**UNITED STATESSECURITIES AND EXCHANGE COMMISSION**

 

**WASHINGTON, D.C.  20549**

 

**FORM 10-Q**

 
| **(Mark One)**                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                |
|---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                          |
| **ý**                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                    | ** ** | **QUARTERLY REPORT PURSUANT TO  SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934** |
|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                          |   |   |
| **For the quarterly period ended**  **September 30, 2004**                                                                                                                                                                                                                                                                                                                                                                                                                                                                                               |
|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                          |   |   |
| **OR**                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                        |
|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                          |   |   |
| **o**                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                         | ** ** | **TRANSITION REPORT PURSUANT TO  SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934** |
|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                          |   |   |
| **For the transition period from                                           to                                          ** |

 

**Commission File Number  1-10581**

 

**BENTLEY PHARMACEUTICALS, INC.**

(Exact name of registrant as specified in itscharter)

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

 

**Bentley Park, 2 Holland Way, Exeter, New Hampshire  03833**

(Current Address of Principal ExecutiveOffices)

 

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

 

Indicate by check mark whether the registrant (1) has filed all reportsrequired to be 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 to suchfiling requirements for the past 90 days.     YES ý       NOo

 

Indicate by check mark whether the registrant is an accelerated filer(as defined in rule 12b-2 of the Exchange Act).  YES ý     NOo

 

The number of shares of the registrant’s common stock outstanding as ofNovember 4, 2004 was 21,307,195.

 

 

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**BENTLEY PHARMACEUTICALS, INC. AND SUBSIDIARIES**

**FORM 10-Q FOR THE QUARTER ENDED SEPTEMBER 30, 2004**

**INDEX**

 
| Part I.  | UNAUDITED FINANCIAL INFORMATION |                                                                                                                                                                                   | PAGE   |
|----------|---------------------------------|----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|--------|
|     |                            |                                                                                                                                                                                   |   |
|     | Item 1.                         | Condensed Consolidated Financial Statements:                                                                                                                                           |   |   |
|     |                            |                                                                                                                                                                                   |   |   |
|     |                            | Consolidated Balance Sheets as of September 30, 2004 and December 31,  2003                                                                                                            |   | 3 |
|     |                            |                                                                                                                                                                                   |   |   |
|     |                            | Consolidated Income  Statements and Statements of Comprehensive Income for the three months ended  September 30, 2004 and 2003, and the nine months ended September 30, 2004 and  2003 |   | 4 |
|     |                            |                                                                                                                                                                                   |   |   |
|     |                            | Consolidated Statement of Changes in  Stockholders’ Equity for the nine months ended September 30, 2004                                                                           |   | 5 |
|     |                            |                                                                                                                                                                                   |   |   |
|     |                            | Consolidated Statements of Cash Flows for  the nine months ended September 30, 2004 and 2003                                                                                           |   | 6 |
|     |                            |                                                                                                                                                                                   |   |   |
|     |                            | Notes to Condensed Consolidated Financial  Statements                                                                                                                                  |   | 8 |
|     |                            |                                                                                                                                                                                   |   |   |
|     | Item 2.                         | Management’s  Discussion and Analysis of Financial Condition and Results of Operations                                                                                            |   | 17 |
|     |                            |                                                                                                                                                                                   |   |   |
|     | Item 3.                         | Quantitative and Qualitative Disclosures  About Market Risk                                                                                                                            |   | 37 |
|     |                            |                                                                                                                                                                                   |   |   |
|     | Item 4.                         | Controls and Procedures                                                                                                                                                                |   | 38 |
|     |                            |                                                                                                                                                                                   |   |   |
| Part II. | OTHER INFORMATION               |                                                                                                                                                                                   |   |
|     |                            |                                                                                                                                                                                   |   |   |
|     | Item 1.                         | Legal Proceedings                                                                                                                                                                      |   | 39 |
|     |                            |                                                                                                                                                                                   |   |   |
|     | Item 6.                         | Exhibits                                                                                                                                                                               |   | 39 |

 

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**BENTLEY PHARMACEUTICALS, INC. AND SUBSIDIARIES**

**CONSOLIDATED BALANCE SHEETS**

 
| **(in thousands, except per share  data)**                                                                 | ** ** | **September 30,  2004** | ** ** | **December 31,  2003** | ** ** |
|------------------------------------------------------------------------------------------------------------|------------|-------------------------|------------|------------------------|------------|
| **ASSETS**                                                                                                 |       |                    |       |                   |       |
| Current assets:                                                                                            |       |                    |       |                   |       |
| Cash and cash equivalents                                                                                  |       | $                       | 33,763     |                   | $          | 39,393 |   |
| Marketable securities                                                                                      |       | 476                     |       | 1,252                  |       |
| Receivables, net                                                                                           |       | 25,863                  |       | 18,036                 |       |
| Inventories, net                                                                                           |       | 9,013                   |       | 7,106                  |       |
| Deferred taxes                                                                                             |       | 210                     |       | 213                    |       |
| Prepaid expenses and other                                                                                 |       | 1,492                   |       | 899                    |       |
| Total current assets                                                                                       |       | 70,817                  |       | 66,899                 |       |
| Non-current assets:                                                                                        |       |                    |       |                   |       |
| Fixed assets, net                                                                                          |       | 25,053                  |       | 18,566                 |       |
| Drug licenses and related costs, net                                                                       |       | 14,109                  |       | 13,818                 |       |
| Restricted cash                                                                                            |       | 1,000                   |       | 1,000                  |       |
| Other                                                                                                      |       | 166                     |       | 180                    |       |
| Total non-current assets                                                                                   |       | 40,328                  |       | 33,564                 |       |
|                                                                                                       |       | $                       | 111,145    |                   | $          | 100,463 |   |
|                                                                                                       |       |                    |       |                   |       |
| **LIABILITIES AND STOCKHOLDERS’ EQUITY**                                                              |       |                    |       |                   |       |
| Current liabilities:                                                                                       |       |                    |       |                   |       |
| Accounts payable                                                                                           |       | $                       | 13,303     |                   | $          | 10,154 |   |
| Accrued expenses                                                                                           |       | 7,395                   |       | 7,103                  |       |
| Short-term borrowings                                                                                      |       | 1,950                   |       | 1,915                  |       |
| Current portion of long-term debt                                                                          |       | —                  |       | 70                     |       |
| Deferred income                                                                                            |       | 3,216                   |       | 1,956                  |       |
| Total current liabilities                                                                                  |       | 25,864                  |       | 21,198                 |       |
| Non-current liabilities:                                                                                   |       |                    |       |                   |       |
| Deferred taxes                                                                                             |       | 2,402                   |       | 2,555                  |       |
| Long-term debt                                                                                             |       | 369                     |       | 369                    |       |
| Other                                                                                                      |       | 75                      |       | 176                    |       |
| Total non-current liabilities                                                                              |       | 2,846                   |       | 3,100                  |       |
|                                                                                                       |       |                    |       |                   |       |
| 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, 21,304 and 20,573 shares |       | 426                     |       | 412                    |       |
| Stock purchase warrants (to purchase zero  and 420 shares of common stock)                                 |       | —                  |       | 333                    |       |
| Additional paid-in capital                                                                                 |       | 140,370                 |       | 136,850                |       |
| Accumulated deficit                                                                                        |       | (62,887                 | )          | (66,599                | )          |
| Accumulated other comprehensive income                                                                     |       | 4,526                   |       | 5,169                  |       |
| Total stockholders’ equity                                                                            |       | 82,435                  |       | 76,165                 |       |
|                                                                                                       |       | $                       | 111,145    |                   | $          | 100,463 |   |

 

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

 

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**BENTLEY PHARMACEUTICALS, INC. AND SUBSIDIARIES**

**CONSOLIDATEDINCOME STATEMENTS**

**AND STATEMENTS OF COMPREHENSIVE INCOME**

 
| ** **                                  | ** ** | **For the Three Months Ended September 30,** | ** ** | **For the Nine Months Ended September 30,** | ** ** |
|---------------------------------------------|------------|----------------------------------------------|------------|---------------------------------------------|------------|
| **(in thousands, except per share  data)**  | ** ** | **2004**                                     | ** ** | **2003**                                    | ** ** | **2004** | ** ** | **2003** | ** ** |
| Revenues:                                   | ** ** | ** **                                   | ** ** | ** **                                  | ** ** | ** ** | ** ** | ** ** | ** ** |
| Net product sales                           |       | $                                            | 17,312     |                                        | $          | 14,540 |   | $ | 51,325 |   | $ | 45,371 |   |
| Licensing and collaboration revenues        |       | 791                                          |       | 335                                         |       | 2,550 |   | 1,246 |   |
| Total revenues                              |       | 18,103                                       |       | 14,875                                      |       | 53,875 |   | 46,617 |   |
|                                        |       |                                         |       |                                        |       |   |   |   |   |
| Cost of net product sales                   |       | 8,568                                        |       | 5,744                                       |       | 25,161 |   | 18,684 |   |
|                                        |       |                                         |       |                                        |       |   |   |   |   |
| Gross profit                                |       | 9,535                                        |       | 9,131                                       |       | 28,714 |   | 27,933 |   |
|                                        |       |                                         |       |                                        |       |   |   |   |   |
| Operating expenses:                         |       |                                         |       |                                        |       |   |   |   |   |
| Selling and marketing                       |       | 3,199                                        |       | 3,224                                       |       | 10,919 |   | 10,203 |   |
| General and administrative                  |       | 2,140                                        |       | 1,744                                       |       | 6,590 |   | 5,089 |   |
| Research and development                    |       | 1,230                                        |       | 966                                         |       | 3,171 |   | 2,863 |   |
| Depreciation and amortization               |       | 447                                          |       | 356                                         |       | 1,260 |   | 967 |   |
|                                        |       |                                         |       |                                        |       |   |   |   |   |
| Total operating expenses                    |       | 7,016                                        |       | 6,290                                       |       | 21,940 |   | 19,122 |   |
|                                        |       |                                         |       |                                        |       |   |   |   |   |
| Income from operations                      |       | 2,519                                        |       | 2,841                                       |       | 6,774 |   | 8,811 |   |
|                                        |       |                                         |       |                                        |       |   |   |   |   |
| Other income (expenses):                    |       |                                         |       |                                        |       |   |   |   |   |
| Interest income                             |       | 157                                          |       | 71                                          |       | 399 |   | 236 |   |
| Interest expense                            |       | (49                                          | )          | (60                                         | )          | (160 | ) | (174 | ) |
| Other, net                                  |       | 130                                          |       | 9                                           |       | 1,405 |   | 5 |   |
|                                        |       |                                         |       |                                        |       |   |   |   |   |
| Income before income taxes                  |       | 2,757                                        |       | 2,861                                       |       | 8,418 |   | 8,878 |   |
|                                        |       |                                         |       |                                        |       |   |   |   |   |
| Provision for income taxes                  |       | 1,344                                        |       | 1,513                                       |       | 4,706 |   | 4,469 |   |
|                                        |       |                                         |       |                                        |       |   |   |   |   |
| Net income                                  |       | $                                            | 1,413      |                                        | $          | 1,348 |   | $ | 3,712 |   | $ | 4,409 |   |
|                                        |       |                                         |       |                                        |       |   |   |   |   |
| Net income per common share:                |       |                                         |       |                                        |       |   |   |   |   |
| Basic                                       |       | $                                            | 0.07       |                                        | $          | 0.08 |   | $ | 0.18 |   | $ | 0.25 |   |
| Diluted                                     |       | $                                            | 0.06       |                                        | $          | 0.06 |   | $ | 0.16 |   | $ | 0.21 |   |
|                                        |       |                                         |       |                                        |       |   |   |   |   |
| Weighted average common shares outstanding: |       |                                         |       |                                        |       |   |   |   |   |
| Basic                                       |       | 21,049                                       |       | 17,911                                      |       | 20,764 |   | 17,635 |   |
| Diluted                                     |       | 22,746                                       |       | 22,228                                      |       | 22,772 |   | 21,321 |   |
|                                        |       |                                         |       |                                        |       |   |   |   |   |
| Net income                                  |       | $                                            | 1,413      |                                        | $          | 1,348 |   | $ | 3,712 |   | $ | 4,409 |   |
| Other comprehensive income (loss):          |       |                                         |       |                                        |       |   |   |   |   |
| Foreign currency translation gains (losses) |       | 895                                          |       | 495                                         |       | (643 | ) | 2,688 |   |
| Comprehensive income                        |       | $                                            | 2,308      |                                        | $          | 1,843 |   | $ | 3,069 |   | $ | 7,097 |   |

 

*The accompanying Notes to CondensedConsolidated Financial Statements are an integral part of these financialstatements.*

 

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**BENTLEY PHARMACEUTICALS, INC. AND SUBSIDIARIES**

**CONSOLIDATEDSTATEMENT OF CHANGES IN STOCKHOLDERS’ EQUITY**

 
| **(in thousands, except per share  data)** | ** ** | **$.02 Par Value  Common Stock** | ** ** | **Stock  Purchase  Warrants** | ** ** | **Additional  Paid-In  Capital** | ** ** | **Accumulated  Deficit** | ** ** | **Accumulated  Other  Comprehensive  Income** | ** ** | **Total** | ** ** |
|--------------------------------------------|------------|----------------------------------|------------|-------------------------------|------------|----------------------------------|------------|--------------------------|------------|-----------------------------------------------|------------|-----------|------------|
| **Shares**                                 | ** ** | **Amount**                       |
|                                       |       |                             |       |                          |       |                             |       |                     |       |                                          |       |      |       |   |   |
| Balance at December 31, 2003               |       | 20,573                           |       | $                             | 412        |                             | $          | 333                      |       | $                                             | 136,850    |      | $          | (66,599 | ) | $ | 5,169 |   | $ | 76,165 |   |
| Exercise of stock options and warrants     |       | 719                              |       | 14                            |       | (333                             | )          | 3,369                    |       | —                                        |       | —    |       | 3,050 |   |
| Equity based compensation                  |       | 12                               |       | —                        |       | —                           |       | 151                      |       | —                                        |       | —    |       | 151 |   |
| Foreign currency translation adjustment    |       | —                           |       | —                        |       | —                           |       | —                   |       | —                                        |       | (643      | )          | (643 | ) |
| Net income                                 |       | —                           |       | —                        |       | —                           |       | —                   |       | 3,712                                         |       | —    |       | 3,712 |   |
| Balance at September 30, 2004              |       | 21,304                           |       | $                             | 426        |                             | $          | —                   |       | $                                             | 140,370    |      | $          | (62,887 | ) | $ | 4,526 |   | $ | 82,435 |   |

 

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

 

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**BENTLEY PHARMACEUTICALS, INC. AND SUBSIDIARIES**

**CONSOLIDATED STATEMENTS OF CASH FLOWS**

 
| ** **                                                                         | ** ** | **For the Nine Months Ended September 30,** | ** ** |
|------------------------------------------------------------------------------------|------------|---------------------------------------------|------------|
| **(in thousands)**                                                                 | ** ** | **2004**                                    | ** ** | **2003** | ** ** |
|                                                                               |       |                                        |       |   |   |
| Cash flows from operating activities:                                              |       |                                        |       |   |   |
| Net income                                                                         |       | $                                           | 3,712      |   | $ | 4,409 |   |
| Adjustments to reconcile net income to net cash  provided by operating activities: |       |                                        |       |   |   |
| Depreciation and amortization                                                      |       | 2,748                                       |       | 1,708 |   |
| Forgiveness of related party loans                                                 |       | —                                      |       | (150 | ) |
| Equity-based compensation expense                                                  |       | 167                                         |       | 377 |   |
| Other non-cash items                                                               |       | (80                                         | )          | (317 | ) |
| (Increase) decrease in assets and increase  (decrease) in liabilities:             |       |                                        |       |   |   |
| Receivables                                                                        |       | (8,272                                      | )          | (1,649 | ) |
| Inventories                                                                        |       | (1,823                                      | )          | (930 | ) |
| Prepaid expenses and other current assets                                          |       | (607                                        | )          | 144 |   |
| Other assets                                                                       |       | (1                                          | )          | (7 | ) |
| Accounts payable and accrued expenses                                              |       | 3,797                                       |       | 4,063 |   |
| Deferred income                                                                    |       | 1,450                                       |       | 702 |   |
| Other liabilities                                                                  |       | (279                                        | )          | — |   |
|                                                                               |       |                                        |       |   |   |
| Net cash provided by operating activities                                          |       | 812                                         |       | 8,350 |   |
|                                                                               |       |                                        |       |   |   |
| Cash flows from investing activities:                                              |       |                                        |       |   |   |
| Proceeds from sale of investments                                                  |       | 149,100                                     |       | 163,400 |   |
| Purchase of investments                                                            |       | (148,230                                    | )          | (163,268 | ) |
| Purchase of API manufacturing assets                                               |       | (3,309                                      | )          | — |   |
| Additions to fixed assets                                                          |       | (6,217                                      | )          | (6,016 | ) |
| Additions to drug licenses and related  costs                                      |       | (849                                        | )          | (2,193 | ) |
|                                                                               |       |                                        |       |   |   |
| Net cash used in investing activities                                              |       | (9,505                                      | )          | (8,077 | ) |
|                                                                               |       |                                        |       |   |   |
|                                                                                    |            |                                             |            |  |  |  |  |

 

(Continued on following page)

 

*The accompanying Notes to Condensed Consolidated FinancialStatements are an integral part of these financial statements.*

 

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**BENTLEY PHARMACEUTICALS, INC. AND SUBSIDIARIES**

**CONSOLIDATED STATEMENTS OF CASH FLOWS (concluded)**

 
| ** **                                                                                      | ** ** | **For the Nine Months Ended September 30,** | ** ** |
|-------------------------------------------------------------------------------------------------|------------|---------------------------------------------|------------|
| **(in thousands)**                                                                              | ** ** | **2004**                                    | ** ** | **2003** | ** ** |
| Cash flows from financing activities:                                                           |       |                                        |       |   |   |
| Proceeds from exercise of stock  options/warrants                                               |       | $                                           | 3,061      |   | $ | 6,239 |   |
| Repayment of borrowings                                                                         |       | (3,728                                      | )          | (2,646 | ) |
| Proceeds from borrowings                                                                        |       | 3,729                                       |       | 2,193 |   |
| Increase in restricted cash                                                                     |       | —                                      |       | (1,000 | ) |
|                                                                                            |       |                                        |       |   |   |
| Net cash provided by financing activities                                                       |       | 3,062                                       |       | 4,786 |   |
|                                                                                            |       |                                        |       |   |   |
| Effect of exchange rate changes on cash                                                         |       | 1                                           |       | 1,098 |   |
|                                                                                            |       |                                        |       |   |   |
| Net (decrease) increase in cash and cash  equivalents                                           |       | (5,630                                      | )          | 6,157 |   |
|                                                                                            |       |                                        |       |   |   |
| Cash and cash equivalents at beginning of  period                                               |       | 39,393                                      |       | 26,581 |   |
|                                                                                            |       |                                        |       |   |   |
| Cash and cash equivalents at end of period                                                      |       | $                                           | 33,763     |   | $ | 32,738 |   |
|                                                                                            |       |                                        |       |   |   |
| **Supplemental Disclosures of Cash Flow Information**                                           |       |                                        |       |   |   |
| The Company paid cash during the period for:                                                    |       |                                        |       |   |   |
|                                                                                            |       |                                        |       |   |   |
| Interest                                                                                        |       | $                                           | 270        |   | $ | 154 |   |
| Foreign income taxes                                                                            |       | $                                           | 3,711      |   | $ | 2,108 |   |
|                                                                                            |       |                                        |       |   |   |
| **Supplemental Disclosures of Non-Cash Financing and  Investing Activities**                    |       |                                        |       |   |   |
| The Company has issued Common Stock in exchange for services as  follows:                       |       |                                        |       |   |   |
|                                                                                            |       |                                        |       |   |   |
| Shares                                                                                          |       | 12                                          |       | 56 |   |
| Amount                                                                                          |       | $                                           | 151        |   | $ | 481 |   |
|                                                                                            |       |                                        |       |   |   |
| Included in accounts payable at period-end are fixed asset and drug  license purchases totaling |       | $                                           | 1,951      |   | $ | 1,369 |   |

 

*The accompanyingNotes to Condensed Consolidated Financial Statements are an integral part ofthese financial statements.*

 

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**BENTLEY PHARMACEUTICALS, INC. AND SUBSIDIARIES**

 

**NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS**

 

HISTORYAND OPERATIONS:

 

BentleyPharmaceuticals, Inc. and Subsidiaries (which may be referred to as *Bentley Pharmaceuticals, Bentley, the Company, we, us*or *our*)**isa U.S.-based international specialty pharmaceutical company, incorporated inthe State of Delaware, focused on:

 

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

 

•                 development, licensing and sales of genericand branded pharmaceutical products and the manufacturing of pharmaceuticalsfor others.

 

In our research and development activities, we have U.S. andinternational patents and other proprietary rights to technologies thatfacilitate the absorption of drugs. Our pharmaceutical product sales and licensingactivities are based in Spain, where we have a significant commercial presenceand manufacture and market approximately 100 pharmaceutical products throughthree wholly-owned Spanish subsidiaries, Laboratorios Belmac, LaboratoriosDavur and Laboratorios Rimafar. These products represent various dosagestrengths and product formulations of more than 30 chemical entities in fourprimary therapeutic areas: cardiovascular, gastrointestinal, neurological andinfectious diseases. We continually add to our product portfolio in response toincreasing market demand for generic and branded therapeutic agents and divestportfolio products that we consider to be redundant or that have becomenon-strategic. Although most of our sales of these products are currently inthe Spanish market, we have recently focused on increasing our sales in otherEuropean countries and other geographic regions through strategic allianceswith companies in these territories. In April of 2004, we purchased amanufacturing facility located in Spain that specializes in the manufacture ofseveral active pharmaceutical ingredients (API), of which, one ingredient hasbeen approved by the U.S. Food and Drug Administration for marketing and salein the U.S. We are manufacturing and marketing these products through our newlyformed subsidiary, Bentley API. Additionally, we have a strategic alliance withTeva Pharmaceutical Industries Ltd. granting us the right to register andmarket several of Teva’s pharmaceutical products in Spain through our salesforce of approximately 150 full-time personnel located in major citiesthroughout Spain. In addition, our Spanish manufacturing facility producespharmaceutical products that are marketed by pharmaceutical companies both inSpain and in other markets. We have also recently entered into a multi-productcollaboration agreement with Perrigo Company, the nation’s largest manufacturerof over-the-counter pharmaceutical and nutritional products for the store brandmarket, to co-develop and market certain generic pharmaceutical products in theU.S. and potentially other markets.

 

We are developing products that incorporate our drugdelivery technologies and have licensed applications of our proprietaryCPE-215® drug delivery technology to Auxilium Pharmaceuticals, Inc., whichlaunched TestimTM, the first product incorporating our drug delivery technology,in February 2003. Testim is a gel indicated for testosterone replacementtherapy, which restores serum testosterone levels in men and thereby improvessymptoms of health problems associated with low testosterone levels(hypogonadism), including loss of muscle mass and a decrease in sexual desire,sexual motivation and frequency of spontaneous erections. We are in discussionswith other pharmaceutical and biotechnology companies to form additionalstrategic alliances to facilitate the development and commercialization ofother products using our drug

 

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delivery technologies,including product candidates that deliver insulin to diabetic patientsintranasally and treat nail fungus infections topically.

 

TheCompany’s Common Stock began trading on the New York Stock Exchange (*NYSE)*onMay 12, 2004, under the trade symbol *BNT.*Priorthereto, the Company’s stock was traded on the American Stock Exchange.

 

BASISOF CONDENSED CONSOLIDATED FINANCIAL STATEMENTS:

 

Theconsolidated financial statements of Bentley Pharmaceuticals as of September30, 2004 and for the three and nine months ended September 30, 2004 and 2003,included herein, have been prepared by us, without audit, pursuant to the rulesand regulations of the Securities and Exchange Commission. Certain informationand footnote disclosures normally included in financial statements prepared inaccordance with accounting principles generally accepted in the United Statesof America have been condensed or omitted insofar as such information wasdisclosed in our consolidated financial statements for the year ended December31, 2003. These condensed consolidated financial statements should be read inconjunction with the summary of significant accounting policies and the auditedconsolidated financial statements and notes thereto included in our AnnualReport on Form 10-K for the year ended December 31, 2003.

 

In the opinion of management, the accompanying unaudited condensed consolidatedfinancial statements as of September 30, 2004 and for the three and nine monthsended September 30, 2004 and 2003 are presented on a basis consistent with theaudited consolidated financial statements for the year ended December 31, 2003and contain all adjustments, consisting only of normal recurring adjustments,necessary to present fairly Bentley’s financial position as of September 30,2004 and the results of its operations and cash flows for the three and ninemonths ended September 30, 2004 and 2003. The results of operations for thethree and nine months ended September 30, 2004 should not necessarily beconsidered indicative of the results to be expected for the full year endingDecember 31, 2004.

 

CASHAND CASH EQUIVALENTS AND RESTRICTED CASH:

 

Included in *cash and cashequivalents*at September 30, 2004 and December 31, 2003 areapproximately $2,897,000 and $29,156,000, respectively, of short-terminvestments considered to be cash equivalents, as the remaining maturity datesof such investments were three months or less when purchased.

 

The Company acquired intellectual property duringthe year ended December 31, 2003 for $1,000,000 plus future royalties on salesand licensing income. In connection with the acquisition, the Company obtaineda renewable, irrevocable letter of credit in the amount of $1,000,000 in favorof the seller to guarantee future royalty payments. This irrevocable letter ofcredit was renewed in June of 2004 for a one year period. The $1,000,000 usedto secure the letter of credit has been classified as *restricted cash*in the ConsolidatedBalance Sheets as of September 30, 2004 and December 31, 2003.

 

MARKETABLESECURITIES:

 

The Company has investments in securities, with maturities of greaterthan three months when purchased, which are classified as available-for-sale,totaling $476,000 as of September 30, 2004, compared to $1,252,000 as ofDecember 31, 2003. The Company’s investments are carried at amortized costwhich approximates fair value due to the short-term nature of theseinvestments.

 

9

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Accordingly, no unrealized gains or losses have been recognized onthese investments. Should the fair values differ significantly from theamortized costs, unrealized gains or losses would be included as a component of*othercomprehensive income (loss).*

 

INVENTORIES:

 

Inventories are stated at the lower of costor market, cost being determined on the first in, first out (“FIFO”) method,and are comprised of the following (in thousands):

 
| ** **                               | ** ** | **September 30, 2004** | ** ** | **December 31, 2003** | ** ** |
|------------------------------------------|------------|------------------------|------------|-----------------------|------------|
| Raw materials                            |       | $                      | 6,262      |                  | $          | 5,351 |   |
| Finished goods                           |       | 2,819                  |       | 1,829                 |       |
|                                     |       | 9,081                  |       | 7,180                 |       |
| Less allowance for slow moving inventory |       | (68                    | )          | (74                   | )          |
|                                     |       | $                      | 9,013      |                  | $          | 7,106 |   |

 

FIXED ASSETS:

 

Fixed assets consist of the following (in thousands):

 
| ** **                    | ** ** | **September 30, 2004** | ** ** | **December 31, 2003** | ** ** |
|-------------------------------|------------|------------------------|------------|-----------------------|------------|
| Land                          |       | $                      | 2,400      |                  | $          | 1,900 |   |
| Buildings and improvements    |       | 13,442                 |       | 9,085                 |       |
| Equipment                     |       | 14,333                 |       | 10,953                |       |
| Furniture and fixtures        |       | 1,570                  |       | 1,497                 |       |
| Leasehold improvements        |       | —                 |       | 43                    |       |
|                          |       | 31,745                 |       | 23,478                |       |
| Less accumulated depreciation |       | (6,692                 | )          | (4,912                | )          |
|                          |       | $                      | 25,053     |                  | $          | 18,566 |   |

 

In April of 2004, we purchased a Spanishmanufacturing facility and related machinery and equipment, used to manufactureactive pharmaceutical ingredients, for approximately $3,309,000. We aremanufacturing and marketing some of these products through our newly formedsubsidiary, Bentley API. The 20,000 square foot facility is currently FDAapproved for one product, which it sells to several customers, includingcustomers in the United States.

 

In order to support the Company’s growth inEurope, we are increasing capacity at our finished pharmaceutical productmanufacturing facility through a series of improvements. During the nine monthsended September 30, 2004, the Company invested over $6,000,000 in machinery,equipment and improvements, including new high speed manufacturing andpackaging equipment.

 

Depreciation expense of approximately $516,000 and $256,000 has beencharged to operations as a component of*depreciation and amortization expense*inthe Consolidated Income Statements for the nine months ended September 30, 2004and 2003, respectively. We have included depreciation totaling approximately$1,488,000 and $741,000 in *cost of netproduct sales*during the three months ended September 30, 2004 and2003, respectively.

 

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STOCKHOLDERS’EQUITY:

 

A substantial amount of our business is conducted in Europe and istherefore influenced by fluctuations in the U.S. Dollar’s value against othercurrencies, principally the Euro. The exchange rates at September 30, 2004 andDecember 31, 2003 were .81 Euros and .80 Euros per U.S. Dollar, respectively.The weighted average exchange rates for the three months ended September 30,2004 and 2003 were .82 Euros and .89 Euros per U.S. Dollar, respectively. Theweighted average exchange rates for the nine months ended September 30, 2004and 2003 were .82 Euros and .90 Euros per U.S. Dollar, respectively. The effectof foreign currency fluctuations on long lived assets for the nine months endedSeptember 30, 2004 was a decrease of $643,000 and the cumulative historicaleffect was an increase of $4,526,000, as reflected in our Consolidated BalanceSheets as *accumulated other comprehensiveincome.*Although exchange rates fluctuated significantly in recentyears, we do not believe that the effect of foreign currency fluctuation ismaterial to our results of operations as the expenses related to much of ourforeign currency revenues are in the same functional currency, the Euro, asthose revenues. However, the carrying value of assets and liabilities can bematerially impacted by foreign currency translation, as can the translatedamounts of revenues and expenses.

 

During the nine months ended September 30, 2004, we received proceedstotaling $600,000 from the issuance of 400,000 shares of Common Stock uponexercise of common stock warrants and an additional $2,461,000 from theissuance of 319,000 shares of Common Stock upon the exercise of stock options.We also issued approximately 12,000 shares of Common Stock as equity-basedcompensation in lieu of cash contributions to the Company-sponsored 401(k)retirement savings plan. Additionally, we granted to our employees anddirectors stock options to purchase approximately 542,000 shares of CommonStock during the nine months ended September 30, 2004.

 

LICENSINGAND COLLABORATION REVENUES:

 

Ourlicensee, Auxilium Pharmaceuticals, Inc., launched its testosterone replacementgel, Testim, which utilizes our patented CPE-215 drug delivery technology,during the first quarter of 2003. Auxilium paid a $500,000 milestone payment tous during the first quarter of 2003, which we recorded as *licensing and collaboration revenues*inthe Consolidated Income Statement for the three months ended March 31, 2003. Inconnection with the Testim product launch, we began earning royalty revenues ona percentage of Testim sales as defined in the licensing agreement withAuxilium. Royalty revenues on Testim product sales are recognized based on anestimate of Auxilium’s sell-through of the Testim product based onprescriptions filled, until such time that returns from wholesalers andpharmacies can be reasonably estimated. At that time, we expect to record aone-time increase in *licensing andcollaboration revenues*related to the recognition of previouslydeferred revenue. For the three and nine months ended September 30, 2004, werecognized royalty revenues of approximately $800,000 and $2,000,000,respectively, compared to $335,000 and $543,000 in the three and nine monthsended September 30, 2003, respectively. The difference between the total amountearned from Auxilium under the royalty arrangement and the amount recognized asa component of*licensing and collaboration revenues is*recordedas a component of*deferred income*in theConsolidated Balance Sheets. As of September 30, 2004 and December 31, 2003,deferred income from Testim royalties was approximately $1,240,000 and$634,000, respectively. We will continue to use available market information todetermine the amount and timing of royalty revenue recognition until such timethat returns from wholesalers and pharmacies can be reasonably estimated.

 

11

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OTHERINCOME (EXPENSES):

 

In addition to interest income on our investment andcash balances and interest expense on our debt obligations, *other income (expenses)*for the three andnine months ended September 30, 2004 includes the reversal of previouslyaccrued tax assessments, as well as interest and penalties associated with thesettlement of the tax audit of our Spanish subsidiary’s tax years 1998 - 2000(see Provision for Income Taxes footnote below). We recorded a pre-tax benefittotaling $1,467,000 ($954,000 after taxes) as a component of*otherincome (expenses)*as the result of the reversal of previouslyaccrued pharmaceutical tax assessments in Spain. These assessments had beenaccrued to be paid to the Spanish government as a vehicle to help reduce theimpact of the rising health care costs in Spain. Due to recent changes in thepharmaceutical industry in Spain and a change in the Spanish politicalenvironment, these liabilities no longer exist. Accordingly, these accrualswere reversed during the quarter ended June 30, 2004.

 

PROVISIONFOR INCOME TAXES:

 

A tax review of our Spanish subsidiary, LaboratoriosBelmac S.A., by the Spanish tax authorities for the tax years 1998, 1999 and2000, which had commenced over a year ago, was completed in the second quarterof 2004. As a result of this audit, our subsidiary has been assessed anadditional tax liability of approximately $604,000, which has been recorded asa component of*provision for income taxes*for thethree months ended June 30, 2004 and the nine months ended September 30, 2004,and approximately $193,000 for related interest and penalties, which have beenrecorded as components of*other income (expenses),*in theconsolidated income statements for the three months ended June 30, 2004 and thenine months ended September 30, 2004.

 

As a result of reporting taxable income in Spain, we recordedprovisions for foreign income taxes totaling $1,344,000 and $1,513,000 for thethree months ended September 30, 2004 and 2003, respectively. The effective taxrate for the three months ended September 30, 2004 is 49% compared to 53% inthe prior year third quarter. We have recorded provisions for foreign incometaxes totaling $4,706,000 ($4,102,000 income tax expense on operations plus$604,000 recorded as a result of the tax audit of**our Spanishsubsidiary in the second quarter of 2004) and $4,469,000 for the nine monthsended September 30, 2004 and 2003, respectively. The effective tax rate inSpain for the nine months ended September 30, 2004 is 56%; however, when the$604,000 tax audit settlement related to prior years is excluded, the effectivetax rate is 49% compared to 50% in the comparable nine month period of theprior year.

 

Asfuture domestic operating profits cannot be reasonably assured, no tax benefithas been recorded for U.S. losses, which totaled $896,000 and $958,000 for thethree months ended September 30, 2004 and 2003, respectively, and $2,378,000and $2,423,000 for the nine months ended September 30, 2004 and 2003,respectively. Accordingly, we have established a valuation allowance equal tothe full amount of the U.S. deferred tax assets. The provisions for incometaxes differ from the amounts computed by applying the U.S. federal income taxrate of 34% to pre-tax income, primarily as a result of the increase in thevaluation allowance to offset U.S. deferred tax assets, certain nondeductibleexpenses in Spain and the higher statutory income tax rate of 35% in Spain.

 

12

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Should we determine that it is more likely than not that we willrealize certain of our net deferred tax assets for which we have previouslyprovided a valuation allowance, an adjustment would be required to reduce theexisting valuation allowance. In addition, we operate within multiple taxingjurisdictions and are subject to audit in those jurisdictions. These audits caninvolve complex issues, which may require an extended period of time forresolution. During the second quarter of 2004, we identified certain taxcontingencies that we determined were probable and reasonably estimable.Consequently, we have included a charge totaling $188,000 in the *provision for income taxes*in the secondquarter of 2004 related to these contingencies. No other potential taxcontingencies were considered probable or reasonably estimable by the Companyat period end. However, there is the possibility that the ultimate resolutionof such potential contingencies could have an adverse effect on our results ofoperations.

 

BASIC AND DILUTED NET INCOME PER COMMON SHARE:

 

Basic and diluted net income per common shareis based on the weighted average number of shares of common stock outstandingduring each period. The dilutive effect of our outstanding stock options andstock purchase warrants, as calculated using the treasury stock method, wereconsidered in the net income per share calculations for the three and ninemonths ended September 30, 2004 and 2003.

 

The following is a reconciliation betweenbasic and diluted net income per common share for the three and nine monthsended September 30, 2004 and 2003. Dilutive securities issuable for the threeand nine months ended September 30, 2004 include approximately 1,697,000 and2,008,000 shares, respectively, issuable as a result of various stock optionsand warrants that are outstanding and exercisable.  Dilutive securities issuable for the three andnine months ended September 30, 2003 include approximately 4,317,000 and3,686,000 shares, respectively, issuable as a result of exercisable Class BWarrants, stock purchase warrants and stock options that were outstanding andexercisable at that time.

 

(in thousands, except per share data)

 

For the Three Months Ended September 30, 2004:

 
| ** **                                 | ** ** | **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 |   |

 

For the Three Months Ended September 30, 2003:

 
| ** **                                 | ** ** | **Basic EPS** | ** ** | **Effect of Dilutive  Securities** | ** ** | **Diluted EPS** | ** ** |
|--------------------------------------------|------------|---------------|------------|------------------------------------|------------|-----------------|------------|
| Net Income                                 |       | $             | 1,348      |                               | $          | —          |       | $ | 1,348 |   |
| Weighted Average Common Shares Outstanding |       | 17,911        |       | 4,317                              | ** ** | 22,228          |       |
| Net Income Per Common Share                |       | $             | 0.08       |                               | $          | (0.02           | )          | $ | 0.06 |   |

 

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Forthe Nine Months Ended September 30, 2004:

 
| ** **                                 | ** ** | **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 |   |

 

Forthe Nine Months Ended September 30, 2003:

 
| ** **                                 | ** ** | **Basic EPS** | ** ** | **Effect of Dilutive  Securities** | ** ** | **Diluted EPS** | ** ** |
|--------------------------------------------|------------|---------------|------------|------------------------------------|------------|-----------------|------------|
| Net Income                                 |       | $             | 4,409      |                               | $          | —          |       | $ | 4,409 |   |
| Weighted Average Common Shares Outstanding |       | 17,635        |       | 3,686                              |       | 21,321          |       |
| Net Income Per Common Share                |       | $             | 0.25       |                               | $          | (0.04           | )          | $ | 0.21 |   |

 

Excluded from the diluted EPS presentation, because their exerciseprices were greater than the average fair value of the Common Stock in therespective periods, were options and warrants to purchase an aggregate of approximately740,000 and 583,000 shares of Common Stock, for the three and nine months endedSeptember 30, 2004, respectively, and options and warrants to purchase anaggregate of 185,000 and 347,000 shares of Common Stock, for the three and ninemonths ended September 30, 2003, respectively.

 

STOCKBASED COMPENSATION:

 

We have stock-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, 2003. We accountfor these plans under the recognition and measurement principles of AccountingPrinciples Board (“APB”) Opinion No. 25, *Accountingfor Stock Issued to Employees,*and related Interpretations. Optionsgranted under these plans have exercise prices equal to or greater than themarket value of the underlying Common Stock on the dates of grant, which isgenerally the date on which compensation is measured. In addition to theseplans, we also sponsor a 401 (k) retirement savings plan for eligible employeesand match eligible contributions with shares of the Company’s Common Stock.From time to time, at the discretion of the Compensation Committee of the Boardof Directors, the Company grants shares of its Common Stock to employees inlieu of cash compensation. Related stock-based employee compensation costs arereflected in the Consolidated Income Statements and Statements of Cash Flows.

 

General and administrative expenses for the three and nine months endedSeptember 30, 2004 include $14,000 and $61,000, respectively, of non-cashequity-based compensation. General and administrative expenses for the threeand nine months ended September 30, 2003 include $75,000 and $177,000,respectively, of non-cash equity-based compensation. Research and developmentexpenses for the three and nine months ended September 30, 2004 include $24,000and $106,000, respectively, of non-cash equity-based compensation. Research anddevelopment expenses for the three and nine months ended September 30, 2003include $65,000 and $200,000, respectively, of non-cash equity-basedcompensation.

 

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The following table illustrates the effect on netincome per share if we had applied the fair value recognition provisions ofStatement of Financial Accounting Standards (“SFAS”) No. 123, *Accounting for Stock-Based Compensation,*tostock-based employee compensation.

 
| ** **                                                                                                 | ** ** | **For the Three Months  Ended September 30,** | ** ** | **For the Nine Months  Ended September 30,** | ** ** |
|------------------------------------------------------------------------------------------------------------|------------|-----------------------------------------------|------------|----------------------------------------------|------------|
|                                                                                                       |       | **2004**                                      | ** ** | **2003**                                     | ** ** | **2004** | ** ** | **2003** |   |
| Net income, as reported                                                                                    |       | $                                             | 1,413      |                                         | $          | 1,348 |   | $ | 3,712 |   | $ | 4,409 |   |
|                                                                                                       |       |                                          |       |                                         |       |   |   |   |   |
| Add: Stock-based employee compensation  expense included in reported net income                            |       | 38                                            |       | 140                                          |       | 167 |   | 377 |   |
|                                                                                                       |       |                                          |       |                                         |       |   |   |   |   |
| Deduct: Total stock-based employee compensation  expense determined under fair value method for all awards |       | (467                                          | )          | (850                                         | )          | (2,168 | ) | (2,367 | ) |
|                                                                                                       |       |                                          |       |                                         |       |   |   |   |   |
| Pro forma net income                                                                                       |       | $                                             | 984        |                                         | $          | 638 |   | $ | 1,711 |   | $ | 2,419 |   |
|                                                                                                       |       |                                          |       |                                         |       |   |   |   |   |
| Net income per common share:                                                                               |       |                                          |       |                                         |       |   |   |   |   |
| Basic - as reported                                                                                        |       | $                                             | 0.07       |                                         | $          | 0.08 |   | $ | 0.18 |   | $ | 0.25 |   |
| Basic - pro forma                                                                                          |       | $                                             | 0.05       |                                         | $          | 0.04 |   | $ | 0.08 |   | $ | 0.14 |   |
|                                                                                                       |       |                                          |       |                                         |       |   |   |   |   |
| Diluted - as reported                                                                                      |       | $                                             | 0.06       |                                         | $          | 0.06 |   | $ | 0.16 |   | $ | 0.21 |   |
| Diluted - pro forma                                                                                        |       | $                                             | 0.04       |                                         | $          | 0.03 |   | $ | 0.08 |   | $ | 0.11 |   |

 

The preceding pro forma results were calculated using the Black-Scholesoption pricing model with the following weighted average assumptions (resultsmay vary depending on the assumptions applied within the model):

 
| ** **                    | ** ** | **For the Three Months  Ended September 30,** | ** ** | **For the Nine Months  Ended September 30,** | ** ** |
|-------------------------------|------------|-----------------------------------------------|------------|----------------------------------------------|------------|
| ** **                    | ** ** | **2004**                                      | ** ** | **2003**                                     | ** ** | **2004** | ** ** | **2003** | ** ** |
|                          |       |                                          |       |                                         |       |   |   |   |   |
| Risk-free interest rate       |       | 2.59                                          | %          | 3,48                                         | %          | 2.96 | % | 3.88 | % |
| Dividend yield                |       | 0.00                                          | %          | 0.00                                         | %          | 0.00 | % | 0.00 | % |
| Expected life                 |       | 5 years                                       |       | 5 years                                      |       | 5 years |   | 5 years |   |
| Volatility                    |       | 48.14                                         | %          | 53.12                                        | %          | 49.25 | % | 54.25 | % |
| Fair value of options granted |       | $                                             | 5.62       |                                         | $          | 4.79 |   | $ | 6.02 |   | $ | 4.99 |   |
|                               |            |                                               |            |                                              |            |  |  |  |  |  |  |  |  |

 

Stockor other equity-based compensation for non-employees is accounted for under thefair value method as required by SFAS No. 123 and Emerging Issues Task Force (“E1TF”)issue No. 96-18, *Accounting for EquityInstruments That Are Issued to Other Than Employees for Acquiring, or inConjunction with Selling, Goods or Services*and other relatedinterpretations.

 

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RECLASSIFICAT1ONS:

 

Certain prior period amounts have beenreclassified to conform with the current period’s presentation. Suchreclassifications are not material to the Consolidated Financial Statements.

 

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**Item2****.   Management’s Discussion and Analysis ofFinancial Condition and Results of Operations**

 

The following discussion and analysis shouldbe read together with all financial and non-financial information appearingelsewhere in this report and with our consolidated financial statements andrelated notes included in our Annual Report on Form 10-K for the year endedDecember 31, 2003, which has been previously filed with the Securities andExchange Commission. In addition to historical information, the followingdiscussion and other parts of this report contain forward-looking informationthat involves risks and uncertainties. Our actual results could differmaterially from those anticipated by such forward-looking information due tocompetitive factors and other risks discussed below under the caption “ImportantFactors That May Affect Future Results”.

 

**RESULTS OF OPERATTONS:**

 

**Three Months Ended September 30, 2004 versus Three MonthsEnded September 30, 2003**

 

*Revenues*

 
| ** **                             | ** ** | **For the Three Months Ended September 30,** | ** ** | **Change** | *** *** |
|----------------------------------------|------------|----------------------------------------------|------------|------------|--------------|
| **(in thousands)**                     | ** ** | **2004**                                     | ** ** | **%**      | ** **   | **2003** | ** ** | **%** | ** ** | **$** | ** ** | **%** | *** *** |
| *Revenues:*                            |       |                                         |       |       |         |   |   |   |   |   |   |   | * * |
| *Net product sales*                    | * *   | *$*                                          | *17, 312*  | * *   | *96*         | *%* | *$* | *14,540* | * * | *98* | *%* | *$* | *2,772* | * * | *19* | *%* |
| *Licensing and collaboration revenues* | * *   | *791*                                        | * *   | *4*        | *%*          | *335* | * * | *2* | *%* | *456* | * * | *136* | *%* |
| *Total revenues*                       | * *   | *$*                                          | *18,103*   | * *   | *100*        | *%* | *$* | *14,875* | * * | *100* | *%* | *$* | *3,228* |   | 22 | *%* |

 

Total revenues for the three months ended September 30, 2004 increased22% from the same period in the prior year. However, our total revenuesincreased approximately 12% when expressed in constant currency. An increase inthe weighted average value of the Euro, in relation to the U.S. Dollar, had theeffect of increasing revenues by approximately $1,378,000, partially offsettingthe impact of price reductions in Spain.  Price reductions were mandated for certainpharmaceutical products by the Spanish government in late 2003, which we putinto effect on December 1, 2003. Over the past nine months, we have implementedseveral initiatives to reduce our production costs and increase our margins onseveral of our products affected by the price reductions. Additionally, throughstrategic pricing, we have been able to increase our market share on these andother products. The advancement of our proprietary drug delivery programs inthe U.S., as evidenced by the growing royalty stream from sales of Testim, thefirst marketed product incorporating our CPE-215 drug delivery technology, haveincreased our revenues by approximately $456,000 in the three months endedSeptember 30, 2004 over the same period in the prior year.

 

Our revenues are generated through our live primary sales channels:branded pharmaceuticals, generic pharmaceuticals, contract manufacturing forother pharmaceutical companies, sales outside of Spain and licensing andcollaborations. Set forth below is a summary of our revenues by sales channeland top-selling product lines:

 

17

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For the three months ended September 30, 2004 (in thousands):

 

 
| ** **                     | ** ** | **Sales Within Spain** | ** ** | ** **            | ** ** | ** **                     | *** *** | ** **          | *** *** |
|--------------------------------|------------|------------------------|------------|-----------------------|------------|--------------------------------|--------------|---------------------|--------------|
| **Product Line**               | ** ** | **Branded  Products**  | ** ** | **Generic  Products** | ** ** | **Contract  Manu-  facturing** | ** **   | **Other  Revenues** | ** **   | **Total** | *** *** | **% of Total  Revenues** | *** *** |
|                           |       |                   |       |                  |       |                           |         |                |         |   | * * |   | * * |
| *Omeprazole*                   | * *   | *$*                    | *742*      | * *              | *$*        | *3,296*                        | * *     | *$*                 | *—*     | * * | *$* | *—* | * * | *$* | *4,038* | * * | *22* | *%* |
| *Simvastatin*                  | * *   | *374*                  | * *   | *929*                 | * *   | *—*                       | * *     | *—*            | * *     | *1,303* | * * | *7* | *%* |
| *Enalapril*                    | * *   | *725*                  | * *   | *348*                 | * *   | *—*                       | * *     | *—*            | * *     | *1,073* | * * | *6* | *%* |
| *Paraxetine*                   | * *   | *225*                  | * *   | *698*                 | * *   | *—*                       | * *     | *—*            | * *     | *923* | * * | *5* | *%* |
| *Pentoxifylline*               | * *   | *—*               | * *   | *668*                 | * *   | *—*                       | * *     | *—*            | * *     | *668* | * * | *4* | *%* |
| *All other products*           | * *   | *2,216*                | * *   | *1,144*               | * *   | *—*                       | * *     | *809*               | * *     | *4,169* | * * | *23* | *%* |
| *Contract manufacturing*       | * *   | *—*               | * *   | *—*              | * *   | *3,077*                        | * *     | *—*            | * *     | *3,077* | * * | *17* | *%* |
| *Sales outside of Spain*       | * *   | *—*               | * *   | *—*              | * *   | *—*                       | * *     | *2.061*             | * *     | *2,061* | * * | *12* | *%* |
| *Licensing and collaborations* | * *   | *—*               | * *   | *—*              | * *   | *—*                       | * *     | *791*               | * *     | *791* | * * | *4* | *%* |
| *Total Revenues*               | * *   | *$*                    | *4,282*    | * *              | *$*        | *7,083*                        | * *     | *$*                 | *3,077*      | * * | *$* | *3,661* | * * | *$* | *18,103* | * * | *100* | *%* |
| *% of Total Revenues*          | * *   | *24*                   | *%*        | *39*                  | *%*        | *17*                           | *%*          | *20*                | *%*          | *100* | *%* |   | * * |

 

For the three months ended September 30, 2003 (in thousands):

 
| ** **                     | ** ** | **Sales Within Spain** | ** ** | ** **            | ** ** | ** **                     | *** *** | ** **          | *** *** |
|--------------------------------|------------|------------------------|------------|-----------------------|------------|--------------------------------|--------------|---------------------|--------------|
| **Product Line**               | ** ** | **Branded  Products**  | ** ** | **Generic  Products** | ** ** | **Contract  Manu-  facturing** | ** **   | **Other  Revenues** | ** **   | **Total** | *** *** | **%****of TotaI****Revenues** | *** *** |
| ** **                     | ** ** | ** **             | ** ** | ** **            | ** ** | ** **                     | ** **   | ** **          | ** **   | ** ** | *** *** | ** ** | *** *** |
| *Omeprazole*                   | * *   | *$*                    | *1,515*    | * *              | *$*        | *3,238*                        | * *     | *$*                 | *—*     | * * | *$* | *—* | * * | *$* | *4,753* | * * | *32* | *%* |
| *Simvastatin*                  | * *   | *618*                  | * *   | *1,109*               | * *   | *—*                       | * *     | *—*            | * *     | *1,727* | * * | *12* | *%* |
| *Enalapril*                    | * *   | *646*                  | * *   | *379*                 | * *   | *—*                       | * *     | *—*            | * *     | *1,025* | * * | *7* | *%* |
| *Paroxetine*                   | * *   | *—*               | * *   | *135*                 | * *   | *—*                       | * *     | *—*            | * *     | *135* | * * | *1* | *%* |
| *Pentoxifylline*               | * *   | *—*               | * *   | *489*                 | * *   | *—*                       | * *     | *—*            | * *     | *489* | * * | *3* | *%* |
| *All other products*           | * *   | *1,672*                | * *   | *941*                 | * *   | *—*                       | * *     | *—*            | * *     | *2,613* | * * | *18* | *%* |
| *Contract manufacturing*       | * *   | *—*               | * *   | *—*              | * *   | *1,856*                        | * *     | *—*            | * *     | *1,856* | * * | *12* | *%* |
| *Sales outside of Spain*       | * *   | *—*               | * *   | *—*              | * *   | *—*                       | * *     | *1,942*             | * *     | *1,942* | * * | *13* | *%* |
| *Licensing and collaborations* | * *   | *—*               | * *   | *—*              | * *   | *—*                       | * *     | *335*               | * *     | *335* | * * | *2* | *%* |
| *Total Revenues*               | * *   | *$*                    | *4,451*    | * *              | *$*        | *6,291*                        | * *     | *$*                 | *1,856*      | * * | *$* | *2,277* | * * | *$* | *14,875* | * * | *100* | *%* |
| *% of Total Revenues*          | * *   | *30*                   | *%*        | *42*                  | *%*        | *13*                           | *%*          | *15*                | *%*          | *100* | *%* |   | * * |

* *

*Spanish Operations.   *The core of ourSpanish operations has been the efficient manufacturing and in-countrymarketing of branded and generic pharmaceutical products. Historically, ourpharmaceutical products were sold only within Spain. However,  the execution of our long-term strategic planover the past eight years has created an opportunity for our Spanish operationsto expand beyond the borders of Spain into other European countries and othercountries outside of Europe. The increase in third quarter 2004 product salesover the 2003 third quarter is due primarily to a 66% increase in contractmanufacturing sales, sales of active pharmaceutical ingredients (API) from ournew manufacturing facility (included in *“Allother products”*above), revenues from our paroxetine product line,which was launched in May of 2003 and growth in the number of units sold andmarketshare, partially offset by lower prices. Contract manufacturing salesincreased by $1,221,000 when compared to the prior year quarter and accountedfor approximately 38% of our revenue growth in the period. API sales added$809,000

 

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to our revenues in the thirdquarter of 2004 and accounted for 25% of our revenue growth in the period. Ourparoxetine product line generated net sales of $923,000, representing 5% of ourtotal revenues during the three months ended September 30, 2004, compared to 1%in the comparable period of the prior year and accounted for 24% of our revenuegrowth in the period. However, revenues from our top two selling products,omeprazole and simvastatin, comprised an aggregate of 29% of our total revenuesin the third quarter of 2004, compared to 44% in the same quarter of the prioryear, as a result of lower selling prices that we implemented on December 1,2003.

 

Prices for prescription pharmaceuticalproducts in Spain must be approved by the Ministry of Health. For several yearsnow, the Ministry of Health has encouraged the substitution ofgeneric-equivalent products in order to help control rising healthcare costs.In further efforts to reduce healthcare costs, the Ministry of Health hadcontemplated new laws and regulations that would significantly reduce themarket prices of certain pharmaceutical products in Spain, includinggeneric-equivalent drugs. In late October 2003, the Spanish government enacteda regulation that reduced the prices that the government reimburses for nine ofour chemical entities, including the chemical entities omeprazole, simvastatinand enalapril, which accounted for approximately 65% to 70% of net productsales in the year ended December 31, 2003. These new prices were required totake effect on December 26, 2003. However, we, and some other pharmaceuticalcompanies in Spain, strategically implemented the new prices on December 1,2003.

 

Although the law required laboratories tobegin selling at the new prices in December 2003, pharmacies in Spain were ableto continue to sell at the old higher prices until January 31, 2004. Thistransition period was an attempt to reduce returns of the higher priced productsby allowing the higher priced products to pass through the distribution channelto the end users. On average, our customers maintain a stock of approximatelyone to two months’ supply of our products. As we began selling at the new lowerprices on December 1, 2003 we expected the majority of our products that werelabeled and stamped at the old higher prices to have cleared the distributionchannel by January 31, 2004. We experienced an unforeseen level of returnstotaling approximately $1,800,000 in February and March of 2004. A majority ofthe products returned were either expired, nearing expiration or otherwise notresalable and consequently were destroyed. These product returns exceeded ourallowance for estimated sales returns at that time, which resulted in areduction in total revenues of approximately $1,800,000 and a reduction in ourgross profit of approximately $1,600,000 in the first quarter of 2004.Consequently our gross margins on net product sales in that quarter werenegatively impacted, resulting in a temporary decline in gross our margins to51%, compared to 57% in the three months ended March 31, 2003. Product returnsin April and May of 2004 were decreased from the first quarter but remainedelevated; however, returns subsequent to May of 2004 have returned to levelsconsistent with our historical experience. Gross margins on pharmaceuticalproduct sales excluding sales of active pharmaceutical ingredients were 53% inthe second and third quarters of 2004 up from 51% in the first quarter of 2004.See additional discussion in the *GrossProfit*section.

 

Over the past nine months, we have implemented several initiativeswhich have effectively reduced our production costs on several of our productsand increased our gross margins. These initiatives include the purchase of newhigh speed manufacturing equipment, new product launches, and increased salesvolume and marketshare through strategic pricing. We expect to continue toincrease our future sales volume through our pipeline of approximately 100products. Additionally, we recently purchased a manufacturing facility, locatedin Spain, which specializes in the manufacture of several active pharmaceuticalingredients. The ability to manufacture active pharmaceutical ingredients hasdiversified our revenue base. We will continue to focus on acquiring,developing and launching new products that will improve our product mix. Wewill also continue

 

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our efforts to increase oursales outside of Spain through additional registration, marketing, and supplyagreements. We will also continue to make significant investments in renovatingand increasing capacity in our manufacturing facilities, as well as continuedinvestments in new high speed, high volume equipment. We anticipate that ourgross margins will continue to gradually increase in the following quarters aswe continue to implement our strategy and benefit from economies of scale.

 

*Branded Pharmaceutical Products*

 
| ** **                   | ** ** | **For the Three Months Ended September 30,** | ** ** | **Change** | ** ** |
|------------------------------|------------|----------------------------------------------|------------|------------|------------|
| **(in thousands)**           | ** ** | **2004**                                     | ** ** | **%**      | ** ** | **2003** | ** ** | **%** | ** ** | **$** | ** ** | **%** | ** ** |
| *Branded Product Sales:*     | * *   | * *                                     | * *   | * *   | * *   | * * | * * | * * | * * | * * | * * | * * | * * |
| *Omeprazole*                 | * *   | $                                            | 742        | * *   | *17*       | *%* | $ | 1,515 | * * | *34* | *%* | $ | (773 | ) | *-51* | *%* |
| *Enalapril*                  | * *   | 725                                          | * *   | *17*       | *%*        | 647 | * * | *15* | *%* | 78 |   | *12* | *%* |
| *Codeisan*                   | * *   | 607                                          | * *   | *14*       | *%*        | 454 | * * | *10* | *%* | 153 |   | *34* | *%* |
| *All other branded products* | * *   | 2,208                                        | * *   | *52*       | *%*        | 1,835 | * * | *41* | *%* | 373 |   | *20* | *%* |
| *Total branded sales*        | * *   | $                                            | 4,282      | * *   | *100*      | *%* | $ | 4,451 | * * | *100* | *%* | $ | (169 | ) | *-4* | *%* |

 

Sales of our branded pharmaceutical products in the three months endedSeptember 30, 2004 decreased by approximately 4% compared to the same period ofthe prior year, and they accounted for 24% of total revenues during the threemonths ended September 30, 2004 compared to 30% of total revenues during thethree months ended September 30, 2003. An increase in the weighted average valueof the Euro, in relation to the U.S. Dollar, had the effect of increasingbranded net product sales by approximately $347,000 in the third quarter of2004. Price reductions continued to erode the sales of our branded omeprazoleand simvastatin, which decreased by approximately $773,000 and $244,000,respectively, from the same quarter in the prior year. Our branded omeprazole,Belmazol, experienced the most severe of the price reductions, suffering onaverage a 61% price cut. Even in the face of these price cuts and stronggeneric competition, we were successful in increasing market share of Belmazolwith a 16% increase in units sold in the third quarter of 2004 when compared tothe same period of the prior year. Generic competition has led to a 30% decreasein unit volume of Belmalip, our branded simvastatin, in the three months endedSeptember 30, 2004 when compared to the same period of the prior year, whichhas been partially offset by a 22% increase in unit volume of our genericsimvastatin. Sales of our branded enalapril experienced a 55% increase in unitvolume when compared to the same period of the prior year and accounted for 17%of total branded sales. Strong sales of our cough and cold medicine, Codeisan,and the launch of our branded version of paroxetine in May of 2003 also helpedto mitigate the impact of price cuts. While we expect to continue to develop,acquire, and launch new branded products, our focus on generics and salesoutside of Spain are expected to increase those revenues at a significantlyhigher pace than those of our branded products.

 

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*GenericPharmaceutical Products*

 
| ** **                   | ** ** | **For the Three Months Ended September 30.** | ** ** | **Change** | ** ** |
|------------------------------|------------|---------------------------------------------------|------------|------------|------------|
| **(in  thousands)**          | ** ** | **2004**                                          | ** ** | **%**      | ** ** | **2003** | ** ** | **%** | ** ** | **$** | ** ** | **%** | ** ** |
| *Generic Product Sales:*     |       |                                              |       |       |       |   |   |   |   |   |   |   |   |
| *Omeprazole*                 |       | $                                                 | 3,296      |       | *47*       | *%* | $ | 3,238 | * * | *51* | %  | $ | 58 |   | *2* | *%* |
| *Simvastatin*                |       | 929                                               |       | *13*       | *%*        | 1,109 | * * | *18* | % | (180 | ) | *-16* | *%* |
| *Paroxetine*                 |       | 698                                               | * *   | *10*       | *%*        | 135 | * * | *2* | % | 563 | * * | *417* | *%* |
| *Pentaxifylline*             |       | 668                                               | * *   | *9*        | *%*        | 489 | * * | *8* | % | 179 | * * | *37* | *%* |
| *All other generic products* |       | 1,492                                             | * *   | *21*       | *%*        | 1,320 | * * | *21* | % | 172 | * * | *13* | *%* |
| *Total generic sales*        |       | $                                                 | 7,083      | * *   | *100*      | *%* | $ | 6,291 | * * | *100* | % | $ | 792 | * * | *13* | *%* |

 

Sales of our generic pharmaceutical products in the three months ended September 30,2004 increased by approximately 13% compared to the same period of the prioryear, and they accounted for 39% of total revenues during the three monthsended September 30, 2004 compared to 42% of total revenues during thethree months ended September 30, 2003.  An increase in the weighted average value of the Euro, in relation tothe U.S. Dollar, had the effect of increasing generic product sales byapproximately $565,000 in the third quarter of 2004. Sales of our genericomeprazole in the third quarter of 2004, while 18% higher in terms of unitssold, increased by only 2% in U.S. dollars when compared to the prior year andaccounted for 47% of our generic pharmaceutical revenues in the third quarterof 2004, compared to 51% of generic revenues in the third quarter of 2003, as aresult of price reductions. Similarly, sales of our generic simvastatin, whilehigher in terms of units sold, decreased by approximately 16% when expressed inU.S. Dollars. Sales of our generic paroxetine, which was launched in May of2003, added approximately $563,000 to our generic sales, and continued to be amajor contributor again in the third quarter of 2004 accounting for 10% ofgeneric product sales, compared to 2% in the third quarter of the prior year.Sales of our generic pentoxifylline in the third quarter of 2004 increased byapproximately $179,000, or approximately 37% from the same quarter in the prioryear. We expect to continue to increase our generic drug portfolio and increaseour generic drug sales in Spain as products come off patent in the future.

 

*Contract Manufacturing*

 
| ** **               | ** ** | **For the Three Months Ended September 30,** | ** ** | **Change** | ** ** |
|--------------------------|------------|---------------------------------------------------|------------|------------|------------|
| **(in  thousands)**      | ** ** | **2004**                                          | ** ** | **2003**   | ** ** | **$** | ** ** | **%** | ** ** |
|                     |       |                                              |       |       |       |   |   |   |   |
| *Contract manufacturing* | * *   | *$*                                               | *3,077*    | * *   | *$*        | *1,856* | * * | *$* | *1,221* | * * | *66* | *%* |
|                          |            |                                                   |            |            |            |  |  |  |  |  |  |  |

 

In addition to manufacturing our own products, our Spanishmanufacturing facility supplies branded and generic products to severalentities in Spain under approximately 30 contract manufacturing supplyagreements. These customers market the products under their own names withtheir own labeling. Revenues generated from contract manufacturing represented17% of total revenues in the three months ended September 30, 2004,compared to 12% of total revenues in the three months ended September 30,2003. An increase in the weighted average value of the Euro, in relation to theU.S. Dollar, had the effect of increasing contract manufacturing sales byapproximately $246,000 in the third quarter of 2004.

 

*Sales**Outside**of Spain*

 
| ** **               | ** ** | **For the Three Months Ended September 30,** | ** ** | **Change** | ** ** |
|--------------------------|------------|---------------------------------------------------|------------|------------|------------|
| **(in****thousands)**    | ** ** | **2004**                                          | ** ** | **2003**   | ** ** | **$** | ** ** | **%** | ** ** |
|                     |       |                                              |       |       |       |   |   |   |   |
| *Sales outside of Spain* | * *   | *$*                                               | *2,061*    | * *   | *$*        | *1,942* | * * | *$* | *119* | * * | *6* | *%* |
|                          |            |                                                   |            |            |            |  |  |  |  |  |  |  |

 

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We have more than 30 license agreements pursuant to which we areselling our products outside of Spain. However, we currently have an additional57 signed license agreements to sell our products outside of Spain awaitingregulatory approvals. These license agreements are usually accompanied byfive-year exclusive supply agreements whereby the related products can only bepurchased from our subsidiaries. Sales under these supply agreements increasedby $119,000 or 6% when compared to the comparable period of the prior year. Theincrease is attributable to increased demand for products that we are able tomanufacture at relatively low costs and sell to customers in other countriesaround the world as they search to find low cost manufacturing alternatives toremain competitive in their respective markets. We believe that our highlyefficient manufacturing processes could lead to increased sales outside ofSpain as other countries around the world seek to reduce health care costs andother pharmaceutical companies outside of Spain search for cost savingalternatives. An increase in the weighted average value of the Euro, inrelation to the U.S. Dollar, had the effect of increasing sales outside ofSpain by approximately $165,000 during the three months ended September 30,2004 compared to the third quarter of 2003.

 

*Licensing and CollaborationRevenues*

 
| ** **                    | ** ** | **For the Three Months Ended September 30,** | ** ** | **Change** | ** ** |
|-------------------------------|------------|---------------------------------------------------|------------|------------|------------|
| **(in  thousands)**           | ** ** | **2004**                                          | ** ** | **2003**   | ** ** | **$** | ** ** | **%** | ** ** |
|                          |       |                                              |       |       |       |   |   |   |   |
| *Licensing and collaboration* | * *   | *$*                                               | *791*      | * *   | *$*        | *335* | * * | *$* | *456* | * * | *136* | *%* |
|                               |            |                                                   |            |            |            |  |  |  |  |  |  |  |

 

Licensing and collaboration revenues accounted for 4% of total revenuesin the three months ended September 30, 2004 compared to 2% of totalrevenues in the three months ended September 30, 2003. These revenuesinclude royalties of approximately $800,000 (compared to $335,000 in the thirdquarter of the prior year) from the commercialization and continuing sales ofTestim, the first product incorporating our drug delivery technology, which waslaunched by our licensee, Auxilium, in February 2003. Testim is currentlyreported to capture approximately 11-12% of all new testosterone gelreplacement prescriptions in the market.

 

*Gross Profit.   *Gross profitincreased by approximately $404,000, or 4%, in the three months ended September 30,2004 when compared to the three months ended September 30, 2003, while ourgross margins on net product sales have decreased from 60% in the three monthsended September 30, 2003 to 51% in the three months ended September 30,2004 (53% gross margins on sales of pharmaceutical products, excluding sales ofactive pharmaceutical ingredients). As discussed previously, our gross marginson net product sales have been negatively impacted by the December 2003price reductions and related product returns in Spain; however, product returnssubsequent to May 2004 have returned to levels consistent with our historicalexperience.

 

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*Sellingand Marketing Expenses*

 
| ** **              | ** ** | **For the Three Months Ended September 30,** | ** ** | **Change** | ** ** |
|-------------------------|------------|---------------------------------------------------|------------|------------|------------|
| **(in  thousands)**     | ** ** | **2004**                                          | ** ** | **2003**   | ** ** | **$** | ** ** | **%** | ** ** |
| *Selling and marketing* | * *   | *$*                                               | *3,199*    | * *   | *$*        | *3,224* | * * | *$* | *(25* | *)* | *-1* | *%* |
|                         |            |                                                   |            |            |            |  |  |  |  |  |  |  |

 

Selling and marketing expenses for the three months ended September 30,2004 remained relatively consistent with the same period in the prior year whenexpressed in U.S. dollars; however, the weighted average value of the Euro, inrelation to the U.S. Dollar, had the effect of increasing selling and marketingexpenses by approximately $266,000 in the three months ended September 30,2004. Selling and marketing expenses as a percentage of net product salesdecreased from 22% in the three months ended September 30, 2003, to 18% inthe three months ended September 30, 2004.

 

*Generaland Administrative Expenses*

 
| ** **                   | ** ** | **For the Three Months Ended September 30,** | ** ** | **Change** | ** ** |
|------------------------------|------------|---------------------------------------------------|------------|------------|------------|
| **(in  thousands)**          | ** ** | **2004**                                          | ** ** | **2003**   | ** ** | **$** | ** ** | **%** | ** ** |
|                         |       |                                              |       |       |       |   |   |   |   |
| *General and administrative* | * *   | *$*                                               | *2,140*    | * *   | *$*        | *1,744* | * * | *$* | *396* | * * | *23* | *%* |
|                              |            |                                                   |            |            |            |  |  |  |  |  |  |  |

 

General and administrative expenses for the three months ended September 30,2004 increased 23% over the same period in the prior year. The $396,000increase was the result of increased general and administrative activitiesrequired to support our continued growth and prepare for our anticipatedgrowth. These expenditures include increased costs in the current year foradditional employees, outside services, insurance and other costs to supportthe growth of our organization including costs of regulatory filings related toproducts that we anticipate selling in the future under license agreements andcosts associated with the implementation of the Sarbanes-Oxley Act of 2002.General and administrative expenses as a percent of total revenues in the threemonths ended September 30, 2004 remained at a consistent 12% when comparedto the three months ended September 30, 2003. General and administrativeexpenses would have been approximately $80,000 lower, absent the increase inthe weighted average value of the Euro, in relation to the U.S. Dollar, in thethree months ended September 30, 2004. We expect that our futureexpenditures for general and administrative expenses will continue to increaseas we grow.

 

*Researchand Development Expenses*

 
| ** **                 | ** ** | **For the Three Months Ended September 30,** | ** ** | **Change** | ** ** |
|----------------------------|------------|---------------------------------------------------|------------|------------|------------|
| **(in  thousands)**        | ** ** | **2004**                                          | ** ** | **2003**   | ** ** | **$** | ** ** | **%** | ** ** |
| *Research and development* | * *   | *$*                                               | *1,230*    | * *   | *$*        | *966* | * * | *$* | *264* | * * | *27* | *%* |
|                            |            |                                                   |            |            |            |  |  |  |  |  |  |  |

 

Research and development expenses for the three months ended September 30,2004 increased 27% over the same period in the prior year. In the first quarterof 2004, 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. We have recently completed thein-patient stage of a Phase II study of our clinical program for the intranasaldelivery of insulin and are in the data analysis and reporting stages of thatstudy. We initiated certain clinical programs to support our strategy for theeventual distribution of certain of our Spanish generic pharmaceutical productsin other countries, including the U.S. In order to further our strategy, werecently entered into a multi-product collaboration agreement with Perrigo Companyto co-develop and market certain generic pharmaceutical products in the U.S.and potentially other markets. We expect to continue to incur costs to conductclinical trials and support the required

 

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regulatory submissionsfor our clinical programs. We also incur costs related to pre-clinical programsfor product formulation and testing efforts being performed in the laboratoryin our U.S. headquarters and at our facilities in Spain. We are using our U.S.laboratory to develop potential product applications using our drug deliverytechnologies. The expenditures in research and development reflect our focus onprojects that are necessary for expansion of our portfolio of marketed productsand clinical trials involving our drug delivery technologies. Some of our costestimates for our research and development programs are preliminary, and thespecific timing is not known; however, based upon our most recent information,we estimate that our research and development expenses for the year ending December 31,2004 could be approximately $500,000 to $1,000,000 higher than in the yearended December 31, 2003 as a result of our increased developmentactivities.

 

*Provision for Income Taxes*

 
| ** **                             | ** ** | **For the Three Months Ended September 30, 2004** | *** *** |
|----------------------------------------|------------|--------------------------------------------------------|--------------|
| **(in  thousands)**                    | ** ** | **Spain**                                              | ** **   | **U.S.** | ** ** | **Consolidated** | *** *** |
|                                   |       |                                                   |         |   |   |   | * * |
| *Income (loss) before income taxes*    | * *   | *$*                                                    | *3,653*      | * * | *$* | *(896* | *)* | *$* | *2,757* | * * |
|                                   |       |                                                   |         |   |   |   | * * |
| *Provision (benefit) for income taxes* | * *   | *1,344*                                                | * *     | *(305* | *)* | *1,039* | * * |
| *Valuation allowance*                  |       | —                                                 |         | *305* | * * | *305* | * * |
|                                   |       |                                                   |         |   |   |   | * * |
| *Net provision for income taxes*       | * *   | *1,344*                                                | * *     | *—* | * * | *1,344* | * * |
|                                   |       |                                                   |         |   |   |   | * * |
| *Net income (loss)*                    | * *   | *$*                                                    | *2,309*      | * * | *$* | *(896* | *)* | *$* | *1,413* | * * |
|                                   |       |                                                   |         |   |   |   | * * |
| *Effective tax rate*                   | * *   | *37*                                                   | *%*          | *0* | *%* | *49* | *%* |

 

As a result of reporting taxable income in Spain, we recordedprovisions for foreign income taxes totaling $1,344,000 and $ 1,513,000 for thethree months ended September 30, 2004 and 2003, respectively. Theeffective tax rate in Spain for the three months ended September 30, 2004is 37% compared to 40% in the prior year third quarter. The provision forforeign income taxes would have been approximately $102,000 lower thanreported, absent the increase in the weighted average value of the Euro, inrelation to the U.S. Dollar, during the twelve months ended September 30,2004.

 

We generated additional U.S. federal net operating loss carry-forwardsin the three months ended September 30, 2004 and 2003 as a result of U.S. pre-taxlosses of $896,000 and $958,000, 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.

 

Should we determine that it is more likely than not that we willrealize certain of our net deferred tax assets for which we have previouslyprovided a valuation allowance, an adjustment would be required to reduce theexisting valuation allowance. In addition, we operate within multiple taxingjurisdictions and are subject to audit in those jurisdictions. These audits caninvolve complex issues, which may require an extended period of time forresolution. During the quarter ended June 30, 2004, we identified certaintax contingencies that we determined are probable and reasonably estimable.Consequently, we have included a charge totaling $188,000 related to thesecontingencies in the*provision for income taxes*for thequarter ended June 30, 2004. No other potential tax contingencies wereconsidered probable and reasonably estimable by Bentley at period end. However,there is the possibility that the ultimate resolution of such potentialcontingencies could have an adverse effect on our results of operations.

 

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*Net Income*

 
| ** **                                    | ** ** | **For the Three Months Ended September 30,** | ** ** | **Change** | ** ** |
|-----------------------------------------------|------------|---------------------------------------------------|------------|------------|------------|
| **(in  thousands, except per share data)**    | ** ** | **2004**                                          | ** ** | **2003**   | ** ** | **$** | ** ** | **%** | ** ** |
|                                          |       |                                              |       |       |       |   |   |   |   |
| *Net income*                                  | * *   | *$*                                               | *1,413*    | * *   | *$*        | *1,348* | * * | *$* | *65* | * * | *5* | *%* |
|                                          |       |                                              |       |       |       |   |   |   |   |
| *Net income per common share:*                |       |                                              |       |       |       |   |   |   |   |
| *Basic*                                       | * *   | *$*                                               | *0.07*     | * *   | *$*        | *0.08* | * * | *$* | *(0.01* | *)* | *-13* | *%* |
| *Diluted*                                     | * *   | *$*                                               | *0.06*     | * *   | *$*        | *0.06* | * * | *$* | *—* | * * | *0* | *%* |
|                                          |       |                                              |       |       |       |   |   |   |   |
| *Weighted average common shares outstanding:* |       |                                              |       |       |       |   |   |   |   |
| *Basic*                                       | * *   | *21,049*                                          | * *   | *17,911*   | * *   | *3,138* | * * | *18* | *%* |
| *Diluted*                                     | * *   | *22,746*                                          | * *   | *22,228*   | * *   | *518* | * * | *2* | *%* |
|                                               |            |                                                   |            |            |            |  |  |  |  |  |  |  |  |  |

 

We reported income from operations of $2,519,000 in the three monthsended September 30, 2004 compared to $2,841,000 in the three months ended September 30,2003. The combination of income from operations of $2,519,000 and thenon-operating items, primarily the provision for income taxes of $1,344,000,resulted in net income of $1,413,000, or $0.07 per basic common share ($0.06per diluted common share) on 21,049,000 weighted average basic common sharesoutstanding (22,746,000 weighted average diluted common shares outstanding) inthe three months ended September 30, 2004, compared to net income of$1,348,000, or $0.08 per basic common share ($0.06 per diluted common share) on17,911,000 weighted average basic common shares outstanding (22,228,000weighted average diluted common shares outstanding) in the same period of theprior year. Net income in the future could be negatively impacted as a resultof the lower selling prices in Spain and anticipated increases in research anddevelopment programs that are expected to benefit future periods. However, aspreviously discussed, our broad-based growth strategy should mitigate theimpact of these developments over time.

 

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**Nine Months Ended September 30, 2004 versus Nine MonthsEnded September 30, 2003**

 

***Revenues***

 
| ** **                             | ** ** | **For the Nine Months Ended September 30,** | ** ** | **Change** | ** ** |
|----------------------------------------|------------|--------------------------------------------------|------------|------------|------------|
| **(in  thousands)**                    | ** ** | **2004**                                         | ** ** | **%**      | ** ** | **2003** | ** ** | **%** | ** ** | **$** | ** ** | **%** | ** ** |
| *Revenues:*                            |       |                                             |       |       |       |   |   |   |   |   |   |   |   |
| *Net product sales*                    | * *   | *$*                                              | *51,325*   | * *   | *95*       | *%* | *$* | *45,371* | * * | *97* | *%* | *$* | *5,954* | * * | *13* | *%* |
| *Licensing and collaboration revenues* | * *   | *2,550*                                          | * *   | *5*        | *%*        | *1,246* | * * | *3* | *%* | *1,304* | * * | *105* | *%* |
| *Total revenues*                       | * *   | *$*                                              | *53,875*   | * *   | *100*      | *%* | *$* | *46,617* | * * | *100* | *%* | *$* | *7,258* | * * | *16* | *%* |

 

Total revenues for the nine months ended September 30, 2004increased 16% from the same nine month period in the prior year. However, ourtotal revenues increased approximately 5% when expressed in constant currency.An increase in the weighted average value of the Euro, in relation to the U.S.Dollar, had the effect of increasing revenues by approximately $4,913,000,partially offsetting the impact of price reductions in Spain. The advancementof our proprietary drug delivery programs in the U.S., as evidenced by thegrowing royalty stream from sales of Testim, and other licensing revenues haveincreased our year to date 2004 revenues by approximately $1,304,000 whencompared to the same period in the prior year.

 

Set forth below is a summary of our revenues by sales channel andtop-selling product lines as generated through our five primary sales channels:

 

For the nine months ended September 30, 2004 (in thousands):

 
| ** **                     | ** ** | **Sales Within Spain** | ** ** | ** **            | ** ** | ** **                     | *** *** | ** **            | *** *** |
|--------------------------------|------------|------------------------|------------|-----------------------|------------|--------------------------------|--------------|-----------------------|--------------|
| **Product  Line**              | ** ** | **Branded  Products**  | ** ** | **Generic  Products** | ** ** | **Contract  Manu-  facturing** | ** **   | **Other****Revenues** | ** **   | **Total** | *** *** | **% of Total  Revenues** | *** *** |
| * *                       | * *   | * *               | * *   | * *              | * *   | * *                       | * *     | * *              | * *     | * * | * * | * * | * * |
| *Omeprazole*                   | * *   | *$*                    | *1,923*    | * *              | *$*        | *9,783*                        | * *     | *$*                   | *—*     | * * | *$* | *—* | * * | *$* | *11,706* | * * | *22* | *%* |
| *Simvastatin*                  | * *   | *968*                  | * *   | *2,570*               | * *   | *—*                       | * *     | *—*              | * *     | *3,538* | * * | *7* | *%* |
| *Enalapril*                    | * *   | *2,280*                | * *   | *883*                 | * *   | *—*                       | * *     | *—*              | * *     | *3,163* | * * | *6* | *%* |
| *Paroxetine*                   | * *   | *703*                  | * *   | *2,282*               |       | *—*                       | * *     | *—*              | * *     | *2,985* | * * | *5* | *%* |
| *Codeisan*                     | * *   | *2,118*                | * *   | *—*              |       | *—*                       |         | *—*              | * *     | *2,118* | * * | *4* | *%* |
| *All other products*           | * *   | *4,852*                | * *   | *5,149*               |       | *—*                       | * *     | *1,076*               | * *     | *11,077* | * * | *20* | *%* |
| *Contract manufacturing*       | * *   | *—*               | * *   | *—*              | * *   | *7,915*                        | * *     | *—*              | * *     | *7,915* | * * | *15* | *%* |
| *Sales outside of Spain*       | * *   | *—*               | * *   | *—*              | * *   | *—*                       | * *     | *8,823*               | * *     | *8,823* | * * | *16* | *%* |
| *Licensing and collaborations* | * *   | *—*               | * *   | *—*              | * *   | *—*                       | * *     | *2,550*               | * *     | *2,550* | * * | *5* | *%* |
| *Total Revenues*               | * *   | *$*                    | *12,844*   | * *              | *$*        | *20,667*                       | * *     | *$*                   | *7,915*      | * * | *$* | *12,449* | * * | *$* | *53,875* | * * | *100* | *%* |
| *% of Total Revenues*          | * *   | *24*                   | *%*        | *38*                  | *%*        | *15*                           | *%*          | *23*                  | *%*          | *100* | *%* |   | * * |
|                                |            |                        |            |                       |            |                                |              |                       |              |  |  |  |  |  |  |  |  |  |  |  |

 

26

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For the nine months ended September 30, 2003 (in thousands):

 
| ** **                     | ** ** | **Sales Within Spain** | ** ** | ** **            | ** ** | ** **                     | *** *** | ** **          | ** ** |
|--------------------------------|------------|------------------------|------------|-----------------------|------------|--------------------------------|--------------|---------------------|------------|
| **Product  Line**              | ** ** | **Branded  Products**  | ** ** | **Generic  Products** | ** ** | **Contract  Manu-  facturing** | ** **   | **Other  Revenues** | ** ** | **Total** | *** *** | **% of Total  Revenues** | ** ** |
|                           |       |                   |       |                  |       |                           |         |                |       |   | * * |   |   |
| *Omeprazole*                   | * *   | *$*                    | *4,769*    | * *              | *$*        | *9,780*                        | * *     | *$*                 | *—*   | * * | *$* | *—* | * * | *$* | *14,549* | * * | *31* | *%* |
| *Simvastatin*                  | * *   | *1,579*                | * *   | *3,021*               | * *   | *—*                       | * *     | *—*            | * *   | *4,600* | * * | *10* | *%* |
| *Enalapril*                    | * *   | *1,867*                | * *   | *1,334*               | * *   | *—*                       | * *     | *—*            | * *   | *3,201* | * * | *7* | *%* |
| *Paroxetine*                   | * *   | *—*               | * *   | *340*                 | * *   | *—*                       | * *     | *—*            | * *   | *340* | * * | *1* | *%* |
| *Codeisan*                     | * *   | *1,678*                | * *   | *—*              | * *   | *—*                       | * *     | *—*            | * *   | *1,678* | * * | *3* | *%* |
| *All other products*           | * *   | *3,676*                | * *   | *4,547*               | * *   | *—*                       | * *     | *—*            | * *   | *8,223* | * * | *18* | *%* |
| *Contract manufacturing*       | * *   | *—*               | * *   | *—*              | * *   | *6,949*                        | * *     | *—*            | * *   | *6,949* | * * | *15* | *%* |
| *Sales outside of Spain*       | * *   | *—*               | * *   | *—*              | * *   | *—*                       | * *     | *5,831*             | * *   | *5,831* | * * | *12* | *%* |
| *Licensing and collaborations* | * *   | *—*               |       | *—*              | * *   | *—*                       | * *     | *1,246*             | * *   | *1,246* | * * | *3* | *%* |
| *Total Revenues*               | * *   | *$*                    | *13,569*   | * *              | *$*        | *19,022*                       | * *     | *$*                 | *6,949*    | * * | *$* | *7,077* | * * | *$* | *46,617* | * * | *100* | *%* |
| *% of Total Revenues*          | * *   | *29*                   | *%*        | *41*                  | *%*        | *15*                           | *%*          | *15*                | *%*        | *100* | *%* |   |   |

 

*Spanish Operations.   *The increasein product sales for the nine months ended September 30, 2004 over thesame period of 2003 was primarily due to the introduction of our paroxetineproduct line, which was launched in May of 2003, increases in contractmanufacturing and growth in licensing and collaboration revenues. Ourparoxetine product line generated net sales of $2,985,000, representing 5% ofour total revenues during the nine months ended September 30, 2004 and 36%of our growth. In spite of reduced selling prices, revenues from our omeprazoleproducts in the first nine months of 2004 comprised 22% of our revenues,compared to 31% in the same period of the prior year.

 

*Branded Pharmaceutical Products*

 
| ** **                   | ** ** | **For the Nine Months Ended September 30,** | ** ** | **Change** | ** ** |
|------------------------------|------------|--------------------------------------------------|------------|------------|------------|
| **(in  thousands)**          | ** ** | **2004**                                         | ** ** | **%**      | ** ** | **2003** | ** ** | **%** | ** ** | **$** | ** ** | **%** | ** ** |
| *Branded Product Sales:*     |       |                                             |       |       |       |   |   |   |   |   |   |   |   |
| *Omeprazole*                 |       | $                                                | 1,923      |       | *15*       | *%* | $ | 4,769 |   | *35* | *%* | $ | (2,846 | ) | *-60* | *%* |
| *Enalapril*                  |       | 2,280                                            |       | *18*       | *%*        | 1,867 |   | *14* | *%* | 413 |   | *22* | *%* |
| *Codeisan*                   |       | 2,118                                            |       | *16*       | *%*        | 1,678 |   | *12* | *%* | 440 |   | *26* | *%* |
| *All other branded products* |       | 6,523                                            |       | *51*       | *%*        | 5,255 |   | *39* | *%* | 1,268 |   | *24* | *%* |
| *Total branded sales*        |       | $                                                | 12,844     |       | *100*      | *%* | $ | 13,569 |   | *100* | *%* | $ | (725 | ) | *-5* | *%* |

 

Sales of our branded pharmaceutical products decreased by approximately5% in U.S. Dollars compared to the prior year, and accounted for 24% of totalrevenues during the nine months ended September 30, 2004 compared to 29%of total revenues during the nine months ended September 30, 2003. Anincrease in the weighted average value of the Euro, in relation to the U.S.Dollar, had the effect of increasing branded net product sales by approximately$1,207,000 in the nine months ended September 30, 2004. Price reductionscontinued to negatively impact our branded product sales year-to-date. Mostsignificantly, sales of our branded omeprazole and simvastatin productsdecreased by approximately $2,843,000 and $1,062,000, respectively, from thesame period in the prior year, as a result of price reductions effected in December 2003.In the face of price cuts and strong generic competition, we were successful inincreasing market share of Belmazol with a 6% increase in the number of unitsof sold in the nine

 

27

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months ended September 30,2004 when compared to the same period of the prior year. Sales of our brandedenalapril, which experienced a 60% increase in unit volume compared to the sameperiod of the prior year, increased 22% from the prior year in spite of pricecuts, and now accounts for 18% of our year to date branded product sales.Strong sales of our cough and cold medicine, Codeisan, and the launch of ourbranded version of paroxetine in May of 2003 also helped to mitigate the impactof price cuts.

 

*GenericPharmaceutical Products*

 
| ** **                   | ** ** | **For the Nine Months Ended September 30,** | ** ** | **Change** | ** **   |
|------------------------------|------------|--------------------------------------------------|------------|------------|--------------|
| **(in  thousands)**          | ** ** | **2004**                                         | ** ** | **%**      | ** **   | **2003** | ** ** | **%** | ** ** | **$** | ** ** | **%** | ** ** |
| *Generic  Product Sales:*    | ** ** | ** **                                       | ** ** | ** ** | *** *** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| *Omeprazole*                 |       | $                                                | 9,783      |       | *47*         | *%* | $ | 9,780 |   | *51* | *%* | $ | 3 |   | *0* | *%* |
| *Simvastatin*                |       | 2,570                                            | * *   | *12*       | *%*          | 3,021 |   | *16* | *%* | (451 | ) | *-15* | *%* |
| *Paroxetine*                 |       | 2,282                                            | * *   | *11*       | *%*          | 340 |   | *2* | *%* | 1,942 |   | *571* | *%* |
| *Pentoxifylline*             |       | 1,946                                            | * *   | *9*        | *%*          | 1,457 |   | *8* | *%* | 489 |   | *34* | *%* |
| *Trimetazidine*              |       | 1,424                                            | * *   | *7*        | *%*          | 346 |   | *2* | *%* | 1,078 |   | *312* | *%* |
| *All other generic products* |       | 2,662                                            |       | *13*       | *%*          | 4,078 | * * | *21* | *%* | (1,416 | ) | *-35* | *%* |
| *Total generic sales*        |       | $                                                | 20,667     | * *   | *100*        | *%* | $ | 19,022 | * * | *100* | *%* | $ | 1,645 |   | *9* | *%* |
|                              |            |                                                  |            |            |              |  |  |  |  |  |  |  |  |  |  |  |  |

 

Sales of our generic pharmaceutical products increased by 9% during thenine months ended September 30, 2004 compared to the nine months ended September 30,2003. An increase in the weighted average value of the Euro, in relation to theU.S. Dollar, had the effect of increasing generic product sales byapproximately $1,942,000 in the first nine months of 2004. Sales of our genericomeprazole, which experienced a 9% increase in unit volume, remained consistentwhen expressed in U.S. Dollars as a result of price reductions and accountedfor 47% of our generic pharmaceutical revenues in the nine months ended September 30,2004, compared to 51% of generic revenues in the comparable period of the prioryear. Sales of our generic simvastatin which experienced a 22% increase in unitvolume, decreased by approximately 15%, when expressed in U.S. Dollars as aresult of price reductions. Our generic paroxetine, which was launched in Mayof 2003, added approximately $1,942,000 to our generic sales when compared tothe same period in the prior year, positioning it third behind our genericomeprazole and simvastatin products in the nine months ended September 30,2004. Sales of our generic trimetazidine increased by approximately $1,078,000,or approximately 312% from the comparable period of the prior year, while salesof our generic pentoxifylline increased by $489,000 or approximately 34%.Trimetazidine became a major contributor to our generic pharmaceutical salesduring the nine months ended September 30, 2004.

 

*ContractManufacturing*

 
| ** **               | ** ** | **For the Nine Months Ended September 30,** | ** ** | **Change** | ** ** |
|--------------------------|------------|--------------------------------------------------|------------|------------|------------|
| **(in  thousands)**      | ** ** | **2004**                                         | ** ** | **2003**   | ** ** | **$** | ** ** | **%** | ** ** |
|                     |       |                                             |       |       |       |   |   |   |   |
| *Contract manufacturing* | * *   | *$*                                              | *7,915*    | * *   | *$*        | *6,949* | * * | *$* | *966* | * * | *14* | *%* |
|                          |            |                                                  |            |            |            |  |  |  |  |  |  |  |

 

Revenues generated from contract manufacturing represented a consistent15% of total revenues in the nine months ended September 30, 2004 whencompared to the comparable period of the prior year. An increase in theweighted average value of the Euro, in relation to the U.S. Dollar, had theeffect of increasing contract manufacturing sales by approximately $744,000 inthe nine months ended September 30, 2004.

 

28

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*Sales Outside of Spain*

 
| ** **               | ** ** | **For the Nine Months Ended September 30,** | ** ** | **Change** | ** ** |
|--------------------------|------------|--------------------------------------------------|------------|------------|------------|
| **(in  thousands)**      | ** ** | **2004**                                         | ** ** | **2003**   | ** ** | **$** | ** ** | **%** | ** ** |
|                     |       |                                             |       |       |       |   |   |   |   |
| *Sales outside of Spain* | * *   | *$*                                              | *8,823*    | * *   | *$*        | *5,831* | * * | *$* | *2,992* | * * | *51* | *%* |
|                          |            |                                                  |            |            |            |  |  |  |  |  |  |  |

 

Sales outside of Spain under our supply agreements increased 51% fromthe nine months ended September 30, 2003. The $2,992,000 increase isattributable to increased demand for products that we are able to manufactureat relatively low costs and sell to customers in other countries around theworld as they search to find low cost manufacturing alternatives to remaincompetitive in their respective markets. An increase in the weighted averagevalue of the Euro, in relation to the U.S. Dollar, had the effect of increasingsales outside of Spain by approximately $829,000 during the nine months ended September 30,2004.

 

*Licensing and Collaboration Revenues*

 
| ** **                     | ** ** | **For the Nine Months Ended September 30,** | ** ** | **Change** | ** ** |
|--------------------------------|------------|--------------------------------------------------|------------|------------|------------|
| **(in  thousands)**            | ** ** | **2004**                                         | ** ** | **2003**   | ** ** | **$** | ** ** | **%** | ** ** |
|                           |       |                                             |       |       |       |   |   |   |   |
| *Licensing and*c*ollaboration* | * *   | *$*                                              | *2,550*    | * *   | *$*        | *1,246* | * * | *$* | *1,304* | * * | *105* | *%* |
|                                |            |                                                  |            |            |            |  |  |  |  |  |  |  |

 

Licensing and collaboration revenues accounted for 5% of total revenuesin the nine months ended September 30, 2004. These revenues includeroyalties of approximately $2,000,000 (compared to $543,000 in the same periodof the prior year) from the commercialization and continuing sales of Testim.Licensing and collaboration revenues in the comparable prior year periodincluded a one-time milestone payment of $500,000.

 

*Gross Profit.   *Gross profitincreased by approximately $781,000, or 3%, in the nine months ended September 30,2004 when compared to the nine months ended September 30, 2003, while ourgross margins on net product sales decreased from 59% to 51% in those periods(52% gross margins on sales of pharmaceutical products, excluding sales ofactive pharmaceutical ingredients). Product returns of approximately $2,500,000in the nine months ended September 30, 2004 served to reduce revenues byapproximately $2,300,000 during the period; however, product returns subsequentto May 2004 have returned to levels consistent with our historical experience.

 

*Selling and Marketing Expenses*

 
| ** **              | ** ** | **For the Nine Months Ended September 30,** | ** ** | **Change** | ** ** |
|-------------------------|------------|--------------------------------------------------|------------|------------|------------|
| **(in  thousands)**     | ** ** | **2004**                                         | ** ** | **2003**   | ** ** | **$** | ** ** | **%** | ** ** |
| *Selling and marketing* | * *   | *$*                                              | *10,919*   | * *   | *$*        | *10,203* | * * | *$* | *716* | * * | *7* | *%* |
|                         |            |                                                  |            |            |            |  |  |  |  |  |  |  |

 

Selling and marketing expenses for the nine months ended September 30,2004 increased 7% from the same period in the prior year. The weighted averagevalue of the Euro, in relation to the U.S. Dollar, had the effect of increasingselling and marketing expenses by approximately $1,028,000 in the nine monthperiod, indicating that selling and marketing expenses actually decreased inlocal currency from the same period in the prior year. Selling and marketingexpenses as a percentage of net product sales in the nine months ended September 30,2004 decreased to 21% from 22% in the same period of the prior year.

 

29

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*General and Administrative Expenses*

 
| ** **                   | ** ** | **For the Nine Months Ended September 30,** | ** ** | **Change** | ** ** |
|------------------------------|------------|--------------------------------------------------|------------|------------|------------|
| **(in  thousands)**          | ** ** | **2004**                                         | ** ** | **2003**   | ** ** | **$** | ** ** | **%** | ** ** |
| *General and administrative* | * *   | *$*                                              | *6,590*    | * *   | *$*        | *5,089* | * * | *$* | *1,501* | * * | *29* | *%* |
|                              |            |                                                  |            |            |            |  |  |  |  |  |  |  |

 

General and administrative expenses for the nine months ended September 30,2004 increased 29% over the same period in the prior year. The $1,501,000increase was the result of increased general and administrative activitiesrequired to support our continued growth and prepare for our anticipated growth.General and administrative expenses as a percent of total revenues increased toapproximately 12% in the nine months ended September 30, 2004, fromapproximately 11% of total revenues in the nine months ended September 30,2003. General and administrative expenses would have been approximately$347,000 lower, absent the increase in the weighted average value of the Euro,in relation to the U.S. Dollar, in the twelve months ended September 30,2004. This foreign currency impact accounted for 23% of the increase in generaland administrative expenses when compared to the same period of the prior year.

 

*Research and Development Expenses*

 
| ** **                 | ** ** | **For the Nine Months Ended September 30,** | ** ** | **Change** | ** ** |
|----------------------------|------------|--------------------------------------------------|------------|------------|------------|
| **(in  thousands)**        | ** ** | **2004**                                         | ** ** | **2003**   | ** ** | **$** | ** ** | **%** | ** ** |
| *Research and development* | * *   | *$*                                              | *3,171*    | * *   | *$*        | *2,863* | * * | *$* | *308* | * * | *11* | *%* |
|                            |            |                                                  |            |            |            |  |  |  |  |  |  |  |

 

Research and development expenses for the nine months ended September 30,2004 increased 11% over the same period in the prior year consistent with ourincrease in research and development activities in the current year. These activitiesinclude additional studies performed on our intranasal insulin deliverytechnology and other clinical programs to support the eventual distribution ofcertain of our Spanish generic pharmaceutical products in other countries,including the U.S.

 

*Other, net*

 
| ** **          | ** ** | **For the Nine Months Ended September 30,** | ** ** | **Change** | ** ** |
|---------------------|------------|--------------------------------------------------|------------|------------|------------|
| **(in  thousands)** | ** ** | **2004**                                         | ** ** | **2003**   | ** ** | **$** | ** ** | **%** | ** ** |
| *Other, net*        | * *   | *$*                                              | *1,405*    | * *   | *$*        | *5* | * * | *$* | *1,400* | * * | *** |   |
|                     |            |                                                  |            |            |            |  |  |  |  |  |  |  |

 

----

**  Not meaningful*

 

Other, net for the nine months ended September 30, 2004 increasedby $1,400,000 over the same period in the prior year. The increase is primarilydue to the reversal of previously accrued tax assessments totaling $1,467,000partially offset by interest and penalties totaling $193,000 associated withthe settlement of the tax audit of our Spanish subsidiary (see *Provision for Income Taxes*)**duringthe second quarter of 2004. We recorded a pre-tax benefit totaling $1,467,000($954,000 after taxes) as a component of *otherincome (expenses)*as the result of the reversal of previouslyaccrued pharmaceutical tax assessments in Spain. These assessments had beenaccrued to be paid to the Spanish government as a vehicle to help reduce theimpact of the rising health care costs in Spain. Due to recent changes in thepharmaceutical industry in Spain and a change in the Spanish politicalenvironment, these liabilities no longer exist. Accordingly, these accrualswere reversed during the second quarter of 2004.

 

30

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*Provisionfor Income Taxes*

 
| ** **                                   | ** ** | **For the Nine Months Ended September 30, 2004** | ** ** |
|----------------------------------------------|------------|-------------------------------------------------------|------------|
| **(in thousands)**                           | ** ** | **Spain**                                             | ** ** | **U.S.** | ** ** | **Consolidated** | ** ** |
|                                         |       |                                                  |       |   |   |   |   |
| *Income (loss) before income taxes*          | * *   | *$*                                                   | *10,795*   | * * | *$* | *(2,377* | *)* | *$* | *8,418* | * * |
|                                         |       |                                                  |       |   |   |   |   |
| *Provision (benefit) for income taxes*       | * *   | *4,102*                                               | * *   | *(808* | *)* | *3,294* | * * |
| *Tax liability, 1998-2000 audit*             | * *   | *604*                                                 | * *   | *—* | * * | *604* | * * |
| *Total provision (benefit) for income taxes* | * *   | *4,706*                                               | * *   | *(808* | *)* | *3,898* | * * |
| *Valuation allowance*                        | * *   | *—*                                              | * *   | *808* | * * | *808* | * * |
| *Net provision for income taxes*             | * *   | *4,706*                                               | * *   | *—* | * * | *4,706* | * * |
| *Net income (loss)*                          | * *   | *$*                                                   | *6,089*    | * * | *$* | *(2,377* | *)* | *$* | *3,712* | * * |
| *Effective tax rate*                         | * *   | *44*                                                  | *%*        | *0* | *%* | *56* | *%* |

 

A tax review of our Spanish subsidiary, Laboratories Belmac S.A., bythe Spanish tax authorities for the tax years 1998, 1999 and 2000, which hadcommenced over a year ago, was completed in the quarter ended June 30,2004. As a result of this audit, our subsidiary has been assessed an additionaltax liability of approximately $604,000, which has been recorded as a componentof *provision for income taxes,*andapproximately $193,000 for related interest and penalties, which have beenrecorded as components of *other income andexpenses,*in the consolidated income statements for the nine monthsended September 30, 2004.

 

We have recorded provisions for foreign income taxes totaling$4,706,000 ($4,102,000 income tax expense on operations plus $604,000 recordedas a result of the 1998 - 2000 tax audit of our Spanish subsidiary) and$4,469,000 for the nine months ended September 30, 2004 and 2003,respectively. The effective tax rate in Spain for the nine months ended September 30,2004 is 44%; however, when the $604,000 tax audit settlement related to prioryears is excluded, the effective tax rate is 38% compared to 40% in thecomparable nine month period of the prior year. The provision for foreignincome taxes would have been approximately $439,000 lower than reported, absentthe increase in the weighted average value of the Euro, in relation to the U.S.Dollar, during the twelve months ended September 30, 2004.

 

We generated additional U.S. federal net operating loss carry-forwardsin the nine months ended September 30, 2004 and 2003 as a result of U.S.pre-tax losses of $2,377,000 and $2,423,000, respectively. As future domesticoperating profits cannot be reasonably assured, no tax benefit has beenrecorded for U.S. losses. Accordingly, we have established a valuationallowance equal to the full amount of the U.S. deferred tax assets.

 

During the second quarter of 2004, we identified certain taxcontingencies that we have determined are probable and reasonably estimable.Consequently, we have included a charge totaling $188,000 in the*provision for income taxes*related to these contingencies.

 

31

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*Net Income*

 
| ** **                                    | ** ** | **For the Nine Months Ended September 30,** | ** ** | **Change** | ** **   |
|-----------------------------------------------|------------|--------------------------------------------------|------------|------------|--------------|
| **(in  thousands, except per share data)**    | ** ** | **2004**                                         | ** ** | **2003**   | ** **   | **$** | ** ** | **%** | ** ** |
|                                          |       |                                             |       |       |         |   |   |   |   |
| *Net income*                                  | * *   | *$*                                              | *3,712*    | * *   | *$*          | *4,409* | * * | *$* | *(697* | *)* | *-16* | *%* |
|                                          |       |                                             |       |       |         |   |   |   |   |
| *Net income per common share:*                |       |                                             |       |       |         |   |   |   |   |
| *Basic*                                       | * *   | *$*                                              | *0.18*     | * *   | *$*          | *0.25* | * * | *$* | *(0.07* | *)* | *-28* | *%* |
| *Diluted*                                     | * *   | *$*                                              | *0.16*     | * *   | *$*          | *0.21* | * * | *$* | *(0.05* | *)* | *-24* | *%* |
|                                          |       |                                             |       |       |         |   |   |   |   |
| *Weighted average common shares outstanding:* |       |                                             |       |       |         |   |   |   |   |
| *Basic*                                       | * *   | *20,764*                                         | * *   | *17,635*   |         | *3,129* |   | *18* | *%* |
| *Diluted*                                     | * *   | *22,772*                                         | * *   | *21,321*   | *** *** | *1,451* | * * | *7* | *%* |

 

We reported income from operations of $6,774,000 in the nine monthsended September 30, 2004 compared to $8,811,000 (which included anon-recurring one-time milestone revenue payment of $500,000) in the ninemonths ended September 30, 2003. The combination of income from operationsof $6,774,000 and the non-operating items, primarily the provision for incometaxes of $4,706,000 and the reversal of previously accrued tax assessmentstotaling $1,467,000 resulted in net income of $3,712,000, or $0.18 per basiccommon share ($0.16 per diluted common share) on 20,764,000 weighted averagebasic common shares outstanding (22,772,000 weighted average diluted commonshares outstanding) in the nine months ended September 30, 2004, comparedto net income of $4,409,000, or $0.25 per basic common share ($0.21 per dilutedcommon share) on 17,635,000 weighted average basic common shares outstanding(21,321,000 weighted average diluted common shares outstanding) in the ninemonths ended September 2003.

 

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**LIQUIDITY****AND CAPITAL****RESOURCES****:**

 

Total assets increased from $100,463,000 at December 31, 2003 to$111,145,000 at September 30, 2004, while stockholders’ equity increasedfrom $76,165,000 at December 31, 2003 to $82,435,000 at September 30,2004. The increase in stockholders’ equity during the nine months ended September 30,2004 primarily reflects net income of $3,712,000 and net proceeds from theexercise of stock options and warrants of approximately $3,061,000, partiallyoffset by the negative impact of the fluctuation of the Euro/U.S. dollarexchange rate, which totaled $643,000.

 

Cash, cash equivalents and marketable securities decreased by almost16% or $6,406,000 from $40,645,000 at December 31,  2003 to $34,239,000 at September 30,2004. The decrease was primarily due to the cash acquisition of an activepharmaceutical ingredients manufacturing facility for approximately $3,309,000and other fixed asset additions of approximately $6,217,000, which decreaseswere partially offset by cash provided by operating activities totalingapproximately $812,000 and proceeds from exercises of stock options andwarrants totaling approximately $3,061,000. Cash and cash equivalents at September 30,2004 include approximately $2,897,000 of short-term liquid investmentsconsidered to be cash equivalents.

 

Receivables increased by 43% from $18,036,000 at December 31, 2003to $25,863,000 at September 30, 2004. Our receivable balances at December 31,2003 and September 30, 2004 include approximately $884,000 and $2,012,000,respectively, of royalties due from Auxilium, evidencing the continued successof Testim sales. Fluctuation in foreign currency exchange rates during 2004decreased receivables reported in U.S. dollars by approximately $445,000. Inaddition to royalties receivable from Auxilium, receivables at September 30,2004 are comprised of trade receivables totaling $21,929,000, VAT receivablestotaling $1,617,000 and other receivables totaling $305,000. Receivables fromone international customer totaled $6,335,000 at September 30, 2004 andare secured by bills of exchange. We owe the same customer approximately$3,300,000 for co-marketing expenses. Subsequent to September 30, 2004this customer has made arrangements to pay approximately $1,464,000 toward itsreceivable balance and we have received $958,000 from Auxilium toward itsreceivable balance. We have not experienced any material delinquencies on anyof our receivables that have had a material effect on our financial position,results of operations or cash flows.

 

Inventories increased by approximately $1,907,000 from $7,106,000 at December 31,2003 to $9,013,000 at September 30, 2004, primarily as a result ofincreased production during the period required to meet anticipated salesdemand and purchases of raw materials to facilitate product testing, launchesand manufacturing demand. Inventory increased by approximately $1,741,000 inlocal currency, and fluctuations in foreign currency exchange rates increasedinventories reported in U.S. dollars by approximately $166,000.

 

The combined total of accounts payable and accrued expenses increasedfrom $17,257,000 at December 31, 2003 to $20,698,000 at September 30,2004. The $3,441,000 increase was primarily attributed to increases in accountspayable of $815,000 for inventory purchases and $282,000 for fixed assetpurchases, an increase in income taxes payable of approximately $2,057,000 andan increase of $1,445,000 in co-marketing costs payable, partially offset by, a$1,457,000 decrease in accrued expenses as a result of the reversal ofpreviously accrued tax assessments and a decrease of approximately $356,000 asa result of fluctuations in foreign currency exchange rates.

 

Short-term borrowings and current portion of long-term debt decreased from$1,985,000 at December 31, 2003 to $1,950,000 at September 30, 2004,primarily as a result of payment of the

 

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current portion oflong-term debt and the effect of fluctuations in foreign currency exchangerates. The weighted average interest rate on our short-term borrowings at September 30,2004 was 4.7%.

 

Operating activities for the nine months ended September 30, 2004provided net cash of $812,000 compared to $8,350,000 in the nine months endedSeptember 30, 2003. The reduction in operating cash flows was primarily due toincreased receivable balances and reduced selling prices on certain of ourpharmaceutical products. Our future operating cash flows could be negativelyimpacted as a result of government regulations that impact pharmaceuticalpricing in Spain and anticipated increases in research and development spendingfor programs that are expected to benefit future periods. However, aspreviously discussed, our broad-based growth strategy should mitigate theimpact of these developments.

 

Investing activities, primarily capital expenditures to: (i) acquire anactive pharmaceutical ingredients manufacturing facility in Spain; (ii)increase the capacity of our other manufacturing facility in Spain; and (iii)increase our manufacturing and packaging capabilities, along with additions todrug licenses and related costs, partially offset by proceeds from investmentmaturities, used net cash of $9,505,000 during the nine months ended September 30,2004.

 

Financing activities during the nine months ended September 30,2004 provided cash totaling $3,062,000, primarily representing the proceedsfrom the exercise of stock options and our remaining stock purchase warrants.

 

Our licensee, Auxilium Pharmaceuticals, Inc., launched its testosteronereplacement gel, Testim, which utilizes our patented CPE-215 drug deliverytechnology, during the first quarter of 2003. Auxilium paid a $500,000milestone payment to us during the first quarter of 2003, which we recorded as *licensing and collaboration revenues*inthe Consolidated Income Statement for the three months ended March 31,2003.  In connection with the Testimproduct launch, we began earning royalty revenues on a percentage of Testimsales as defined in the licensing agreement with Auxilium. Royalty revenues onTestim product sales are recognized based on an estimate of Auxilium’s sell-throughof the Testim product based on prescriptions filled, until such time that returnsfrom wholesalers and pharmacies can be reasonably estimated. At that time, weexpect to record a one-time increase in *licensingand collaboration revenues*related to the recognition of previouslydeferred revenue. For the nine months ended September 30, 2004 and 2003,we recognized royalty revenues of approximately $2,000,000 and $543,000,respectively, based on an estimate of prescriptions filled. The differencebetween the total amount earned from Auxilium under the royalty arrangement andthe amount recognized as a component of *licensingand collaboration revenues*is recorded as a component of *deferred income*in the ConsolidatedBalance Sheets. As of September 30, 2004 and December 31, 2003,deferred income from Testim royalties was approximately $1,240,000 and$634,000, respectively. We will continue to use available market information todetermine the amount and timing of royalty revenue recognition until such time thatreturns from wholesalers and pharmacies 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 more pharmaceutical products whose sales areseasonal, seasonality of sales may become more significant.

 

*Effect of Inflation and Changing Prices.*Neither inflation nor changing prices hasmaterially impacted our revenues or income from operations for the periods presented.

 

*Liquidity.*We plan to continue making improvements to our manufacturing facilitiesduring the balance of 2004 to accommodate our continuing growth. As previouslydiscussed, in April of 2004, we purchased a manufacturing facility locatedin Spain, for approximately $3,309,000, which specializes in the manufacture ofseveral active pharmaceutical ingredients. We also plan to continue

 

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improving and expandingboth of our manufacturing facilities in Spain and purchasing new equipment tosupport our research and development activities in the U.S. We expect to investan additional $1,500,000 in capital improvements and additions for these itemsduring the balance of 2004. As mentioned above, we have cash, cash equivalentsand short-term liquid investments totaling approximately $34,239,000 as of September 30,2004, which we believe will be sufficient to fund our operations for theforeseeable future. Even though we are generating positive cash flow from operations,(approximately $812,000 in the nine months ended September 30, 2004),there can be no assurance that changes in our research and development plans,capital expenditures and acquisitions, or other events affecting our netproduct sales or operating expenses will not result in the earlier depletion ofour funds. We continue to explore alternative sources for financing ourbusiness activities. In appropriate situations, which will be strategicallydetermined, we may seek financial assistance from other sources, includingcontribution by others to joint ventures and other collaborative or licensingarrangements for the development, testing, manufacturing and marketing ofproducts under development.

 

**Critical Accounting Policies and Estimates**

 

Our significant accounting policies are more fully described in Note 2to our consolidated financial statements in our Annual Report on Form 10-K forthe year ended December 31, 2003. Certain of our accounting policies areparticularly important to the portrayal of our financial position, results ofoperations and cash flows and require the application of significant judgmentby our management; as a result they are subject to an inherent degree ofuncertainty. 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 observance 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 complete discussionincluded in our Annual Report on Form 10-K for the year ended December 31,2003.

 

**Important Factors That May AffectFuture Results**

 

This Quarterly Report on Form 10-Q contains forward-looking statements.These forward-looking statements appear principally in the section entitled“Management’s Discussion and Analysis of Financial Condition and Results ofOperations.” Forward-looking statements may appear in other sections of thisreport, as well. Generally, the forward-looking statements in this reportinclude such words as “expect,” “believe,” “continue,” “anticipate,” “estimate,”“may,” “will,” “could,” “opportunity,” “future,” “project,” and similarexpressions.

 

The forward-looking statements include statements about our:

•                  Strategic plans;

•                  Sales growth;

•                  Anticipated sources of future revenues;

•                  Anticipated 2004 expenses, margins andoperating performance;

•                  Expected launch of new products;

•                  Anticipated expenses and spending;

•                  Commencing and continuing clinical trials;

•                  Anticipated regulatory approvals; and

•                  The sufficiency of capital to fund ouroperations.

 

These forward-looking statements are based on our current expectations,beliefs,

 

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assumptions, estimates,forecasts and projections for our business and the industry and markets inwhich we compete. These statements are not guarantees of future performance andinvolve certain risks, uncertainties and assumptions that are difficult topredict. Therefore, actual outcomes and results may differ materially from whatis expressed in such forward-looking statements. We caution investors not toplace undue reliance on the forward-looking statements contained in thisreport. These statements speak only as of the date of this report, and we donot undertake any obligation to update or revise them, except as required bylaw. The following factors, among others, create risks and uncertainties thatcould affect our future or other performance: expanding generic and brandeddrug operations, efficacy and safety of our products, changes in third-partyreimbursement and government mandates which impact pharmaceutical pricing,development and commercialization of our products, relationships with ourstrategic partners, uncertainty of clinical trial results, regulatory approvalprocess, unpredictability of patent protection, technological changes, theeffects of economic conditions, risks associated with international operations,competition from other manufacturers of generic and proprietary pharmaceuticals,and difficulties in managing our growth and the other risk factors contained inthe section entitled “Risk Factors” in our Annual Report on Form 10-Kfiled for the year ended December 31, 2003. 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.

 

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**Item 3****. Quantitative andQualitative Disclosures About Market Risk**

 

*Foreign Currency.*A substantial amount of our business isconducted in Europe and is therefore influenced to the extent to which thereare fluctuations in the U.S. Dollar’s value against other currencies,principally the Euro. The exchange rates at September 30, 2004 and December 31,2003 were .81 Euros and .80 Euros per U.S. Dollar, respectively. The weightedaverage exchange rates for the three months ended September 30, 2004 and2003 were .82 Euros and .89 Euros per U.S. Dollar, respectively. The weightedaverage exchange rates for the nine months ended September 30, 2004 and2003 were .82 Euros and .90 Euros per U.S. Dollar, respectively. The effect offoreign currency fluctuations on long lived assets for the nine months ended September 30,2004 was a decrease of $643,000 and the cumulative historical effect was anincrease of $4,526,000, as reflected in our Consolidated Balance Sheets as *accumulated other comprehensive income.*Althoughexchange rates have fluctuated significantly in recent years, we do not believethat the effect of foreign currency fluctuation is material to our results ofoperations as the expenses related to much of our foreign currency revenues arein the same functional currency as those revenues, namely the Euro. However,the carrying value of assets and liabilities can be materially impacted byforeign currency translation, as can the translated amounts of revenues andexpenses. Nonetheless, we do not plan to modify our business practices at thistime.

 

We have relied primarily upon financing activities to fund ouroperations in the U.S. In the event that we are required to fund U.S.operations or cash needs with funds generated in Europe, or vice versa,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 fluctuations.

 

*Interest Rates.*As of September 30, 2004, the weightedaverage interest rate on our short-term borrowings of $1,582,000 is 4.7%. Aportion of our long-term borrowings is non-interest bearing and the balanceoutstanding on these borrowings at September 30, 2004 is $369,000including imputed interest (ranging from 4.8% to 6.0%) of $75,000. The weightedaverage interest rate on our long-term borrowings is 5.6%. The effect of anincrease in interest rates of one percentage point (one hundred basis points)to an average of 5.7% on short-term borrowings and to an average of 6.6% onlong-term borrowings would have the effect of increasing interest expense byapproximately $19,000 annually.

 

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**Item 4****. Controls and Procedures**

 

Bentley Pharmaceuticals maintains disclosure controls and proceduresthat are designed to ensure that information required to be disclosed inBentley’s reports that are filed with the Securities and Exchange Commission isrecorded, processed, summarized and reported within the time periods requiredfor each report and that such information is reported to Bentley’s management,including its Chief Executive Officer and Chief Financial Officer, asappropriate, to allow timely decisions regarding required disclosure.

 

As of September 30, 2004, Bentley carried out an evaluation, underthe supervision of, and with the participation of Bentley’s management,including Bentley’s Chief Executive Officer and Chief Financial Officer, of theeffectiveness of the design and operation of Bentley’s disclosure controls andprocedures (as defined in Exchange Act Rules 13a-15(c) and 15(d)-15(c)). Basedon that evaluation, Bentley’s Chief Executive Officer and Chief FinancialOfficer concluded that Bentley’s disclosure controls and procedures areeffective in timely alerting them to material information relating to Bentley(including its consolidated subsidiaries), which is required to be included inits publicly filed reports or submitted under the Exchange Act, and in ensuringthat such information is recorded, processed, summarized and reported withinthe time periods specified in the Securities and Exchange Commission’s rulesand forms. Although Bentley’s management continues to evaluate the internalcontrol structure and strengthen Bentley’s control procedures, particularly inconnection with the requirements of Section 404 of the Sarbanes-Oxley Actof 2002, there have been no changes that have materially affected, or arereasonably likely to materially affect Bentley’s internal controls overfinancial reporting during the quarter ended September 30, 2004.

 

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**PART II****.**                                  **OTHER INFORMATION**

 

**Item 1. Legal Proceedings**

 

In September 2004, a legal action was filed against us in the U.S.District Court for the District of Delaware by Ethypharm S.A., a French-baseddrug delivery company, primarily claiming misappropriation of unspecifiedalleged trade secrets in connection with the manufacture of omeprazole since March 2002by Laboratorios Belmac, one of our Spanish subsidiaries. A related claim waspreviously brought against Laboratorios Belmac in the Spanish courts requestingpreliminary inquiries into possible patent infringement, which remainsunresolved. We intend to vigorously defend against the claims in the U.S. andLaboratorios Belmac is doing the same in the Spanish proceeding.

 

Also, see Item 1. Legal Proceedings in our Quarterly Report on Form10-Q for the quarterly period ended March 31, 2004.

 

We are party to various other legal actions that arise in the ordinarycourse of business. We do not expect that resolution of these matters willhave, individually or in the aggregate, a material adverse effect on ourfinancial position, results of operations or cash flows.

 

**Item 6. Exhibits**

 

The Exhibits filed as part of this report are listed on the ExhibitIndex immediately preceding the exhibits, which Exhibit Index is incorporatedherein by reference.

 

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SIGNATURES

 

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

 
|                   |   | BENTLEY  PHARMACEUTICALS, INC                                         |   |
|------------------------|--------|-----------------------------------------------------------------------|--------|
|                   |   | Registrant                                                            |
|                   |   |                                                                  |
|                   |   |                                                                  |
| November 4,  2004 | By:    | /s/  James R. Murphy                                                  |   |
|                   |   | James  R. Murphy                                                      |
|                   |   | Chairman  of the Board of Directors, President and Chief              |
|                   |   | Executive  Officer                                                    |
|                   |   | (Principal  Executive Officer)                                        |
|                   |   |                                                                  |
|                   |   |                                                                  |
| November 4,  2004 | By:    | /s/  Michael D. Price                                                 |   |
|                   |   | Michael  D. Price                                                     |
|                   |   | Vice  President, Chief Financial Officer,                             |
|                   |   | Treasurer  and Secretary (Principal Financial and Accounting Officer) |
|                        |        |                                                                       |        |  |

 

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# **ExhibitIndex**

 
| **Exhibit  Number** | ** ** | **Description of Exhibit**                                                                                                                                                         |
|---------------------|------------|------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|                |       |                                                                                                                                                                               |
| 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. |

 

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