined on the first in, first out (“FIFO”)method. Reserves for slow moving and obsolete inventories are provided based onhistorical experience and current product demand.

 

9

----

 

Inventory balances arecomprised of the following (in thousands):

 
| ** **                               | ** ** | **September 30, 2005** | ** ** | **December 31, 2004** | ** ** |
|------------------------------------------|------------|-----------------------------|------------|----------------------------|------------|
| Raw materials                            |       | $                           | 8,162      |                       | $          | 5,953 |   |
| Finished goods                           |       | 4,662                       |       | 4,380                      |       |
|                                     |       | 12,824                      |       | 10,333                     |       |
| Less allowance for slow moving inventory |       | (66                         | )          | (75                        | )          |
|                                     |       | $                           | 12,758     |                       | $          | 10,258 |   |

 

**Fixed assets**

 

Fixedassets consist of the following (in thousands):

 
| ** **                    | ** ** | **September 30, 2005** | ** ** | **December 31, 2004** | ** ** |
|-------------------------------|------------|-----------------------------|------------|----------------------------|------------|
| Land                          |       | $                           | 2,701      |                       | $          | 2,573 |   |
| Buildings and improvements    |       | 16,068                      |       | 16,076                     |       |
| Equipment                     |       | 19,283                      |       | 18,448                     |       |
| Furniture and fixtures        |       | 1,978                       |       | 1,850                      |       |
| Other                         |       | 146                         |       | 102                        |       |
|                          |       | 40,176                      |       | 39,049                     |       |
| Less accumulated depreciation |       | (9,356                      | )          | (8,200                     | )          |
|                          |       | $                           | 30,820     |                       | $          | 30,849 |   |

 

In order to support the Company’s growth in Europe, management isexpanding the capacity of its manufacturing facilities through a series ofcapital investments. The Company invested approximately $6,673,000 in capitaladditions, including $367,000 for the purchase of land, during the nine monthsended September 30, 2005.  Adecrease in the value of the Euro compared to the U.S. Dollar from December 31,2004 to September 30, 2005 has reduced the value of net fixed assets byapproximately $3,807,000.

 

Depreciation expense ofapproximately $235,000 and $220,000 has been charged to operations as acomponent of *depreciation and amortizationexpense* in the Consolidated Income Statements for the nine monthsended September 30, 2005 and 2004, respectively. Depreciation totalingapproximately $2,513,000 and $1,710,000 has been included in *cost of net product sales* during the ninemonths ended September 30, 2005 and 2004, respectively.

 

**Stockholders’ equity**

 

Asubstantial amount of the Company’s business is conducted in Europe and istherefore influenced by fluctuations in the U.S. Dollar’s value in relation toother currencies, specifically the Euro. The exchange rates at September 30,2005 and December 31, 2004 were .83 Euros and .73 Euros per U.S. Dollar,respectively. The weighted average exchange rate for the three months ended September 30,2005 and 2004 was .82 Euros per U.S. Dollar. The weighted average exchangerates for the nine months ended September 30, 2005 and 2004 were .79 Eurosand .82 Euros per U.S. Dollar, respectively. The net effect of foreign currencytranslation on the Company’s Condensed Consolidated Financial Statements forthe nine months ended September 30, 2005 was a net decrease of $7,006,000and the cumulative historical effect as of September 30, 2005 was anincrease of $2,716,000, as reflected in the Consolidated Balance Sheets as *accumulated other**comprehensive income*. The carrying valueof assets and liabilities can be materially affected by foreign currencytranslation, as can the translated amounts of revenues and expenses.Nonetheless, management does not plan to modify its business practices.

 

During the nine monthsended September 30, 2005, the Company issued approximately 16,000 sharesof Common Stock as equity-based compensation to the Company-sponsored 401(k)retirement savings plan. Certain employees and an independent consultant weregranted stock options to purchase an aggregate of 819,500 shares of CommonStock in the nine months ended September 30, 2005 at exercise pricesranging from $7.39 to $12.01 per share, which resulted in a weighted averageexercise price of $8.93 per share.

 

10

----

 

**Supplemental disclosures relatedto Consolidated Statements of Cash Flows**

 

Duringthe nine months ended September 30, 2005, the Chief Executive Officer (“CEO”),the Chief Financial Officer (“CFO”) and the Chief Medical Officer (“CMO”) ofthe Company exercised stock options to purchase an aggregate of 801,300 sharesof the Company’s Common Stock. In satisfaction of the option exercise prices,the Company received approximately $1,218,000 in cash proceeds and an aggregateof approximately 127,000 shares of previously acquired Bentley Common Stock,with a fair market value of approximately $1,400,000. The Company also receiveda total of approximately 147,800 shares of Common Stock, with a fair marketvalue of approximately $1,668,000, from the three employees in order tosatisfy minimum federal and statutory tax withholding requirements.Approximately $1,082,000 of the withholding taxes on these option exerciseswere remitted by the Company during the nine months ended September 30, 2005and the remaining $586,000 were remitted subsequent to September 30, 2005.Additionally, the Company repurchased approximately 90,600 shares of CommonStock with a fair market value of approximately $1,041,000 from the CEO andCMO, of which approximately $736,000, representing the repurchase of approximately62,800 shares, was recorded as a related party payable to the CEO atSeptember 30, 2005 and subsequently paid. The shares of Common Stock acquired by the Company in connection withthese stock option exercises were recorded at fair market value and are held bythe Company as treasury shares.

 

**Revenue recognition**

 

Revenue on product salesis recognized when persuasive evidence of an arrangement exists, the price isfixed and final, delivery has occurred and there is a reasonable assurance ofcollection of the sales proceeds. The Company generally obtains purchaseauthorizations from its customers for a specified amount of product at aspecified price and considers delivery to have occurred when the customer takespossession of the product. The Company provides its customers with a limitedright of return. Revenue is recognized upon delivery and a reserve for salesreturns is recorded when considered appropriate. The Company has demonstratedthe ability to make reasonable and reliable estimates of product returns inaccordance with Statement of Financial Accounting Standards (SFAS) No. 48,*Revenue Recognition When Right of Return Exists,*and of allowances for doubtful accounts based on significant historicalexperience.

 

Revenue from service,research and development, and licensing agreements is recognized when theservice procedures have been completed or as revenue recognition criteria havebeen met for each separate unit of accounting as defined in Emerging IssuesTask Force (EITF) Issue No. 00-21, *Accountingfor Revenue Arrangements with Multiple Deliverables*.  The Company has deferred the recognition ofapproximately $2,707,000 and $2,147,000 of licensing revenues as of September 30,2005 and December 31, 2004, respectively, for which the earnings processhas not been completed.

 

Royaltyrevenues on Testim product sales are currently recognized based on an estimateof Auxilium’s sell-through of the Testim product based on prescriptionsdispensed. For the three and nine months ended September 30, 2005, theCompany recognized royalty revenues of $1,391,000 and $3,512,000, respectively,compared to approximately $800,000 and $2,000,000 in the three and nine monthsended September 30, 2004, respectively. Under SFAS No. 48, theCompany cannot recognize all of the royalty revenues earned on productshipments of Testim until product returns related to those shipments can bereasonably estimated. The difference between the total amount earned fromAuxilium under the royalty arrangement and the amount recognized as a componentof *licensing and collaboration revenues* isrecorded as a component of current *deferred income*in the Consolidated Balance Sheets. Once returns can be reasonably estimated,the Company expects to record a one-time increase in *licensing andcollaboration revenues* related to the recognition of previouslydeferred royalty revenues. As of September 30, 2005 and December 31,2004, deferred income from Testim royalties totaled $1,635,000 and $1,233,000,respectively.

 

11

----

 

# **Provision for income taxes**

# ** **

Spanishtax authorities completed a tax review of the Company’s Spanish subsidiary,Laboratorios Belmac S.A., during the second quarter of 2004 for the tax years1998, 1999 and 2000. As a result of this audit, the subsidiary was assessed anadditional tax liability of approximately $604,000, which was recorded as acomponent of *provision for income taxes*forthe nine months ended September 30, 2004, and approximately $193,000 forrelated interest and penalties, which were recorded as components of *other income (expenses)*, in the consolidated incomestatements for the nine months ended September 30, 2004.

 

Asa result of reporting taxable income in Spain, the Company recorded a provisionfor foreign income taxes totaling $1,377,000 and $1,344,000 for the threemonths ended September 30, 2005 and 2004, respectively. The Companyrecorded provisions for foreign income taxes totaling $4,521,000 and $4,706,000(which amount includes the $604,000 tax audit settlement) for the nine monthsended September 30, 2005 and 2004, respectively. The effective tax rate inSpain for the nine months ended September 30, 2005 and 2004 is 33% and 44%(38% when excluding the $604,000 tax audit settlement), respectively.

 

As future domesticoperating profits cannot be reasonably assured, no tax benefit has beenrecorded for U.S. losses, which totaled $251,000 and $896,000 for the threemonths ended September 30, 2005 and 2004, respectively, and $1,819,000 and$2,377,000 for the nine months ended September 30, 2005 and 2004,respectively. Accordingly, the Company has established a valuation allowanceequal to the full amount of the U.S. net deferred tax asset. The 2004 provisionfor income taxes differs from the amounts computed by applying the U.S. federalincome tax rate of 34% to pre-tax income, primarily as a result of the increasein the valuation allowance to offset U.S. deferred tax assets, certainnondeductible expenses in Spain and the higher statutory income tax rate of 35%in Spain.

 

Should theCompany determine that it is more likely than not that it will realize certainof its deferred tax assets for which it had previously provided a valuationallowance, an adjustment would be required to reduce the existing valuationallowance.

 

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

# ** **

Basicand diluted net income per common share is based on the weighted average numberof shares of common stock outstanding during each period. The dilutive effectof outstanding stock options and stock purchase warrants, as calculated usingthe treasury stock method, were considered in the net income per sharecalculations for the three and nine months ended September 30, 2005 and2004.

 

Thefollowing is a reconciliation between basic and diluted net income per commonshare for the three and nine months ended September 30, 2005 and2004.  Dilutive securities issuable forthe three and nine months ended September 30, 2005 include approximately1,318,000 and 1,245,000 dilutive incremental shares, respectively, issuable asa result of various stock options that are outstanding. Dilutive securitiesissuable for the three and nine months ended September 30, 2004 includedapproximately 1,697,000 and 2,008,000 dilutive incremental shares,respectively, issuable as a result of various stock options and warrants thatwere outstanding.

 

Forthe Three Months Ended September 30, 2005 (in thousands, except per sharedata):

 
|                                       | ** ** | **Basic EPS** | ** ** | **Effect of Dilutive  Securities** | ** ** | **Diluted EPS** | ** ** |
|--------------------------------------------|------------|---------------|------------|------------------------------------|------------|-----------------|------------|
| Net Income                                 |       | $             | 2,485      | * *                           | $          | *—*        |       | $ | 2,485 |   |
| Weighted Average Common Shares Outstanding |       | 21,652        |       | 1,318                              |       | 22,970          |       |
| Net Income Per Common Share                |       | $             | 0.11       | * *                           | $          | *—*        |       | $ | 0.11 |   |

 

12

----

 

 

Forthe Three Months Ended September 30, 2004 (in thousands, except per sharedata):

 
| ** **                                 | ** ** | **Basic EPS** | ** ** | **Effect of Dilutive  Securities** | ** ** | **Diluted EPS** | ** ** |
|--------------------------------------------|------------|---------------|------------|------------------------------------|------------|-----------------|------------|
| Net Income                                 |       | $             | 1,413      | * *                           | $          | —          |       | $ | 1,413 |   |
| Weighted Average Common Shares Outstanding |       | 21,049        |       | 1,697                              |       | 22,746          |       |
| Net Income Per Common Share                |       | $             | 0.07       |                               | $          | (0.01           | )          | $ | 0.06 |   |

 

Forthe Nine Months Ended September 30, 2005 (in thousands, except per sharedata):

 
| ** **                                 | ** ** | **Basic EPS** | ** ** | **Effect of Dilutive Securities** | ** ** | **Diluted EPS** | ** ** |
|--------------------------------------------|------------|---------------|------------|-----------------------------------|------------|-----------------|------------|
| Net Income                                 |       | $             | 7,263      | * *                          | *$*        | *—*        |       | $ | 7,263 |   |
| Weighted Average Common Shares Outstanding |       | 21,455        |       | 1,245                             |       | 22,700          |       |
| Net Income Per Common Share                |       | $             | 0.34       |                              | $          | (0.02           | )          | $ | 0.32 |   |

 

Forthe Nine Months Ended September 30, 2004 (in thousands, except per sharedata):

 
| ** **                                 | ** ** | **Basic EPS** | ** ** | **Effect of Dilutive Securities** | ** ** | **Diluted EPS** | ** ** |
|--------------------------------------------|------------|---------------|------------|-----------------------------------|------------|-----------------|------------|
| Net Income                                 |       | $             | 3,712      | * *                          | *$*        | *—*        |       | $ | 3,712 |   |
| Weighted Average Common Shares Outstanding |       | 20,764        |       | 2,008                             |       | 22,772          |       |
| Net Income Per Common Share                |       | $             | 0.18       |                              | $          | (0.02           | )          | $ | 0.16 |   |

 

Excluded from the dilutedearnings per share presentation, because their exercise prices were greaterthan the average fair market value of the Common Stock in the respectiveperiods, were options to purchase an aggregate of approximately 702,000 and1,135,000 shares of Common Stock, for the three and nine months ended September 30,2005, respectively, and options to purchase an aggregate of approximately740,000 and 583,000 shares of Common Stock, for the three and nine months endedSeptember 30, 2004, respectively.

 

**Equity-based compensation**

 

TheCompany has equity-based employee compensation plans that are described morefully in Note 11 of the Notes to Consolidated Financial Statements included inthe Annual Report on Form 10-K for the year ended December 31,2004.  The Company currently accounts forthese plans under the recognition and measurement principles of AccountingPrinciples Board (APB) Opinion No. 25, *Accounting for StockIssued to Employees*, and related Interpretations.  However, the Company is required to adoptSFAS No. 123 (Revised), *Share-Based Payment*as of January 1, 2006, which will change the method the Company uses toaccount for its equity-based compensation. Stock options granted under theseplans have exercise prices equal to or greater than the market value of theunderlying common stock on the dates of grant, which is generally the date onwhich compensation is measured. In addition to these plans, the Company alsosponsors a 401(k) Plan for eligible employees and matches eligiblecontributions with shares of the Company’s Common Stock.

 

13

----

 

Aspreviously disclosed, the Company acquired shares of Common Stock from certainemployees in connection with stock option exercises during the nine monthsended September 30, 2005. In accordance with APB Opinion No. 25 andFASB Interpretation No. 44, *Accounting for CertainTransactions Involving Stock Compensation*, no compensation expensehas been recorded as a result of the stock option exercises or shares acquiredby the Company. Although the ultimate disposition of the treasury shares hasnot yet been determined, the Company has elected to follow the accountingtreatment prescribed for the retirement of stock, which has resulted in a$4,109,000 reduction of *stockholders’ equity*inthe Consolidated Balance Sheet as of September 30, 2005, representing thefair market value of the 364,000 shares of Common Stock acquired.

 

 General and administrative expenses for thethree and nine months ended September 30, 2005 include approximately$30,000 and $74,000, respectively, of non-cash equity-based compensation.General and administrative expenses for the three and nine months ended September 30,2004 include approximately $14,000 and $61,000, respectively, of non-cashequity-based compensation. Research and development expenses for the three andnine months ended September 30, 2005 include approximately $35,000 and $105,000,respectively, of non-cash equity-based compensation. Research and developmentexpenses for the three and nine months ended September 30, 2004 includeapproximately $24,000 and $106,000, respectively, of non-cash equity-basedcompensation. Included in equity based compensation of $179,000 in the ninemonths ended September 30, 2005 is approximately $161,000, representingapproximately 16,000 shares of Common Stock issued to the Company-sponsored401(k) retirement savings plan.

 

The following table illustratesthe effect on net income per share if the Company had applied the fair valuerecognition provisions of SFAS No. 123, *Accountingfor Stock-Based Compensation*, to equity-based employee compensation(in thousands, except per share data):

 
| ** **                                                                                                   | ** ** | **For the Three Months Ended  September 30,** | ** ** | **For the Nine Months Ended  September 30,** | ** ** |
|--------------------------------------------------------------------------------------------------------------|------------|----------------------------------------------------|------------|---------------------------------------------------|------------|
| ** **                                                                                                   | ** ** | **2005**                                           | ** ** | **2004**                                          | ** ** | **2005** | ** ** | **2004** | ** ** |
| Net income, as reported                                                                                      |       | $                                                  | 2,485      |                                              | $          | 1,413 |   | $ | 7,263 |   | $ | 3,712 |   |
| Add:  Equity-based employee compensation expense included in reported net income                             |       | 65                                                 |       | 38                                                |       | 179 |   | 167 |   |
| Deduct: Total  equity-based employee compensation expense determined under fair value method  for all awards |       | (1,232                                             | )          | (467                                              | )          | (2,565 | ) | (2,168 | ) |
| Pro forma net income                                                                                         |       | $                                                  | 1,318      |                                              | $          | 984 |   | $ | 4,877 |   | $ | 1,711 |   |
|                                                                                                         |       |                                               |       |                                              |       |   |   |   |   |
| Net income per common share:                                                                                 |       |                                               |       |                                              |       |   |   |   |   |
| Basic - as  reported                                                                                         |       | $                                                  | 0.11       |                                              | $          | 0.07 |   | $ | 0.34 |   | $ | 0.18 |   |
| Basic - pro  forma                                                                                           |       | $                                                  | 0.06       |                                              | $          | 0.05 |   | $ | 0.23 |   | $ | 0.08 |   |
|                                                                                                         |       |                                               |       |                                              |       |   |   |   |   |
| Diluted - as  reported                                                                                       |       | $                                                  | 0.11       |                                              | $          | 0.06 |   | $ | 0.32 |   | $ | 0.16 |   |
| Diluted - pro  forma                                                                                         |       | $                                                  | 0.06       |                                              | $          | 0.04 |   | $ | 0.22 |   | $ | 0.08 |   |

 

14

----

 

 

The preceding pro formaresults were calculated using the Black-Scholes option pricing model with thefollowing weighted average assumptions (results may vary depending on theassumptions applied within the model):

 
| ** **                    | ** ** | **For the Three Months Ended September 30,** | ** ** | **For the Nine Months Ended  September 30,** | ** ** |
|-------------------------------|------------|---------------------------------------------------|------------|---------------------------------------------------|------------|
| ** **                    | ** ** | **2005**                                          | ** ** | **2004**                                          | ** ** | **2005** | ** ** | **2004** | ** ** |
|                          |       |                                              |       |                                              |       |   |   |   |   |
| Risk-free interest rate       |       | 4.09%                                             |       | 2.59%                                             |       | 3.97% |   | 2.96% |   |
| Dividend yield                |       | 0.00%                                             |       | 0.00%                                             |       | 0.00% |   | 0.00% |   |
| Expected life                 |       | 5 years                                           |       | 5 years                                           |       | 5 years |   | 5 years |   |
| Volatility                    |       | 46.28%                                            |       | 48.14%                                            |       | 45.44% |   | 49.25% |   |
| Fair value of options granted |       | $5.02                                             |       | $5.62                                             |       | $3.87 |   | $6.02 |   |

 

**Reclassifications**

 

Certain prior perioddepreciation amounts have been reclassified from *operatingexpenses* to *cost of net product sales*to conform with the current period’s presentation.  Such reclassifications are not material tothe Condensed Consolidated Financial Statements.

 

**New Accounting Pronouncements**

 

In December 2004, theFinancial Accounting Standards Board (FASB) issued SFAS No. 123 (Revised),*Share-Based Payment*. This Statement is arevision of SFAS No. 123, *Accounting for Stock-BasedCompensation*, and will supersede APB Opinion No. 25, *Accounting for Stock Issued to Employees*, and its relatedimplementation guidance.  SFAS No. 123(Revised) focuses primarily on accounting for transactions in which an entityobtains employee services in share-based payment transactions. The Statementwill require entities to recognize stock compensation expense for awards ofequity instruments to employees based on the grant-date fair value of thoseawards (with limited exceptions). On April 14, 2005, the Securities andExchange Commission delayed the effective date of SFAS No. 123 (Revised)to the beginning of the first fiscal year after September 15, 2005. As aresult, the Company anticipates adopting SFAS No. 123 (Revised) on January 1,2006. Management is evaluating the two methods of adoption allowed by SFAS No. 123(Revised), the modified-prospective transition method and themodified-retrospective transition method, and the related impact on itsConsolidated Financial Statements. Adoption of this Statement will havea significant impact on the Company’s results of operations, the impact ofwhich cannot be estimated at this time, although it is not expected to have anymaterial impact on the Company’s overall financial position or cash flows.

 

15

----

 

# **Item2.    Management’s Discussion and Analysisof Financial Condition and Results of Operations**

# ** **

Youshould read the following discussion and analysis together with all financialand non-financial information appearing elsewhere in this report and with ourconsolidated financial statements and related notes included in our AnnualReport on Form 10-K for the year ended December 31, 2004, which hasbeen previously filed with the SEC. In addition to historical information, thefollowing discussion and other parts of this report contain forward-lookinginformation that involves risks and uncertainties.  Our actual results could differ materiallyfrom those anticipated by such forward-looking information due to competitivefactors and other risks discussed below under the caption “Important FactorsThat May Affect Future Results”.

 

**Overview**

 

Weare a specialty pharmaceutical company focused on:

 

•                  development, licensing and sales of genericand branded pharmaceutical products and active pharmaceutical ingredients andthe manufacturing of pharmaceuticals for ourselves and others in Spain, otherparts of Europe and international markets, including the U.S. market; and

 

•                  research, development andlicensing/commercialization of advanced proprietary drug delivery technologiesfor new and existing pharmaceutical products.

 

*Brandedand Generic Pharmaceuticals*

 

Ourpharmaceutical product sales activities are based in Spain, where we have asignificant commercial presence and we manufacture and market approximately 35products.  Our products includeapproximately 135 product formulations of various dosages and strengths in fourprimary therapeutic areas: cardiovascular, gastrointestinal, neurological andinfectious diseases. In 2004 approximately 30% of our product revenues werederived from two of our product lines. We market our branded and genericproducts to physicians and pharmacists through our three separate sales andmarketing organizations based in Spain: Laboratorios Belmac, Laboratorios Davurand Laboratorios Rimafar.  As prices forprescription pharmaceuticals have been lowered in Spain by action of theMinistry of Health, which has authority to approve pharmaceutical prices, weare working to improve the efficiency of our manufacturing operations to reduceour costs, while also increasing sales. We have recently focused on increasing our sales in other Europeancountries and other geographic regions through strategic alliances with othergeneric companies and distributors in these territories.  We also target markets that offer compatibleregulatory approval regimes and attractive product margins.

 

Wealso expect to grow our business by acquiring or licensing additional productsto sell through our organization and our strategic alliances. We continuallyacquire rights to new products in response to increasing market demand forgeneric and branded therapeutic products and, when appropriate, we divestproducts that we consider to be redundant or that have becomenon-strategic.  For example, in November 2004,we entered into a collaboration agreement with Perrigo Company, the largestU.S. manufacturer of over-the-counter pharmaceutical and nutritional productsfor the store brand market, to co-develop and market a generic pharmaceuticalproduct in the U.S. and potentially other markets.

 

Wealso manufacture pharmaceuticals for other drug companies.  In April 2004, we purchased amanufacturing facility located in Spain that specializes in the manufacture ofactive pharmaceutical ingredients. The facility has been approved by the FDAfor the manufacture of one ingredient for marketing and sale in the U.S. We aremanufacturing and marketing active pharmaceutical ingredients through oursubsidiary, Bentley API.  In addition,our Spanish pharmaceutical product manufacturing facility producespharmaceutical products that are marketed by other pharmaceutical companiesboth in Spain and in other international markets.

 

16

----

 

*ProprietaryDrug Delivery Technologies and Products*

 

Wedevelop products that incorporate our drug delivery technologies that we havedeveloped in the United States.  We havelicensed applications of our proprietary CPE-215 drug delivery technology toAuxilium Pharmaceuticals, Inc., which launched Testim, the first productincorporating our CPE-215 drug delivery technology, in the United States in February 2003.  Testim is a gel indicated for lowtestosterone levels.  Testim was launchedin Germany in January 2005 and in the United Kingdom in April 2005.On April 25, 2005, we announced that we had entered into a licenseagreement with Dong Sung Pharm. Co. Ltd. for the development of an intranasalspray formulation of insulin for the South Korean market and possiblyadditional territories. On May 2, 2005 we announced the discovery andsynthesis of a thermodynamically stable, biodegradable NanocapletTMtechnology for the delivery of macromolecule therapeutics as a result of afour-year sponsored research collaboration with the University of NewHampshire.  We are also in discussionswith other pharmaceutical and biotechnology companies to form additionalstrategic alliances to facilitate the development and commercialization ofother products using our drug delivery technologies, including productformulations to treat nail fungus infections topically.

 

*Effectof Foreign Currency Fluctuations*

 

Asubstantial amount of our business is conducted in Europe and is thereforeinfluenced by fluctuations in the U.S. Dollar’s value in relation to othercurrencies, specifically the Euro. Foreign currency fluctuations had nomaterial impact on our third quarter results. However an increase in theweighted average value of the Euro over the past year, in relation to the U.S. Dollar had the following impact on ouroperations for the nine months ended September 30, 2005: (1) totalrevenues were increased by approximately $1,975,000, (2) gross profit wasincreased by approximately $1,015,000, (3) operating expenses wereincreased by approximately $585,000, (4) provision for income taxes wasincreased by approximately $130,000, and (5) net income was increased byapproximately $300,000.  At the presenttime, we do not anticipate altering our business plans and practices tocompensate for future currency fluctuations.

 

**RESULTS OF OPERATIONS:**

 

**Three Months Ended September 30, 2005 versusThree Months Ended September 30, 2004**

 

*Revenues*

 
| **(in  thousands)**                     | ** ** | **For the Three Months Ended September 30,** | ** ** | **Change** | ** ** |
|-----------------------------------------|------------|---------------------------------------------------|------------|------------|------------|
| ** **                              | ** ** | **2005**                                          | ** ** | **%**      | ** ** | **2004** | ** ** | **%** | ** ** | **$** | ** ** | **%** | ** ** |
| * *                                | * *   | * *                                          | * *   | * *   | * *   | * * | * * | * * | * * | * * | * * | * * | * * |
| *Net  product sales*                    | * *   | *$*                                               | *22,057*   | * *   | *94*       | *%* | *$* | *17,312* | * * | *96* | *%* | *$* | *4,745* | * * | *27* | *%* |
| *Licensing  and collaboration revenues* | * *   | *1,455*                                           | * *   | *6*        | *%*        | *791* | * * | *4* | *%* | *664* | * * | *84* | *%* |
| *Total revenues*                        | * *   | *$*                                               | *23,512*   | * *   | *100*      | *%* | *$* | *18,103* | * * | *100* | *%* | *$* | *5,409* | * * | *30* | *%* |

 

Totalrevenues for the three months ended September 30, 2005 increased 30% fromthe same period in the prior year. Our current period growth was drivenprimarily by increased sales outside of Spain, strong sales of our top threeproducts (omeprazole, simvastatin and enalapril) and increased royalty revenuesfrom sales of Testim, the first marketed product incorporating our CPE-215 drugdelivery technology. Our growing royalty stream from Testim sales contributedapproximately $1,391,000 to our licensing and collaboration revenues in the three months ended September 30,2005, compared to approximately $800,000 in the third quarter of the prioryear.

 

Ourrevenues are generated through our primary sales channels of brandedpharmaceuticals, generic pharmaceuticals, sales to licensees and others andlicensing and collaboration revenues. The following is a summary of ourrevenues by sales channel and top-selling product lines:

 

17

----

 

Forthe three months ended September 30, 2005:

 
| **(in  thousands)**              | ** ** | **Revenues Within Spain** | ** ** | ** **   | ** ** | ** ** | ** ** | ** **     | ** ** |
|----------------------------------|------------|---------------------------|------------|--------------|------------|------------|------------|----------------|------------|
| ** **                       | ** ** | ** **                | ** ** | **Revenues** | ** ** | ** ** | ** ** | ** **     | ** ** |
| ** **                       | ** ** | **Branded**               | ** ** | **Generic**  | ** ** | ** ** | ** ** | **Outside of** | ** ** | ** ** | ** ** | **% of Total** | ** ** |
| **Product  Line**                | ** ** | **Products**              | ** ** | **Products** | ** ** | **Other**  | ** ** | **Spain**      | ** ** | **Total** | ** ** | **Revenues** | ** ** |
| *Omeprazole*                     | * *   | *$*                       | *657*      | * *     | *$*        | *3,694*    | * *   | *$*            | *—*   | * * | *$* | *—* | * * | *$* | *4,351* | * * | *19* | *%* |
| *Simvastatin*                    | * *   | *402*                     | * *   | *1,277*      | * *   | *—*   | * *   | *—*       | * *   | *1,679* | * * | *7* | *%* |
| *Enalapril*                      | * *   | *933*                     | * *   | *407*        | * *   | *—*   | * *   | *—*       | * *   | *1,340* | * * | *6* | *%* |
| *Paroxetine*                     | * *   | *294*                     | * *   | *765*        | * *   | *—*   | * *   | *—*       | * *   | *1,059* | * * | *5* | *%* |
| *Pentoxifylline*                 | * *   | *—*                  | * *   | *607*        | * *   | *—*   | * *   | *—*       | * *   | *607* | * * | *2* | *%* |
| *All  other products*            | * *   | *2,651*                   | * *   | *1,765*      | * *   | *86*       | * *   | *424*          | * *   | *4,926* | * * | *21* | *%* |
| *Sales  to licensees and others* | * *   | *—*                  | * *   | *—*     | * *   | *2,479*    | * *   | *5,616*        | * *   | *8,095* | * * | *34* | *%* |
| *Licensing  and collaborations*  | * *   | *—*                  | * *   | *—*     | * *   | *58*       | * *   | *1,397*        | * *   | *1,455* | * * | *6* | *%* |
| *Total  Revenues*                | * *   | *$*                       | *4,937*    | * *     | *$*        | *8,515*    | * *   | *$*            | *2,623*    | * * | *$* | *7,437* | * * | *$* | *23,512* | * * | *100* | *%* |
| *% of  Q-3 2005 Revenues*        | * *   | *21*                      | *%*        | *36*         | *%*        | *11*       | *%*        | *32*           | *%*        | *100* | *%* | * * | * * |

 

Forthe three months ended September 30, 2004:

 
| **(in  thousands)**              | ** ** | **Revenues Within Spain** | ** ** | ** **   | ** ** | ** ** | ** ** | ** **     | ** ** |
|----------------------------------|------------|---------------------------|------------|--------------|------------|------------|------------|----------------|------------|
| ** **                       | ** ** | ** **                | ** ** | **Revenues** | ** ** | ** ** | ** ** | ** **     | ** ** |
| ** **                       | ** ** | **Branded**               | ** ** | **Generic**  | ** ** | ** ** | ** ** | **Outside of** | ** ** | ** ** | ** ** | **% of Total** | ** ** |
| **Product  Line**                | ** ** | **Products**              | ** ** | **Products** | ** ** | **Other**  | ** ** | **Spain**      | ** ** | **Total** | ** ** | **Revenues** | ** ** |
| *Omeprazole*                     | * *   | *$*                       | *742*      | * *     | *$*        | *3,296*    | * *   | *$*            | *—*   | * * | *$* | *—* | * * | *$* | *4,038* | * * | *22* | *%* |
| *Simvastatin*                    | * *   | *374*                     | * *   | *929*        | * *   | *—*   | * *   | *—*       | * *   | *1,303* | * * | *7* | *%* |
| *Enalapril*                      | * *   | *725*                     | * *   | *348*        | * *   | *—*   | * *   | *—*       | * *   | *1,073* | * * | *6* | *%* |
| *Paroxetine*                     | * *   | *225*                     | * *   | *698*        | * *   | *—*   | * *   | *—*       | * *   | *923* | * * | *5* | *%* |
| *Pentoxifylline*                 | * *   | *—*                  | * *   | *668*        | * *   | *—*   | * *   | *—*       | * *   | *668* | * * | *4* | *%* |
| *All  other products*            | * *   | *2,216*                   | * *   | *1,144*      | * *   | *430*      | * *   | *379*          | * *   | *4,169* | * * | *23* | *%* |
| *Sales  to licensees and others* | * *   | *—*                  | * *   | *—*     | * *   | *3,077*    | * *   | *2,061*        | * *   | *5,138* | * * | *29* | *%* |
| *Licensing  and collaborations*  | * *   | *—*                  | * *   | *—*     | * *   | *—*   | * *   | *791*          | * *   | *791* | * * | *4* | *%* |
| *Total  Revenues*                | * *   | *$*                       | *4,282*    | * *     | *$*        | *7,083*    | * *   | *$*            | *3,507*    | * * | *$* | *3,231* | * * | *$* | *18,103* | * * | *100* | *%* |
| *% of  Q-3 2004 Revenues*        | * *   | *24*                      | *%*        | *39*         | *%*        | *19*       | *%*        | *18*           | *%*        | *100* | *%* | * * | * * |

 

*Spanish Operations.*    The core of our Spanishoperations has been the efficient manufacturing and in-country marketing ofbranded and generic pharmaceutical products. Historically, our pharmaceutical products were sold only withinSpain.  However, the execution of ourlong-term strategic plan over the past several years has created an opportunityfor our Spanish operations to expand beyond the borders of Spain into otherEuropean countries and countries outside of Europe. The increase in thirdquarter 2005 product sales is due primarily to an increase in sales tolicensees and others totaling $2,957,000 and an increase in sales of our threetop selling product lines (omeprazole, simvastatin and enalapril) totaling $956,000.

 

*Branded Pharmaceutical Products*

 
| **(in  thousands)**           | ** ** | **For the Three Months Ended September 30,** | ** ** | **Change** | ** ** |
|-------------------------------|------------|---------------------------------------------------|------------|------------|------------|
| ** **                    | ** ** | **2005**                                          | ** ** | **%**      | ** ** | **2004** | ** ** | **%** | ** ** | **$** | ** ** | **%** | ** ** |
| *Branded  Product Sales:*     | * *   | * *                                          | * *   | * *   | * *   | * * | * * | * * | * * | * * | * * | * * | * * |
| *Enalapril*                   | * *   | *$*                                               | *933*      | * *   | *19*       | *%* | *$* | *725* | * * | *17* | *%* | *$* | *208* | * * | *29* | *%* |
| *Omeprazole*                  | * *   | *657*                                             | * *   | *13*       | *%*        | *742* | * * | *17* | *%* | *(85* | *)* | *-11* | *%* |
| *Codeisan*                    | * *   | *534*                                             | * *   | *11*       | *%*        | *607* | * * | *14* | *%* | *(73* | *)* | *-12* | *%* |
| *Lansoprazole*                | * *   | *427*                                             | * *   | *9*        | *%*        | *—* | * * | *0* | *%* | *427* | * * | *** | * * |
| *Simvastatin*                 | * *   | *402*                                             | * *   | *8*        | *%*        | *374* | * * | *9* | *%* | *28* | * * | *7* | *%* |
| *All  other branded products* | * *   | *1,984*                                           | * *   | *40*       | *%*        | *1,834* | * * | *43* | *%* | *150* | * * | *8* | *%* |
| *Total  branded sales*        | * *   | *$*                                               | *4,937*    | * *   | *100*      | *%* | *$* | *4,282* | * * | *100* | *%* | *$* | *655* | * * | *15* | *%* |

 

** Notmeaningful*

 

18

----

 

Salesof our branded pharmaceutical products increased by 15% during the three monthsended September 30, 2005 compared to the three months ended September 30,2004.  Sales of lansoprazole, which waslaunched in December 2004, accounted for 9% of our branded pharmaceuticalrevenues during the three months ended September 30, 2005 and 65% of theincrease in our branded sales. We experienced decreased sales of our brandedomeprazole in favor of our generic formulations and decreased sales of Codeisandue to seasonality; however, our branded enalapril and omeprazole togetheraccounted for 32% of our branded product sales in the three months ended September 30,2005. While we expect to continue to develop, acquire, launch and support newand existing branded products, our focus on generics and sales outside of Spainare expected to increase those revenues at a significantly higher pace thanthat of our branded products.

 

*Generic Pharmaceutical Products*

 
| **(in  thousands)**           | ** ** | **For the Three Months Ended September 30,** | ** ** | **Change** | ** ** |
|-------------------------------|------------|---------------------------------------------------|------------|------------|------------|
| ** **                    | ** ** | **2005**                                          | ** ** | **%**      | ** ** | **2004** | ** ** | **%** | ** ** | **$** | ** ** | **%** | ** ** |
| ** **                    | ** ** | ** **                                        | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| *Generic  Product Sales:*     | * *   | * *                                          | * *   | * *   | * *   | * * | * * | * * | * * | * * | * * | * * | * * |
| *Omeprazole*                  | * *   | *$*                                               | *3,694*    | * *   | *43*       | *%* | *$* | *3,296* | * * | *47* | *%* | *$* | *398* | * * | *12* | *%* |
| *Simvastatin*                 | * *   | *1,277*                                           | * *   | *15*       | *%*        | *929* | * * | *13* | *%* | *348* | * * | *38* | *%* |
| *Paroxetine*                  | * *   | *765*                                             | * *   | *9*        | *%*        | *698* | * * | *10* | *%* | *67* | * * | *10* | *%* |
| *Pentoxifylline*              | * *   | *607*                                             | * *   | *7*        | *%*        | *668* | * * | *9* | *%* | *(61* | *)* | *-9* | *%* |
| *Trimetazidine*               | * *   | *487*                                             | * *   | *6*        | *%*        | *498* | * * | *7* | *%* | *(11* | *)* | *-2* | *%* |
| *All  other generic products* | * *   | *1,685*                                           | * *   | *20*       | *%*        | *994* | * * | *14* | *%* | *691* | * * | *70* | *%* |
| *Total  generic sales*        | * *   | *$*                                               | *8,515*    | * *   | *100*      | *%* | *$* | *7,083* | * * | *100* | *%* | *$* | *1,432* | * * | *20* | *%* |

 

Salesof our generic pharmaceutical products increased by 20% during the three monthsended September 30, 2005, compared to the three months ended September 30,2004.  Strong sales of our generic omeprazoleand simvastatin accounted for approximately 52% of our increase in genericpharmaceutical sales in the third quarter of 2005 over the 2004 third quarter.Also contributing to the increase in generic pharmaceuticals sales were strongsales of our generic formulations of enalapril, lansoprazole, and ibuprofen(included in “*All other generic products*”above) which accounted for 24% of the increase. We expect to continue toincrease our generic drug portfolio and increase our generic drug sales in Spainas products come off patent in the future.

 

TheSpanish Ministry of Health is evaluating a plan for nationwide expansion of aregional practice of filling prescriptions with one of the lowest-pricedgenerics then available if a prescription does not specify a brand nameor laboratory name.  This proposal, if enacted, will not requiregovernment-mandated price reductions as in the past.  We constantly monitor the market, prices andour competitors’ activities, and occasionally adjust prices for competitivepurposes. We do not anticipate that this proposal will have a material impacton our 2005 revenues and profits.

 

*Sales to Licensees and Others*

 
| **(in thousands)**              | ** ** | **For the Three Months Ended September 30,** | ** ** | **Change** | ** ** |
|---------------------------------|------------|---------------------------------------------------|------------|------------|------------|
| ** **                      | ** ** | **2005**                                          | ** ** | **2004**   | ** ** | **$** | ** ** | **%** | ** ** |
| * *                        | * *   | * *                                          | * *   | * *   | * *   | * * | * * | * * | * * |
| *Sales to licensees and others* | * *   | *$*                                               | *8,095*    | * *   | *$*        | *5,138* | * * | *$* | *2,957* | * * | *58* | *%* |
|                                 |            |                                                   |            |            |            |  |  |  |  |  |  |  |

 

Inaddition to manufacturing and selling our own branded and generic products, welicense the right to market products to others within and outside ofSpain.  These license agreements areusually accompanied by long-term exclusive supply agreements, whereby ourlicensees purchase the licensed products from our manufacturing facility (whichare recorded as *net product sales* in theConsolidated Income Statements).  OurSpanish subsidiaries have executed a total of 141 license agreements. While 60of these agreements

 

19

----

 

arepending regulatory approvals (two within Spain and 58 outside of Spain), 81 ofthese agreements (17 within Spain and 64 outside of Spain) cover activelymarketed products that are generating revenues. Additionally, we have 16contract manufacturing agreements in effect in Spain and 6 contractmanufacturing agreements in effect for international customers. Our licenseesmarket these products under their own names and with their own labeling.  Many of the products we manufacture forothers use the same active ingredients that are used in our own marketedproducts.  Sales to licensees and othersin the three months ended September 30, 2005 increased 58% when comparedto the same period of the prior year.

 

*Licensing and Collaboration Revenues.*    Licensing and collaboration revenues increased by 84% and accounted for6% of total revenues for the three month period ended September 30, 2005compared to 4% for the three month period ended September 30, 2004.  These revenues include royalties ofapproximately $1,391,000 in the three months ended September 30, 2005(compared to approximately $800,000 in the third quarter of the prior year) fromthe commercialization and continuing sales of Testim.

 

*Gross Profit.*     Gross profit increased by approximately$2,967,000, or 31%, in the three months ended September 30, 2005, whencompared to the three months ended September 30, 2004.  Gross margins on net product sales were approximately50% in the three months ended September 30, 2005 and 2004, respectively.Increased margins resulting from economies of scale have been partially offsetby the following in the three months ended September 30, 2005: (1) increasedsales of lower margin products including our generic omeprazole andsimvastatin, (2) losses generated by our API manufacturing facility, whichis being expanded to support vertical integration, and (3) increaseddepreciation charges as a result of our aggressive capital investment campaignto expand our manufacturing capacity. Additionally, a charge of approximately$290,000 has been accrued as a result of a pharmaceutical tax that was enactedin the first quarter of 2005 and included in cost of sales in the three monthsended September 30, 2005.

 

*Selling and Marketing Expenses*

 
| **(in  thousands)**      | ** ** | **For the Three Months Ended September 30,** | ** ** | **Change** | ** ** |
|--------------------------|------------|---------------------------------------------------|------------|------------|------------|
| ** **               | ** ** | **2005**                                          | ** ** | **2004**   | ** ** | **$** | ** ** | **%** | ** ** |
| ** **               | ** ** | ** **                                        | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| *Selling  and marketing* | * *   | *$*                                               | *3,503*    | * *   | *$*        | *3,199* | * * | *$* | *304* | * * | *10* | *%* |
|                          |            |                                                   |            |            |            |  |  |  |  |  |  |  |

 

Sellingand marketing expenses for the three months ended September 30, 2005increased by $304,000 or 10% from the same period in the prior year. Increasedsales force costs, primarily sales commissions resulting from our growingproduct sales, account for the increase in selling and marketing expenses. As apercentage of net product sales, selling and marketing expenses decreased from18% in the three months ended September 30, 2004, to 16% in the threemonths ended September 30, 2005.

 

*General and Administrative Expenses*

 
| **(in thousands)**            | ** ** | **For the Three Months Ended September 30,** | ** ** | **Change** | ** ** |
|-------------------------------|------------|---------------------------------------------------|------------|------------|------------|
| ** **                    | ** ** | **2005**                                          | ** ** | **2004**   | ** ** | **$** | ** ** | **%** | ** ** |
| * *                      | * *   | * *                                          | * *   | * *   | * *   | * * | * * | * * | * * |
| *General  and administrative* | * *   | *$*                                               | *3,036*    | * *   | *$*        | *2,140* | * * | *$* | *896* | * * | *42* | *%* |
|                               |            |                                                   |            |            |            |  |  |  |  |  |  |  |

 

Generaland administrative expenses for the three months ended September 30, 2005increased 42% over the same period in the prior year. The $896,000 increase wasthe result of increased general and administrative activities required tosupport our continued growth. These expenditures include increased costs for: (1) Directorsand Officers insurance and medical insurance, (2) additional employees,and (3) other expenses required to support the Company's growth. Generaland administrative expenses as a percent of total revenues increased to almost13% for the three months ended September 30, 2005, compared toapproximately 12% of total revenues in the three months ended September 30,2004.  We expect that our general andadministrative expenses will continue to increase as we grow our business.

 

20

----

 

*Research and Development Expenses*

 
| **(in  thousands)**         | ** ** | **For the Three Months Ended September 30,** | ** ** | **Change** | ** ** |
|-----------------------------|------------|---------------------------------------------------|------------|------------|------------|
| ** **                  | ** ** | **2005**                                          | ** ** | **2004**   | ** ** | **$** | ** ** | **%** | ** ** |
| * *                    | * *   | * *                                          | * *   | * *   | * *   | * * | * * | * * | * * |
| *Research  and development* | * *   | *$*                                               | *1,775*    | * *   | *$*        | *1,230* | * * | *$* | *545* | * * | *44* | *%* |
|                             |            |                                                   |            |            |            |  |  |  |  |  |  |  |

 

Researchand development expenses have increased 44% in the three months ended September 30,2005, to $1,775,000, when compared to the third quarter of 2004.  The increase is directly attributable to theadvancement of our research and development programs. In the first quarter of2004, we completed and reported the results of a Phase I intranasal insulintrial. Our Phase I trial demonstrated the effective delivery of insulinintranasally in healthy human subjects. In April 2005 we announced that wecompleted the data analysis stage of our Phase II study for the intranasaldelivery of insulin, which we had concluded in December 2004. We reported the results of that trialin an abstract titled “Intranasal Insulin Administration in Type I DiabeticPatients Utilizing CPE-215 Technology” at the American Diabetes Association65th Scientific Sessions, June 10-14, 2005, in San Diego, California.Additionally, we are continuing our clinical programs to support our strategyfor the eventual distribution of certain of our Spanish generic pharmaceuticalproducts in other countries, including the U.S. In order to further ourstrategy, we entered into a collaboration agreement with Perrigo Company toco-develop and market a generic pharmaceutical product in the U.S. andpotentially other markets. We expect to continue to incur costs to conductclinical trials and support the required regulatory submissions for ourclinical programs. We also expect to incur increased costs for productformulation and testing efforts. We also expect to incur costs associated withthe acquisition and/or development of new or improved drug deliverytechnologies as evidenced by our May 2, 2005 announcement of the discoveryand synthesis of a thermodynamically stable, biodegradable NanocapletTM technologyfor the delivery of macromolecule therapeutics. The expenditures in researchand development reflect our focus on projects that are necessary for expansionof our portfolio of marketed products and clinical trials involving our drugdelivery technologies. Although some of our cost estimates are preliminary, andthe specific timing is subject to change, we project that our research anddevelopment expenses in 2005 could be approximately $2,500,000 higher than in2004.

 

*Provision for Income Taxes*

 
| **(in  thousands)**                    | ** ** | **For the Three Months Ended September 30, 2005** | ** ** |
|----------------------------------------|------------|--------------------------------------------------------|------------|
| ** **                             | ** ** | **Spain**                                              | ** ** | **U.S.** | ** ** | **Consolidated** | ** ** |
| ** **                             | ** ** | ** **                                             | ** ** | ** ** | ** ** | ** ** | ** ** |
| *Income (loss) before income taxes*    | * *   | *$*                                                    | *4,113*    | * * | *$* | *(251* | *)* | *$* | *3,862* | * * |
| * *                               | * *   | * *                                               | * *   | * * | * * | * * | * * |
| *Provision (benefit) for income taxes* | * *   | *1,377*                                                | * *   | *(101* | *)* | *1,276* | * * |
| *Valuation allowance*                  | * *   | *—*                                               | * *   | *101* | * * | *101* | * * |
| * *                               | * *   | * *                                               | * *   | * * | * * | * * | * * |
| *Net provision for income taxes*       | * *   | *1,377*                                                | * *   | *—* | * * | *1,377* | * * |
| * *                               | * *   | * *                                               | * *   | * * | * * | * * | * * |
| *Net income (loss)*                    | * *   | *$*                                                    | *2,736*    | * * | *$* | *(251* | *)* | *$* | *2,485* | * * |
| * *                               | * *   | * *                                               | * *   | * * | * * | * * | * * |
| *Effective tax rate*                   | * *   | *33*                                                   | *%*        | *0* | *%* | *36* | *%* |

 

Asa result of reporting taxable income for our subsidiaries in Spain, we recordeda provision for foreign income taxes totaling $1,377,000 and $1,344,000 for thethree months ended September 30, 2005 and 2004, respectively.  The effective tax rate in Spain for the threemonths ended September 30, 2005 is 33% compared to 37% in the prior yearthird quarter.

 

21

----

 

Wegenerated additional U.S. federal net operating loss carry-forwards in thethree months ended September 30, 2005 and 2004 as a result of U.S. pretaxlosses of $251,000 and $896,000, respectively. Although we expect to achieveprofitable U.S. operations in the future, any future domestic operating profitscannot be reasonably assured; consequently, no tax benefit has been recordedfor U.S. losses. Accordingly, we have established a valuation allowance equalto the full amount of the U.S. deferred tax assets.

 

Should wedetermine that it is more likely than not that we will realize certain of ournet deferred tax assets for which we have previously provided a valuationallowance, an adjustment would be required to reduce the existing valuationallowance . In addition, we operate within multiple taxing jurisdictions andare subject to audit in those jurisdictions. These audits can involve complexissues, which may require an extended period of time for resolution.

 

*Net Income*

 
| **(in  thousands, except per share data)**    | ** ** | **For the Three Months  Ended September 30,** | ** ** | **Change** | ** ** |
|-----------------------------------------------|------------|----------------------------------------------------|------------|------------|------------|
| ** **                                    | ** ** | **2005**                                           | ** ** | **2004**   | ** ** | **$** | ** ** | **%** | ** ** |
| * *                                      | * *   | * *                                           | * *   | * *   | * *   | * * | * * | * * | * * |
| *Net income*                                  | * *   | *$*                                                | *2,485*    | * *   | *$*        | *1,413* | * * | *$* | *1,072* | * * | *76* | *%* |
| * *                                      | * *   | * *                                           | * *   | * *   | * *   | * * | * * | * * | * * |
| *Net income per common share:*                | * *   | * *                                           | * *   | * *   | * *   | * * | * * | * * | * * |
| *Basic*                                       | * *   | *$*                                                | *0.11*     | * *   | *$*        | *0.07* | * * | *$* | *0.04* | * * | *57* | *%* |
| *Diluted*                                     | * *   | *$*                                                | *0.11*     | * *   | *$*        | *0.06* | * * | *$* | *0.05* | * * | *83* | *%* |
| * *                                      | * *   | * *                                           | * *   | * *   | * *   | * * | * * | * * | * * |
| *Weighted average common shares outstanding:* | * *   | * *                                           | * *   | * *   | * *   | * * | * * | * * | * * |
| *Basic*                                       | * *   | *21,652*                                           | * *   | *21,049*   | * *   | *603* | * * | *3* | *%* |
| *Diluted*                                     | * *   | *22,970*                                           | * *   | *22,746*   | * *   | *224* | * * | *1* | *%* |

 

Wereported income from operations of $3,678,000 in the three months ended September 30,2005 compared to $2,519,000 in the three months ended September 30, 2004,which is an increase of 46%. The combination of income from operations of$3,678,000 and the non-operating items, primarily the provision for incometaxes of $1,377,000, resulted in net income of $2,485,000, or $0.11 per basiccommon share ($0.11 per diluted common share) on 21,652,000 weighted averagebasic common shares outstanding (22,970,000 weighted average diluted commonshares outstanding) in the three months ended September 30, 2005, comparedto net income of $1,413,000, or $0.07 per basic common share ($0.06 per dilutedcommon share) on 21,049,000 weighted average basic common shares outstanding(22,746,000 weighted average diluted common shares outstanding) in the sameperiod of the prior year.

 

22

----

 

**Nine Months Ended September 30, 2005 versusNine Months Ended September 30, 2004**

 

*Revenues*

 
| **(in  thousands)**                     | ** ** | **For the Nine Months Ended September 30,** | ** ** | **Change** | ** ** |
|-----------------------------------------|------------|--------------------------------------------------|------------|------------|------------|
| ** **                              | ** ** | **2005**                                         | ** ** | **%**      | ** ** | **2004** | ** ** | **%** | ** ** | **$** | ** ** | **%** | ** ** |
| * *                                | * *   | * *                                         | * *   | * *   | * *   | * * | * * | * * | * * | * * | * * | * * | * * |
| *Net  product sales*                    | * *   | *$*                                              | *68,769*   | * *   | *95*       | *%* | *$* | *51,325* | * * | *95* | *%* | *$* | *17,444* | * * | *34* | *%* |
| *Licensing  and collaboration revenues* | * *   | *3,751*                                          | * *   | *5*        | *%*        | *2,550* | * * | *5* | *%* | *1,201* | * * | *47* | *%* |
| *Total  revenues*                       | * *   | *$*                                              | *72,520*   | * *   | *100*      | *%* | *$* | *53,875* | * * | *100* | *%* | *$* | *18,645* | * * | *35* | *%* |

 

Totalrevenues for the nine months ended September 30, 2005 increased 35% fromthe same period in the prior year, or 31% when expressed in constant currency.Our current period growth was driven primarily by increased product sales tolicensees and others, strong sales of our top three products (omeprazole,simvastatin and enalapril) and increased royalty revenues from sales of Testim.An increase in the weighted average value of the Euro over the past year, in relation to the U.S. Dollar, had theeffect of increasing year-to-date 2005 revenues by approximately$1,975,000 compared to the same nine month period of 2004. Our growing royaltystream from sales of Testim contributed approximately $3,512,000 to ourrevenues in the nine months ended September 30, 2005, compared toapproximately $2,000,000 in the first nine months of the prior year. Sales ofactive pharmaceutical ingredients from our new manufacturing facility (includedin “*All other products”* in the table below)contributed approximately $1,710,000 to our consolidated revenues for the ninemonths ended September 30, 2005 compared to $1,076,000 in the nine monthsended September 30, 2004.

 

Setforth below is a summary of our revenues by sales channel and top-sellingproduct lines:

 

Forthe nine months ended September 30, 2005:

 
| **(in  thousands)**              | ** ** | **Revenues Within Spain** | ** ** | ** **   | ** ** | ** ** | ** ** | ** **     | ** ** |
|----------------------------------|------------|---------------------------|------------|--------------|------------|------------|------------|----------------|------------|
| ** **                       | ** ** | ** **                | ** ** | **Revenues** | ** ** | ** ** | ** ** | ** **     | ** ** |
| ** **                       | ** ** | **Branded**               | ** ** | **Generic**  | ** ** | ** ** | ** ** | **Outside of** | ** ** | ** ** | ** ** | **% of Total** | ** ** |
| **Product  Line**                | ** ** | **Products**              | ** ** | **Products** | ** ** | **Other**  | ** ** | **Spain**      | ** ** | **Total** | ** ** | **Revenues** | ** ** |
| *Omeprazole*                     | * *   | *$*                       | *2,107*    | * *     | *$*        | *11,948*   | * *   | *$*            | *—*   | * * | *$* | *—* | * * | *$* | *14,055* | * * | *19* | *%* |
| *Simvastatin*                    | * *   | *1,275*                   | * *   | *3,862*      | * *   | *—*   | * *   | *—*       | * *   | *5,137* | * * | *7* | *%* |
| *Enalapril*                      | * *   | *3,084*                   | * *   | *1,319*      | * *   | *—*   | * *   | *—*       | * *   | *4,403* | * * | *6* | *%* |
| *Paroxetine*                     | * *   | *1,011*                   | * *   | *2,413*      | * *   | *—*   | * *   | *—*       | * *   | *3,424* | * * | *5* | *%* |
| *Codeisan*                       | * *   | *2,531*                   | * *   | *—*     | * *   | *—*   | * *   | *—*       | * *   | *2,531* | * * | *4* | *%* |
| *All  other products*            | * *   | *7,003*                   | * *   | *7,429*      | * *   | *271*      | * *   | *1,439*        | * *   | *16,142* | * * | *22* | *%* |
| *Sales  to licensees and others* | * *   | *—*                  | * *   | *—*     | * *   | *9,722*    | * *   | *13,355*       | * *   | *23,077* | * * | *32* | *%* |
| *Licensing  and collaborations*  | * *   | *—*                  | * *   | *—*     | * *   | *228*      | * *   | *3,523*        | * *   | *3,751* | * * | *5* | *%* |
| *Total  Revenues*                | * *   | *$*                       | *17,011*   | * *     | *$*        | *26,971*   | * *   | *$*            | *10,221*   | * * | *$* | *18,317* | * * | *$* | *72,520* | * * | *100* | *%* |
| *% of  YTD 2005 Revenues*        | * *   | *23*                      | *%*        | *37*         | *%*        | *14*       | *%*        | *26*           | *%*        | *100* | *%* | * * | * * |

 

Forthe nine months ended September 30, 2004:

 
| **(in  thousands)**              | ** ** | **Revenues Within Spain** | ** ** | ** **   | ** ** | ** ** | ** ** | ** **     | ** ** |
|----------------------------------|------------|---------------------------|------------|--------------|------------|------------|------------|----------------|------------|
| ** **                       | ** ** | ** **                | ** ** | **Revenues** | ** ** | ** ** | ** ** | ** **     | ** ** |
| ** **                       | ** ** | **Branded**               | ** ** | **Generic**  | ** ** | ** ** | ** ** | **Outside of** | ** ** | ** ** | ** ** | **% of Total** | ** ** |
| **Product  Line**                | ** ** | **Products**              | ** ** | **Products** | ** ** | **Other**  | ** ** | **Spain**      | ** ** | **Total** | ** ** | **Revenues** | ** ** |
| *Omeprazole*                     | * *   | *$*                       | *1,923*    | * *     | *$*        | *9,783*    | * *   | *$*            | *—*   | * * | *$* | *—* | * * | *$* | *11,706* | * * | *22* | *%* |
| *Simvastatin*                    | * *   | *968*                     | * *   | *2,570*      | * *   | *—*   | * *   | *—*       | * *   | *3,538* | * * | *7* | *%* |
| *Enalapril*                      | * *   | *2,280*                   | * *   | *883*        | * *   | *—*   | * *   | *—*       | * *   | *3,163* | * * | *6* | *%* |
| *Paroxetine*                     | * *   | *703*                     | * *   | *2,282*      | * *   | *—*   | * *   | *—*       | * *   | *2,985* | * * | *5* | *%* |
| *Codeisan*                       | * *   | *2,118*                   | * *   | *—*     | * *   | *—*   | * *   | *—*       | * *   | *2,118* | * * | *4* | *%* |
| *All  other products*            | * *   | *4,852*                   | * *   | *5,149*      | * *   | *466*      | * *   | *610*          | * *   | *11,077* | * * | *20* | *%* |
| *Sales  to licensees and others* | * *   | *—*                  | * *   | *—*     | * *   | *7,915*    | * *   | *8,823*        | * *   | *16,738* | * * | *31* | *%* |
| *Licensing  and collaborations*  | * *   | *—*                  | * *   | *—*     | * *   | *541*      | * *   | *2,009*        | * *   | *2,550* | * * | *5* | *%* |
| *Total  Revenues*                | * *   | *$*                       | *12,844*   | * *     | *$*        | *20,667*   | * *   | *$*            | *8,922*    | * * | *$* | *11,442* | * * | *$* | *53,875* | * * | *100* | *%* |
| *% of  YTD 2004 Revenues*        | * *   | *24*                      | *%*        | *38*         | *%*        | *17*       | *%*        | *21*           | *%*        | *100* | *%* | * * | * * |

 

23

----

 

*Spanish Operations.*     The increase in the netproduct sales for the nine months ended September 30, 2005 compared to thenine months ended September 30, 2004 is due primarily to: (1) anincrease in sales to licensees and others totaling $6,339,000; and (2) anaggregate increase totaling $5,188,000 in sales of our three top sellingproduct lines (omeprazole, simvastatin and enalapril); and (3) an increasein the weighted average value of the Euro,in relation to the U.S. Dollar totaling $1,965,000.

 

*Branded Pharmaceutical Products*

 
| **(in  thousands)**           | ** ** | **For the Nine Months Ended September 30,** | ** ** | **Change** | ** ** |
|-------------------------------|------------|--------------------------------------------------|------------|------------|------------|
| ** **                    | ** ** | **2005**                                         | ** ** | **%**      | ** ** | **2004** | ** ** | **%** | ** ** | **$** | ** ** | **%** | ** ** |
| *Branded  Product Sales:*     | * *   | * *                                         | * *   | * *   | * *   | * * | * * | * * | * * | * * | * * | * * | * * |
| *Enalapril*                   | * *   | *$*                                              | *3,084*    | * *   | *18*       | *%* | *$* | *2,280* | * * | *18* | *%* | *$* | *804* | * * | *35* | *%* |
| *Codeisan*                    | * *   | *2,531*                                          | * *   | *15*       | *%*        | *2,118* | * * | *16* | *%* | *413* | * * | *19* | *%* |
| *Omeprazole*                  | * *   | *2,107*                                          | * *   | *12*       | *%*        | *1,923* | * * | *15* | *%* | *184* | * * | *10* | *%* |
| *Lansoprazole*                | * *   | *1,374*                                          | * *   | *8*        | *%*        | *—* | * * | *0* | *%* | *1,374* | * * | *** | * * |
| *Simvastatin*                 | * *   | *1,275*                                          | * *   | *8*        | *%*        | *968* | * * | *8* | *%* | *307* | * * | *32* | *%* |
| *All  other branded products* | * *   | *6,640*                                          | * *   | *39*       | *%*        | *5,555* | * * | *43* | *%* | *1,085* | * * | *20* | *%* |
| *Total  branded sales*        | * *   | *$*                                              | *17,011*   | * *   | *100*      | *%* | *$* | *12,844* | * * | *100* | *%* | *$* | *4,167* | * * | *32* | *%* |

 

** Notmeaningful*

 

Salesof our branded pharmaceutical products increased by 32% during the nine monthsended September 30, 2005 compared to the nine months ended September 30,2004.  Sales of branded enalapril andsimvastatin, which grew by 35% and 32%, respectively, accounted for 18% and 8%of our branded pharmaceutical revenues in the nine months ended September 30,2005, respectively. Sales of lansoprazole, which was launched in December 2004,contributed approximately $1,374,000 to our branded product sales in the ninemonths ended September 30, 2005 and accounted for 33% of our growth inbranded product sales during the nine months ended September 30, 2005.Strong sales of our branded ibuprofen (included in “*All otherbranded products*” above) increased 89% over the same period of theprior year and accounted for approximately 11% of the increase in brandedpharmaceutical product sales. An increase in the weighted average value of theEuro over the past year, in relationto the U.S. Dollar, had the effect of increasing branded product salesby approximately $525,000 in the first nine months of 2005.

 

*Generic Pharmaceutical Products*

 
| **(in thousands)**            | ** ** | **For the Nine Months Ended September 30,** | ** ** | **Change** | ** ** |
|-------------------------------|------------|--------------------------------------------------|------------|------------|------------|
| ** **                    | ** ** | **2005**                                         | ** ** | **%**      | ** ** | **2004** | ** ** | **%** | ** ** | **$** | ** ** | **%** | ** ** |
| *Generic  Product Sales:*     | * *   | * *                                         | * *   | * *   | * *   | * * | * * | * * | * * | * * | * * | * * | * * |
| *Omeprazole*                  | * *   | *$*                                              | *11,948*   | * *   | *45*       | *%* | *$* | *9,783* | * * | *48* | *%* | *$* | *2,165* | * * | *22* | *%* |
| *Simvastatin*                 | * *   | *3,862*                                          | * *   | *14*       | *%*        | *2,570* | * * | *12* | *%* | *1,292* | * * | *50* | *%* |
| *Paroxetine*                  | * *   | *2,413*                                          | * *   | *9*        | *%*        | *2,282* | * * | *11* | *%* | *131* | * * | *6* | *%* |
| *Pentoxifylline*              | * *   | *1,947*                                          | * *   | *7*        | *%*        | *1,946* | * * | *9* | *%* | *1* | * * | *0* | *%* |
| *Trimetazidine*               | * *   | *1,693*                                          | * *   | *6*        | *%*        | *1,424* | * * | *7* | *%* | *269* | * * | *19* | *%* |
| *All  other generic products* | * *   | *5,108*                                          | * *   | *19*       | *%*        | *2,662* | * * | *13* | *%* | *2,446* | * * | *92* | *%* |
| *Total  generic sales*        | * *   | *$*                                              | *26,971*   | * *   | *100*      | *%* | *$* | *20,667* | * * | *100* | *%* | *$* | *6,304* | * * | *31* | *%* |

 

Salesof our generic pharmaceutical products increased by 31% during the nine monthsended September 30, 2005 compared to the nine months ended September 30,2004.  Increased demand for our genericomeprazole and simvastatin products accounted for 55% of our genericpharmaceutical revenue growth in the nine months ended September 30, 2005.Additionally, sales of our generic formulations of ibuprofen, enalapril,lansoprazole, and mirtazapine (included in “*All other generic products*”above) accounted for approximately 25% of the growth in generic pharmaceuticalproduct sales. Paroxetine, pentoxifylline and trimetazidine continue to bemajor contributors to our generic pharmaceutical sales. An increase in theweighted average value of the Euro, inrelation to the U.S. Dollar, had the effect of increasing genericproduct sales by approximately $794,000 in the first nine months of 2005.

 

24

----

 

*Sales to Licensees and Others*

 
| **(in  thousands)**             | ** ** | **For the Nine Months Ended September 30,** | ** ** | **Change** | ** ** |
|---------------------------------|------------|--------------------------------------------------|------------|------------|------------|
| ** **                      | ** ** | **2005**                                         | ** ** | **2004**   | ** ** | **$** | ** ** | **%** | ** ** |
| * *                        | * *   | * *                                         | * *   | * *   | * *   | * * | * * | * * | * * |
| *Sales to licensees and others* | * *   | *$*                                              | *23,077*   | * *   | *$*        | *16,738* | * * | *$* | *6,339* | * * | *38* | *%* |
|                                 |            |                                                  |            |            |            |  |  |  |  |  |  |  |

 

Salesto licensees and others in the nine months ended September 30, 2005increased 38% when compared to the same nine month period of the prior year, or34% in constant currency.  Of thesesales, 58% were to customers outside of Spain compared to 53% in the sameperiod of the prior year. An increase in the weighted average value of the Euroover the past year, in relation to the U.S. Dollar, had the effect ofincreasing our revenues from sales to licensees and others by approximately$593,000 in the first nine months of 2005.

 

*Licensing and Collaboration Revenues.*    Licensing and collaboration revenues accounted for 5% of total revenuesin the nine months ended September 30, 2005 and totaled $3,751,000. Theserevenues include royalties of approximately $3,512,000 in the nine months endedSeptember 30, 2005 (compared to approximately $2,000,000 in the ninemonths ended September 30, 2004) from the commercialization and continuingsales of Testim. Testim is currently reported to capture approximately 15% ofall testosterone gel replacement prescriptions in the U.S. market.

 

*Gross Profit.*     Gross profit increased by approximately$10,105,000, or 35%, in the nine months ended September 30, 2005, whencompared to the nine months ended September 30, 2004.  Gross margins on net product sales were approximately51% in the nine months ended September 30, 2005 and 2004.  Cost of sales in the nine months ended September 30,2005 included a charge of approximately $1,157,000 as a result of apharmaceutical tax that was enacted in the first quarter of 2005.

 

*Selling and Marketing Expenses*

 
| **(in  thousands)**     | ** ** | **For the Nine Months Ended September 30,** | ** ** | **Change** | ** ** |
|-------------------------|------------|--------------------------------------------------|------------|------------|------------|
| ** **              | ** ** | **2005**                                         | ** ** | **2004**   | ** ** | **$** | ** ** | **%** | ** ** |
| * *                | * *   | * *                                         | * *   | * *   | * *   | * * | * * | * * | * * |
| *Selling and marketing* | * *   | *$*                                              | *12,118*   | * *   | *$*        | *10,919* | * * | *$* | *1,199* | * * | *11* | *%* |
|                         |            |                                                  |            |            |            |  |  |  |  |  |  |  |

 

Sellingand marketing expenses for the nine months ended September 30, 2005increased 11% compared to the same period in the prior year. The weighted average value of the Euro, inrelation to the U.S. Dollar, had the effect of increasing selling and marketingexpenses by approximately $377,000 in the nine months ended September 30,2005, accounting for 31% of the increase. See the explanation under *Selling and Marketing Expenses* for the three months endedSeptember 30, 2005. Selling and marketing expenses as a percentage of netproduct sales decreased from 21% in the nine months ended September 30,2004 to 18% in the nine months ended September 30, 2005.

 

*General and Administrative Expenses*

 
| **(in  thousands)**          | ** ** | **For the Nine Months Ended September 30,** | ** ** | **Change** | ** ** |
|------------------------------|------------|--------------------------------------------------|------------|------------|------------|
| ** **                   | ** ** | **2005**                                         | ** ** | **2004**   | ** ** | **$** | ** ** | **%** | ** ** |
| * *                     | * *   | * *                                         | * *   | * *   | * *   | * * | * * | * * | * * |
| *General and administrative* | * *   | *$*                                              | *9,072*    | * *   | *$*        | *6,590* | * * | *$* | *2,482* | * * | *38* | *%* |
|                              |            |                                                  |            |            |            |  |  |  |  |  |  |  |

 

Generaland administrative expenses for the nine months ended September 30, 2005increased 38% compared to the same period in the prior year.  The $2,482,000 increase was the result ofincreased general and administrative activities required to support ourcontinued growth and prepare for our anticipated future growth. See theexplanation under *General and Administrative Expenses*forthe three months ended September 30, 2005. General and administrativeexpenses as a percent of total revenues remained relatively constant for thenine months ended September 30, 2005 compared to the nine months ended September 30,2004.  General and administrativeexpenses would have been approximately $137,000 lower, absent the increase inthe weighted average value of the Euro, in relation to the U.S. Dollar, overthe past year.

 

25

----

 

*Research and Development Expenses*

 
| **(in  thousands)**        | ** ** | **For the Nine Months Ended September 30,** | ** ** | **Change** | ** ** |
|----------------------------|------------|--------------------------------------------------|------------|------------|------------|
| ** **                 | ** ** | **2005**                                         | ** ** | **2004**   | ** ** | **$** | ** ** | **%** | ** ** |
| * *                   | * *   | * *                                         | * *   | * *   | * *   | * * | * * | * * | * * |
| *Research and development* | * *   | *$*                                              | *4,734*    | * *   | *$*        | *3,171* | * * | *$* | *1,563* | * * | *49* | *%* |
|                            |            |                                                  |            |            |            |  |  |  |  |  |  |  |

 

 

Researchand development expenses for the nine months ended September 30, 2005increased 49% compared to the same period in the prior year. The increase isdirectly attributed to the advancement of our research and developmentprograms. See the explanation under *Research and DevelopmentExpenses* for the three months ended September 30, 2005. Weexpect to continue to incur increased costs to support our clinical programs inthe remainder of the year.

 

*Other Income (Expenses)*

 
| **(in  thousands)**       | ** ** | **For the Nine Months Ended September 30,** | ** ** | **Change** | ** ** |
|---------------------------|------------|--------------------------------------------------|------------|------------|------------|
| ** **                | ** ** | **2005**                                         | ** ** | **2004**   | ** ** | **$** | ** ** | **%** | ** ** |
| * *                  | * *   | * *                                         | * *   | * *   | * *   | * * | * * | * * | * * |
| *Other income (expenses)* | * *   | *$*                                              | *470*      | * *   | *$*        | *1,644* | * * | *$* | *(1,174* | *)* | *-71* | *%* |
|                           |            |                                                  |            |            |            |  |  |  |  |  |  |  |

 

Otherincome (expenses) for the nine months ended September 30, 2005 decreasedby $1,174,000 from the same period in the prior year. The reduction isprimarily due to the prior year reversal of previously accrued tax assessmentstotaling $1,467,000, partially offset by interest and penalties totaling$193,000 associated with the settlement of the tax audit of our Spanishsubsidiary in the prior year.  Otherincome (expenses) for the nine months ended September 30, 2005 includedinterest income of approximately $610,000 compared to approximately $399,000 inthe nine months ended September 30, 2004.

 

*Provision for Income Taxes*

 
| **(in  thousands)**                    | ** ** | **For the Nine Months Ended September 30, 2005** | ** ** |
|----------------------------------------|------------|-------------------------------------------------------|------------|
| ** **                             | ** ** | **Spain**                                             | ** ** | **U.S.** | ** ** | **Consolidated** | ** ** |
| * *                               | * *   | * *                                              | * *   | * * | * * | * * | * * |
| *Income (loss) before income taxes*    | * *   | *$*                                                   | *13,603*   | * * | *$* | *(1,819* | *)* | *$* | *11,784* | * * |
| * *                               | * *   | * *                                              | * *   | * * | * * | * * | * * |
| *Provision (benefit) for income taxes* | * *   | *4,521*                                               | * *   | *(728* | *)* | *3,793* | * * |
| *Valuation allowance*                  | * *   | *—*                                              | * *   | *728* | * * | *728* | * * |
| * *                               | * *   | * *                                              | * *   | * * | * * | * * | * * |
| *Net provision for income taxes*       | * *   | *4,521*                                               | * *   | *—* | * * | *4,521* | * * |
| * *                               | * *   | * *                                              | * *   | * * | * * | * * | * * |
| *Net income (loss)*                    | * *   | *$*                                                   | *9,082*    | * * | *$* | *(1,819* | *)* | *$* | *7,263* | * * |
| * *                               | * *   | * *                                              | * *   | * * | * * | * * | * * |
| *Effective tax rate*                   | * *   | *33*                                                  | *%*        | *0* | *%* | *38* | *%* |

 

Wehave recorded provisions for foreign income taxes totaling $4,521,000 and$4,706,000 ($4,102,000 net of the $604,000 tax audit settlement) for the ninemonths ended September 30, 2005 and 2004, respectively. The effective taxrate in Spain for the nine months ended September 30, 2005 is 33% comparedto 44% (38% excluding the $604,000 tax audit settlement in 2004) in the ninemonths ended September 30, 2004. The provision for foreign income taxes would have been approximately$127,000 lower than reported, absent the increase in the weighted average valueof the Euro in relation to the U.S. Dollar, over the past year.

 

Wegenerated additional U.S. federal net operating loss carry-forwards in the ninemonths ended September 30, 2005 and 2004 as a result of U.S. pre-taxlosses of $1,819,000 and $2,377,000, respectively. As future domestic operatingprofits cannot be reasonably assured, no tax benefit has been recorded for U.S.losses. Accordingly, we have established a valuation allowance equal to thefull amount of the U.S. deferred tax assets.

 

26

----

 

*Net Income*

 
| **(in  thousands, except per share data)**    | ** ** | **For the Nine Months  Ended September 30,** | ** ** | **Change** | ** ** |
|-----------------------------------------------|------------|---------------------------------------------------|------------|------------|------------|
| ** **                                    | ** ** | **2005**                                          | ** ** | **2004**   | ** ** | **$** | ** ** | **%** | ** ** |
| * *                                      | * *   | * *                                          | * *   | * *   | * *   | * * | * * | * * | * * |
| *Net income*                                  | * *   | *$*                                               | *7,263*    | * *   | *$*        | *3,712* | * * | *$* | *3,551* | * * | *96* | *%* |
| * *                                      | * *   | * *                                          | * *   | * *   | * *   | * * | * * | * * | * * |
| *Net income per common share:*                | * *   | * *                                          | * *   | * *   | * *   | * * | * * | * * | * * |
| *Basic*                                       | * *   | *$*                                               | *0.34*     | * *   | *$*        | *0.18* | * * | *$* | *0.16* | * * | *89* | *%* |
| *Diluted*                                     | * *   | *$*                                               | *0.32*     | * *   | *$*        | *0.16* | * * | *$* | *0.16* | * * | *100* | *%* |
| * *                                      | * *   | * *                                          | * *   | * *   | * *   | * * | * * | * * | * * |
| *Weighted average common shares outstanding:* | * *   | * *                                          | * *   | * *   | * *   | * * | * * | * * | * * |
| *Basic*                                       | * *   | *21,455*                                          | * *   | *20,764*   | * *   | *691* | * * | *3* | *%* |
| *Diluted*                                     | * *   | *22,700*                                          | * *   | *22,772*   | * *   | *(72* | *)* | *0* | *%* |

 

Wereported net income of $7,263,000 in the nine months ended September 30,2005 compared to $3,712,000 in the nine months ended September 30, 2004.The combination of income from operations of $11,314,000 and the non-operatingitems, primarily the provision for income taxes of $4,521,000 resulted in netincome of $7,263,000, or $0.34 per basic common share ($0.32 per diluted commonshare) on 21,455,000 weighted average basic common shares outstanding(22,700,000 weighted average diluted common shares outstanding) for the ninemonths ended September 30, 2005, compared to net income of $3,712,000, or$0.18 per basic common share ($0.16 per diluted common share) on 20,764,000weighted average basic common shares outstanding (22,772,000 weighted averagediluted common shares outstanding) for the nine months ended September 30,2004.

 

27

----

 

**LIQUIDITYAND CAPITAL RESOURCES****:**

 

Totalassets increased from $121,930,000 at December 31, 2004 to $124,817,000 atSeptember 30, 2005, while stockholders’ equity decreased from $89,657,000at December 31, 2004 to $89,184,000 at September 30, 2005. Thedecrease in stockholders’ equity during the nine months ended September 30,2005 primarily reflects the effect of fluctuations in the Euro/U.S. Dollarexchange rate, which resulted in a net reduction of $7,006,000 in our balancesheet, that was offset by net income of $7,263,000 in the nine months ended September 30,2005.  Also contributing to the decreasein stockholders’ equity, was the acquisition of approximately 364,000 sharesof Common Stock, with a fair market value of approximately $4,109,000, whichwere tendered to the Company by certain employees as consideration for theexercise of stock options and to satisfy minimum federal and statutory taxwithholding requirements,partially offset by stock option exercises totaling $3,200,000.

 

Cashand cash equivalents increased by approximately 5% or $1,583,000 from$34,230,000 at December 31, 2004 to $35,813,000 at September 30,2005, primarily as a result of increased cash flows from operations thatincluded net income of $7,263,000, an increase in deferred income of $1,880,000and the net effect of financing activities as discussed below partially offsetby additions to fixed assets totaling $6,673,000, additions to drug licensestotaling $1,477,000 and the effect of foreign currency exchange rates thatdecreased cash by approximately $678,000. Cash and cash equivalents at September 30,2005 include approximately $11,062,000 of short-term liquid investmentsconsidered to be cash equivalents.

 

Receivablesdecreased by approximately 4% during the nine months ended September 30,2005 from $27,860,000 at December 31, 2004 to $26,856,000 at September 30,2005. Total receivables increased by approximately $2,175,000 in constantcurrency, but fluctuations in foreign currency exchange rates decreasedreceivables reported in U.S. Dollars by approximately $3,179,000. Tradereceivables increased by approximately $2,194,000 in constant currency, butfluctuations in foreign currency exchange rates decreased trade receivablesreported in U.S. Dollars by approximately $3,105,000; however, the averagenumber of days of sales outstanding in uncollected trade and royaltiesreceivable decreased from 125 days at December 31, 2004 to 96 days at September 30,2005. Receivables from one international customer totaled $3,539,000 at September 30,2005; however, we owe the same customer approximately $2,107,000 forco-marketing expenses at September 30, 2005. Revenues from this customerare recorded net of the related co-marketing costs in the Consolidated IncomeStatements. We have not experienced any material delinquencies on any of ourreceivables that have had a material effect on our financial position, resultsof operations or cash flows.

 

Inventoriesincreased by approximately $2,500,000 from $10,258,000 at December 31,2004 to $12,758,000 at September 30, 2005, primarily as a result ofincreases in raw material and finished goods inventories totaling $4,193,000 inconstant currency required to meet anticipated fourth quarter demand, partiallyoffset by fluctuations in foreign currency exchange rates approximating $1,693,000.

 

Thecombined total of accounts payable and accrued expenses increased from$23,217,000 at December 31, 2004 to $25,294,000 at September 30,2005.  The $2,077,000 increase wasprimarily attributed to increases in payables related to inventory purchases(approximately $1,326,000), and increases in taxes payable of approximately$2,592,000, including $1,157,000 attributable to a new pharmaceutical tax,partially offset by fluctuations in foreign currency exchange rates thatdecreased accounts payable and accrued expenses reported in U.S. Dollars byapproximately $2,933,000.

 

Short-termborrowings and current portion of long-term debt decreased from $2,785,000 at December 31,2004 to $2,156,000 at September 30, 2005, primarily as a result of theeffect of fluctuations in foreign currency exchange rates totaling $291,000 andby net repayments totaling $346,000. The weighted average interest rate on ourshort-term borrowings at September 30, 2005 was 3.2%.

 

28

----

 

Operatingactivities for the nine months ended September 30, 2005 provided net cashof $10,344,000 compared to $812,000 during the nine months ended September 30,2004.  Net income, which increased to$7,263,000 during the nine months ended September 30, 2005, and changes inworking capital accounted for the majority of the increase in cash flows fromoperations.

 

Investingactivities, primarily capital expenditures in Spain for land, improvements andequipment to upgrade the capacity of our manufacturing facility in Spain and toincrease our manufacturing and packaging capabilities with new high speedequipment, along with additions to drug licenses and related costs, used netcash of $8,150,000 during the nine months ended September 30, 2005.

 

Financingactivities during the nine months ended September 30, 2005 provided cashtotaling $67,000, and primarily represented the cash proceeds of approximately$1,800,000 received from the exercise of stock options, partially offset by thefollowing: (1) the remittance of employee tax withholding liabilities ofapproximately $1,082,000 resulting from stock option exercises, (2) therepurchase of approximately 27,000 shares of the Company’s Common Stock, with afair market value of approximately $305,000, which were repurchased by theCompany in conjunction with the exercise of employee stock options, and (3) netrepayments of debt totaling $346,000.

 

Our royalty revenues onTestim product sales by Auxilium Pharmaceuticals, Inc., our licensee, arerecognized based on an estimate of Auxilium’s sell-through of the Testimproduct based on prescriptions dispensed. For the nine months ended September 30,2005 and 2004, we recognized royalty revenues of approximately $3,512,000 and$2,000,000, respectively, based on an estimate of prescriptions dispensed.  The difference between the total amountearned from Auxilium under the royalty arrangement and the amount recognized asa component of *licensing and collaboration revenues*is recorded as a component of current *deferred income*in the Consolidated Balance Sheets.  Asof September 30, 2005 and December 31, 2004, deferred income fromTestim royalties was approximately $1,635,000 and $1,233,000,respectively.  We will continue to useavailable market information to determine the amount and timing of royaltyrevenue recognition until such time that returns from wholesalers andpharmacies can be reasonably estimated.

 

*Seasonality.*  In the past, we have experienced lower salesin the third calendar quarter and higher sales in the fourth calendar quarterdue to seasonality.  As we market morepharmaceutical products whose sales are seasonal, seasonality of sales maybecome more significant.

 

*Effect of Inflation and Changing Prices.* Neither inflation nor changing prices has materially effected our netproduct sales or income from operations for the periods presented.

 

*Liquidity*.  We expect to investapproximately $11.6 million over the balance of 2005 and early 2006 for capitalexpenditures related to expansion of our manufacturing facilities toaccommodate future anticipated growth. These capital expenditures will befunded from a combination of cash flows from operations and borrowings. Asmentioned above, we have cash and cash equivalents totaling approximately$35,813,000 as of September 30, 2005, which we believe issufficient to fund our operations and cash requirements for the foreseeable future. Although the Company is generatingpositive cash flow from operations, (approximately $10,344,000 in the ninemonths ended September 30, 2005), there can be no assurance that changesin our research and development plans, capital expenditures and/oracquisitions, or other events affecting our net product sales or operatingexpenses will not result in the earlier depletion of our funds.  However, we continue to explore alternativesources for financing our business activities. In appropriate situations, whichwill be strategically determined, we may seek financial assistance from othersources, including contribution by others to joint ventures and othercollaborative or licensing arrangements for the development, testing,manufacturing and marketing of products under development.

 

**CriticalAccounting Policies and Estimates**

 

Oursignificant accounting policies are more fully described in Note 2 to ourconsolidated financial statements in our Annual Report on Form 10-K forthe year ended December 31, 2004. Certain of our

 

29

----

 

accountingpolicies are particularly important to the portrayal of our financial position,results of operations and cash flows and require the application of significantjudgment by our management; as a result they are subject to an inherent degreeof uncertainty. In applying those policies, our management uses its judgment todetermine the appropriate assumptions to be used in the determination ofcertain estimates. Those estimates are based on our historical experience,terms of existing contracts, our observation of trends in the industry,information provided by our customers and information available from otheroutside sources, as appropriate. For a more detailed discussion of our criticalaccounting policies and estimates, we refer the reader to the completediscussion included in our Annual Report on Form 10-K for the year ended December 31,2004.

 

**ImportantFactors That May Affect Future Results**

 

ThisQuarterly Report on Form 10-Q contains forward-looking statements. Theseforward-looking statements appear principally in the section entitled “Management’sDiscussion and Analysis of Financial Condition and Results of Operations.”Forward-looking statements may appear in other sections of this report, aswell. Generally, the forward-looking statements in this report include suchwords as “expect,” “believe,” “continue,” “anticipate,” “estimate,” “may,” “will,”“could,” “opportunity,” “future,” “project,” and similar expressions.

 

Theforward-looking statements include statements about our:

•                  Strategic plans;

•                  Sales growth;

•                  Anticipated sources of future revenues;

•                  Anticipated 2005 and 2006 expenses, marginsand operating performance;

•                  Expected launch of new products;

•                  Anticipated expenses and spending;

•                  Commencing and continuing clinical trials;

•                  Anticipated regulatory changes and approvals;and

•                  The sufficiency of capital resources to fundour operations.

 

These forward-lookingstatements are based on our current expectations, beliefs, assumptions,estimates, forecasts and projections for our business and the industry andmarkets in which we compete. These statements are not guarantees of futureperformance and involve certain risks, uncertainties and assumptions that aredifficult to predict. Therefore, actual outcomes and results may differmaterially from what is expressed in such forward-looking statements. We cautioninvestors not to place undue reliance on the forward-looking statementscontained in this report. These statements speak only as of the date of thisreport, and we do not undertake any obligation to update or revise them, exceptas required by law.  The followingfactors, among others, create risks and uncertainties that could affect ourfuture or other performance:  the timingand nature of regulatory approvals, expanding generic and branded drugoperations, changes in third-party reimbursement and government mandates whichimpact pharmaceutical pricing, development and commercialization of ourproprietary products and formulations, competition from other manufacturers ofgeneric and proprietary pharmaceuticals, intellectual property litigation, our relationshipswith our strategic partners, the efficacy and safety of our products, theunpredictability of patent protection, the uncertainty of clinical trialresults, technological changes, the effects of economic conditions, risksassociated with international operations, and difficulties in managing ourgrowth and the other risk factors contained in the section entitled “RiskFactors” in our Annual Report on Form 10-K filed for the year ended December 31,2004.  As a result of these and otherfactors, we may experience material fluctuations in our future operatingresults, which could materially affect our business, financial position, andstock price.

 

# **Item3. Quantitative and Qualitative Disclosures About Market Risk**

# ** **

*Foreign Currency.*  A substantial amount of ourbusiness is conducted in Europe and is therefore influenced to the extent towhich there are fluctuations in the U.S. Dollar’s value in relation to othercurrencies, specifically the Euro. The exchange rates at September 30,2005 and December 31, 2004 were .83

 

30

----

 

Eurosand .73 Euros per U.S. Dollar, respectively. The weighted average exchange ratefor the three months ended September 30, 2005 and 2004 was .82 Euros perU.S. Dollar. The weighted average exchange rates for the nine months ended September 30,2005 and 2004 were .79 Euros and .82 Euros per U.S. Dollar, respectively. Thenet effect of foreign currency translation on our Condensed ConsolidatedFinancial Statements for the nine months ended September 30, 2005 was anet decrease of $7,006,000 and the cumulative historical effect as of September 30,2005 was an increase of $2,716,000, as reflected in our Consolidated BalanceSheets as *accumulated other**comprehensive income*. The carrying valueof assets and liabilities can be materially impacted by foreign currencytranslation, as can the translated amounts of revenues and expenses.

 

Wehave relied primarily upon financing activities to fund our operations in theU.S. In the event that we are required to fund U.S. operations or cash needswith funds generated in Europe or cash requirements in Europe with U.S. funds,currency rate fluctuations in the future could have a significant impact on us.However, at the present time, we do not anticipate altering our business plansand practices to compensate for future currency rate fluctuations.

 

*Interest Rates.*  The weighted average interest rate on ourshort-term borrowings is 3.2% and the amount of borrowings outstanding is$2,156,000 as of September 30, 2005. Our long-term borrowings arenon-interest bearing and the balance outstanding on these borrowings at September 30,2005 is $366,000 including imputed interest (ranging from 5.2% to 6.0%) of$47,000. The weighted average interest rate on our long-term borrowings is5.7%. The effect of an increase in interest rates of one percentage point (onehundred basis points) to an average of 4.2% on short-term borrowings and to anaverage of 6.7% on long-term borrowings would have the effect of increasing interestexpense by approximately $25,000 annually.

 

# **Item4. Controls and Procedures**

# ** **

BentleyPharmaceuticals maintains disclosure controls and procedures that are designedto ensure that information required to be disclosed in Bentley’s reports thatare filed with the Securities and Exchange Commission is recorded, processed,summarized and reported within the time periods required for each report andthat such information is reported to Bentley’s management, including its ChiefExecutive Officer and Chief Financial Officer, as appropriate, to allow timelydecisions regarding required disclosure.

 

As of September 30,2005, Bentley’s management carried out an evaluation, with the participation ofBentley’s Chief Executive Officer and Chief Financial Officer, of theeffectiveness of Bentley’s disclosure controls and procedures (as defined inExchange Act Rules 13a-15(e) and 15(d)-15(e)). Based on thatevaluation, Bentley’s Chief Executive Officer and Chief Financial Officerconcluded that Bentley’s disclosure controls and procedures are effective anddesigned to ensure that the information relating to Bentley (including itsconsolidated subsidiaries), which is required to be included in its publiclyfiled reports or submitted under the Exchange Act, is recorded, processed,summarized and reported within the time periods specified in the Securities andExchange Commission’s rules and forms. Although Bentley’s management continuallyevaluates the internal control structure and strengthens Bentley’s controlprocedures, particularly in connection with the requirements of Section 404of the Sarbanes-Oxley Act of 2002 (including, for example, the hiring of aninternal auditor in September 2005), there have been no changes in Bentley’sinternal control over financial reporting during the quarter ended September 30,2005 that have materially affected, or are reasonably likely to materiallyaffect, Bentley’s internal control over financial reporting.

 

31

----

 

**PART II.                OTHER INFORMATION**

 

# **Item 1. Legal Proceedings**

# ** **

OnSeptember 27, 2004, the Company was served with a complaint in an actioncaptioned Ethypharm S.A. France & Ethypharm S.A. Spain v. BentleyPharmaceuticals, Inc., U.S. District Court for the District ofDelaware, Civil Action No. 04-1300 (SLR). In this action, Ethypharm S.A., a French-based drug delivery company,and its Spanish affiliate (collectively, “Ethypharm”), allege that since March 2002the Company and its Spanish subsidiary Laboratorios Belmac, S.A. (“Belmac”) misappropriatedunspecified Ethypharm trade secrets and confidential information and used thatinformation in the manufacture of omeprazole, one of Belmac’s pharmaceuticalproducts.  Based on Ethypharm’s primaryallegation of misappropriation of trade secrets, the complaint also assertedcounts of fraud, unjust enrichment, and intentional interference with actualand prospective business relationships. Ethypharm’s complaint seeks injunctive relief as well as damages. On September 26,2005, the Court granted the Company’s motion to dismiss two counts, Count 1(Fraud) and Count 3 (Unjust Enrichment), of Ethypharm’s complaint but deniedthe Company’s motion to dismiss the complaint in its entirety without prejudiceto its being renewed after the completion of discovery on the issue of agency.The Company intends to contest the case vigorously.

 

OnApril 11, 2005, Ethypharm’s Spanish affiliate, Ethypharm S.A., filed suitagainst Belmac S.A. in the Commercial Court No. 5 of Madrid, Spain.  The complaint alleges that Belmac refused torenew its contract with Ethypharm for the manufacture of omeprazole whichexpired on March 22, 2002, and that after that date Belmac’s continuedmanufacture of omeprazole pursuant to its own patented technology has infringedEthypharm’s Spanish Patent No. ES9301319. In its complaint, Ethypharm seeks an order from the court declaringBelmac to be in violation of Ethypharm’s patent, preventing further sales ofomeprazole by Belmac, and awarding monetary damages.  On July 5, 2005, Belmac filed an answerand counterclaim which denies Ethypharm’s material allegations and seeks adeclaration that Ethypharm’s patent is invalid. No trial date has been set. Belmac intends to defend the case vigorously.

 

# **Item2. Unregistered Sales of Equity Securities and Use of Proceeds**

# ** **

IssuerRepurchases

 
| ** **                                              | ** ** | **(a)  Total Number  of Shares  (or Units)  Purchased (1)** | ** ** | **(b)  Average  Price  Paid per  Share(2)** | ** ** | **(c)  Total Number  of Shares  (or Units)  Purchased as  Part of Publicly  Announced  Plans or  Programs** | ** ** | **(d)  Maximum  Number  (or approximate  dollar value)  of Shares (or  Units) that  may yet be  Purchased  under the Plans  or  Programs** | ** ** |
|---------------------------------------------------------|------------|-------------------------------------------------------------|------------|---------------------------------------------|------------|------------------------------------------------------------------------------------------------------------------|------------|--------------------------------------------------------------------------------------------------------------------------------------------|------------|
| July 1, 2005 through July 31, 2005            |       | —                                                      |       | $                                           | —     |                                                                                                             | —     |                                                                                                                                       | —     |   |
| August 1, 2005 through August 31, 2005        |       | 32,056                                                      |       | 11.494                                      |       | —                                                                                                           |       | —                                                                                                                                     |       |
| September 1,  2005 through September 30, 2005 |       | 112,792                                                     |       | 11.725                                      |       | —                                                                                                           |       | —                                                                                                                                     |       |
|                                                    |       |                                                        |       |                                        |       |                                                                                                             |       |                                                                                                                                       |       |
| Total                                                   |       | 144,848                                                     |       | $                                           | 11.674     |                                                                                                             | —     |                                                                                                                                       | —     |   |

 

----

**(1)****        **Represents shares tendered or repurchased bythe Company for cash at fair market value from option holders using maturestock in connection with the exercise of their vested stock options and sharestendered or repurchased by the Company for cash at fair market value fromoption holders to satisfy minimum tax withholding liabilities. 

**(2)****        **Average of the high and low prices on the NYSEon the dates of exercise.

 

32

----

 

# **Item 6. Exhibits**

# ** **

TheExhibits filed as part of this report are listed on the Exhibit Indeximmediately following the signature page, which Exhibit Index isincorporated herein by reference.

 

33

----

 

SIGNATURES

 

Pursuant to therequirements of the Securities Exchange Act of 1934, the Registrant has dulycaused this report to be signed on its behalf by the undersigned thereunto dulyauthorized.

 

 
|                  |   | BENTLEY  PHARMACEUTICALS, INC.                |   |
|-----------------------|--------|-----------------------------------------------|--------|
|                  |   | Registrant                                    |
|                  |   |                                          |
|                  |   |                                          |
| November 8, 2005 | By:    | /s/ James R. Murphy                           |   |
|                  |   | James R. Murphy                               |
|                  |   | Chairman of the Board  of Directors and       |
|                  |   | Chief Executive Officer                       |
|                  |   | (Principal Executive  Officer)                |
|                  |   |                                          |
|                  |   |                                          |
| November 8, 2005 | By:    | /s/ Michael D. Price                          |   |
|                  |   | Michael D. Price                              |
|                  |   | Vice President, Chief  Financial Officer,     |
|                  |   | Treasurer and Secretary  (Principal Financial |
|                  |   | and Accounting Officer)                       |
|                       |        |                                               |        |  |

 

----

 

# **Exhibit Index**

# ** **

| **Exhibit  umber** | ** **              | **Description of Exhibit** |
|--------------------|-------------------------|----------------------------|
|               |                    |                       |
|               | 10.1   * |                       | Employment  Agreement dated as of August 27, 2005 between the Registrant and John A.  Sedor. Filed herewith. |
|               | 31.1                    |                       | Certification of the Chief Executive Officer pursuant to 18 U.S.C.  Section 1350 as adopted pursuant to Section 302 of the  Sarbanes-Oxley Act of 2002. Filed herewith. |
|               | 31.2                    |                       | Certification of the Chief Financial Officer pursuant to 18 U.S.C.  Section 1350 as adopted pursuant to Section 302 of the  Sarbanes-Oxley Act of 2002. Filed herewith. |
|               | 32.1                    |                       | Certification of the Chief Executive Officer pursuant to 18 U.S.C.  Section 1350 as adopted pursuant to Section 906 of the  Sarbanes-Oxley Act of 2002. Filed herewith. |
|               | 32.2                    |                       | Certification of the Chief Financial Officer pursuant to 18 U.S.C.  Section 1350 as adopted pursuant to Section 906 of the  Sarbanes-Oxley Act of 2002. Filed herewith. |

 

----

*                                                                                         Indicates a management contract orcompensatory plan or arrangement.

 

----