**UNITED STATES**

**SECURITIES AND EXCHANGE COMMISSION**

**Washington, D.C.20549**

**FORM 10-K**
| **(MARK ONE)**                                                                                                                                                                       | ** ** | ** **                                                                                              |
|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|---------------------------------------------------------------------------------------------------------|
| **x**                                                                                                                                                                                | ** ** | **ANNUAL REPORT PURSUANT TO SECTION 13 OR  15(d) OF THE SECURITIES EXCHANGE ACT OF 1934**     |
| **For the fiscal year ended  December 31, 2005**                                                                                                                                |
| **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 No. 000-30123**

**FIRST HORIZON PHARMACEUTICAL CORPORATION**

(Exact name of registrant as specified in its charter)

| **Delaware**                    |   | **58-2004779**                       |
|---------------------------------|--------|--------------------------------------|
| (State or other jurisdiction of |   | (I.R.S. Employer Identification No.) |
| incorporation or organization)  |   | ** **                           |

 

**6195 Shiloh Road, Alpharetta, Georgia 30005**

(Address of principal executive offices) (Zip code)

Registrant’s telephone number, including area code: **(770) 442-9707**

Securities registered pursuant to Section 12(b) ofthe Act:

| Title of each class |   | Name of each exchange |
|---------------------|--------|-----------------------|
|                |   | on which registered   |
| **None**            |   | **None**              |

 

Securities registered pursuant to Section 12(g) ofthe Act: **Common Stock, $0.001 par value**

Indicate by check mark whether the registrant is awell-known seasoned issuer, as defined in Rule 405 of the SecuritiesAct. Yes o No x

Indicate by check mark whether the registrant is notrequired to file reports pursuant to Section 13 or Section 15(d) ofthe Act. Yes o No x

Indicate by check mark whether the registrant (1) hasfiled all reports required to be filed by Section 13 or 15(d) of theSecurities Exchange Act of 1934 during the preceding 12 months (or forsuch shorter period that the registrant was required to file such reports), and(2) has been subject to such filing requirements for the past90 days. Yes x No o

Indicate by check mark if disclosure of delinquentfilers pursuant to Item 405 of Regulation S-K is not contained herein andwill not be contained, to the best of the registrant’s knowledge, in definitiveproxy or information statements incorporated by reference in Part III of thisForm 10-K or any amendment to this Form 10-K. o

Indicate by check mark whether the registrant is alarge accelerated filer, an accelerated filer, or a non-accelerated filer. Seedefinition of “accelerated filer and large accelerated filer” in Rule 12b-2of the Exchange Act.
| Large accelerated filer  o |   | Accelerated filer  x |   | Non-accelerated filer  o |
|--------------------------------------|--------|--------------------------------|--------|------------------------------------|

 

Indicate by check mark whether the registrant is ashell company (as defined in Rule 12b-2 of the Exchange Act). Yes o No x

Common shares of the registrant outstanding as of February 17,2006 were 35,107,376**.**The aggregatemarket value, as of June 30, 2005, of such common shares held bynon-affiliates of the registrant was approximately $517,740,000 based upon thelast sales price reported that date on the Nasdaq Stock Market of $19.04 pershare. (Aggregate market value estimated solely for the purposes of thisreport. For purposes of this calculation, all executive officers, directors and10% stockholders are classified as affiliates.)

**DOCUMENTSINCORPORATED BY REFERENCE**

Part III: Portions ofRegistrant’s Proxy Statement to be filed with the Securities and ExchangeCommission on or about April 28, 2006 relating to the 2006 Annual Meetingof Stockholders expected to be held on June 15, 2006 are incorporated intoPart III of this Form 10-K.

 

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**ANNUAL REPORT OF FORM 10-KFOR THE FISCAL YEAR ENDED DECEMBER 31, 2005**

**TABLE OF CONTENTS**

| **PART I**   | ** ** | ** **                                                                                                         |
|-------------------|------------|--------------------------------------------------------------------------------------------------------------------|
| ITEM 1.           |       | BUSINESS                                                                                                           |   | 1 |
| ITEM 1A.          |       | RISK FACTORS                                                                                                       |   | 18 |
| ITEM 1B.          |       | UNRESOLVED STAFF COMMENTS                                                                                          |   | 30 |
| ITEM 2.           |       | PROPERTIES                                                                                                         |   | 30 |
| ITEM 3.           |       | LEGAL PROCEEDINGS                                                                                                  |   | 30 |
| ITEM 4.           |       | SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS                                                                |   | 31 |
| **PART II**  | ** ** | ** **                                                                                                         |
| ITEM 5.           |       | MARKET FOR REGISTRANT’S COMMON EQUITY, RELATED STOCKHOLDER  MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES |   | 32 |
| ITEM  6.          |       | SELECTED  FINANCIAL DATA                                                                                           |   | 33 |
| ITEM 7.           |       | MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL  CONDITION AND RESULTS OF OPERATIONS                        |   | 34 |
| ITEM 7A.          |       | QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET  RISK                                                        |   | 49 |
| ITEM 8.           |       | FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA                                                                        |   | 50 |
| ITEM 9.           |       | CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON  ACCOUNTING AND FINANCIAL DISCLOSURE                              |   | 50 |
| ITEM 9A.          |       | CONTROLS AND PROCEDURES                                                                                            |   | 50 |
| ITEM  9B.         |       | OTHER  INFORMATION                                                                                                 |   | 53 |
| **PART III** | ** ** | ** **                                                                                                         |
| ITEM 10.          |       | DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT                                                                 |   | 54 |
| ITEM 11.          |       | EXECUTIVE COMPENSATION                                                                                             |   | 54 |
| ITEM 12.          |       | SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND  MANAGEMENT AND RELATED STOCKHOLDER MATTERS                    |   | 54 |
| ITEM 13.          |       | CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS                                                                     |   | 54 |
| ITEM 14.          |       | PRINCIPAL ACCOUNTING FEES AND SERVICES                                                                             |   | 54 |
| **PART IV**  |       |                                                                                                               |
| ITEM 15.          |       | EXHIBITS, FINANCIAL STATEMENT SCHEDULES                                                                            |   | 55 |

 

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**PART I**

**ITEM 1.   BUSINESS**

**Our Business**

FirstHorizon Pharmaceutical Corporation, or the Company, is a specialtypharmaceutical company that markets, develops and sells brand name prescriptionproducts. Our key products focus on two therapeutic categories, Cardiology andWomen’s Health. Our key marketed products include:

|              | **Cardiology** | ** **     | ** ** |  | **Women’s Health** | ** ** |
|--------------|----------------|----------------|------------|--|-------------------------|------------|
| Sular        |           | Prenate  Elite |
| Fortamet     |           | OptiNate       |
| Altoprev     |           | Ponstel        |
| Triglide     |           |           |
| Nitrolingual |           |           |

 

Our current operating plan focuses first on maximizingthe sales of our existing product portfolio. We also plan to accelerate growthby launching line extensions to our current products and by acquiring orlicensing approved products or late stage development products and otherbusinesses. We plan to focus on products that complement our Cardiology andWomen’s Health categories that will allow us to leverage our existing salesforce infrastructure.

We currently market and sell 15 products, eight ofwhich are actively promoted and accounted for approximately 89% of our totalsales for the year ended December 31, 2005. We promote our productsthrough our nationwide sales and marketing force in approximately 525 territories,targeting high-prescribing primary care physicians, endocrinologists,cardiologists, obstetricians and gynecologists.

We were incorporated inDelaware in July 1992 as the surviving corporation of a merger betweenCentury Pharmaceutical Corporation and Horizon Pharmaceutical Corporation. Ourprincipal office is located at 6195 Shiloh Road, Alpharetta, Georgia 30005 andour telephone number is (770) 442-9707. Our corporate internet address iswww.fhrx.com. We make available free of charge on or through our website ourannual reports on Form 10-K, quarterly reports on Form 10-Q,current reports on Form 8-K and amendments to those reports filed orfurnished pursuant to Section 13(a), 13(c), 14 or 15(d) of theExchange Act as soon as reasonably practicable after we electronically filesuch material with, or furnish it to, the SEC. We do not intend for theinformation contained on our website to be a part of this Annual Report.

**Strategy**

Beginning in 1999, we started acquiring and licensingproducts in order to transform ourselves from a small company with a primaryfocus on cough, cold and allergy products to a broader based specialtypharmaceutical company. These acquisitions provided us with a product portfolioand a base of revenue and cash flow that we continue to build upon.

In 2003, management, with the recommendation of theBoard of Directors, formulated a new operating strategy. This new operatingstrategy led to the development of our current operating plan, which focuses onmaximizing the sales of our product portfolio, including the addition of newproducts. We have been executing this plan in four phases by:

·       implementinga lower cost operating model and investing in systems and process improvements;

·       investingin sales force expansion to improve our reach and call frequency to highprescribing physicians;

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·       managingthe life cycle of our products; and

·       acquiringor licensing products and/or companies having products which complement ourexisting therapeutic specialty focus.

Our first step in maximizing the sales of our productportfolio was to implement a lower cost operating model and invest in systemsand process improvements, which we commenced in July 2003. We implementedthis strategy by cutting discretionary spending and streamlining the corporateoffice, reducing costs associated with our selling efforts, investing insystems and process improvements and entering into inventory managementagreements with our largest wholesale customers.

Our second step in maximizing the sales of our productportfolio is to continue to expand our sales force in order to increase ourreach to high prescribing physicians and to increase our call frequency. Tomaximize the effectiveness of our selling efforts, our sales force targetshigh-prescribing primary care physicians and select specialty physicians. Oursales force seeks to develop close relationships with these physicians andrespond to their needs and their patients’ needs. Since 2004, we have expandedour sales force from approximately 360 to approximately 525 professionalsnationwide. In January 2006, we created a separate Women’s Healthspecialty sales force consisting of approximately 75 sales professionalscalling on OBGYN practioners and cardiologists, which are in addition to ourapproximately 450 primary sales force professionals.

Our third step in maximizing the sales of our productsis to manage the lifecycle of our existing products. We have dedicatedprofessionals whose goal is to maximize the potential of our brands. Part ofour marketing team’s directive is to develop ideas for line extensions thatwill extend the lifecycle of our key products.

Our fourth step in maximizing the sales of ourproducts is to expand our product offerings and to accelerate our growththrough acquiring or licensing approved products or late stage development productsand by acquiring companies having such products. We are focusing on productsthat complement our Cardiology and Women’s Health categories and that can besuccessfully distributed through our sales territory infrastructure.

As part of our strategy, in 2004, we entered into anagreement with SkyePharma PLC granting us an exclusive license in the UnitedStates for a term of 15 years to market and distribute a fenofibrate basedproduct, subsequently labeled Triglide. We launched this product in July 2005.Additionally, in March 2005 we licensed and purchased certain rights tothe type 2 diabetes prescription medication Fortamet and the cholesterolmedication Altoprev from Andrx Laboratories. Also in March 2005, welaunched OptiNate, the latest addition to the Prenate line. We have activelybegun marketing these products as well.

There is no assurance thatwe will successfully implement our current operating plan or that we will beable to acquire or license additional products on favorable terms or at all.

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**Products**

Mostof our products treat recurring or chronic conditions or disorders whichinvolve repeated use over an extended period of time. Our current key productsinclude:

| **Product**                                              | ** ** | ** ** | ** ** | **Year of Our  Introduction**                                                               | ** ** | **Product Use** |
|----------------------------------------------------------|------------|------------|------------|---------------------------------------------------------------------------------------------|------------|-----------------|
| Sular (nisoldipine) Tablets                              |       | 2002       |       | Hypertension                                                                                |
| Fortamet (metformin HCl) Tablets                         |       | 2005       |       | Adjunct to diet and exercise in lowering blood  glucose in Type 2 Diabetes patients         |
| Altoprev (lovastatin extended release) Tablets           |       | 2005       |       | Cholesterol reduction and coronary heart disease                                            |
| Triglide (fenofibrate) Tablets                           |       | 2005       |       | Primary hypercholesterolemia and mixed dyslipidemia                                         |
| Nitrolingual Pumpspray (nitroglycerin sublingual  spray) |       | 2000       |       | Acute relief of an attack or prophylaxis of angina  pectoris due to coronary artery disease |
| Prenate Elite                                            |       | 2004(1)    |       | Prenatal vitamin                                                                            |
| OptiNate                                                 |       | 2005(1)    |       | Prenatal vitamin                                                                            |
| Ponstel Capsules (mefenamic acid)                        |       | 2000       |       | Primary dysmenorrhea in patients 3  14 years of age                                    |

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(1)          ThePrenate line was introduced in 2001. Prenate Elite and OptiNate are lineextensions of the original Prenate product.

*Sular*

In March 2002, weacquired exclusive U.S. rights to distribute and sell the antihypertensiveprescription medication Sular from AstraZeneca and Bayer Healthcare for aperiod of 10 years. We also entered into a long-term manufacturing, supplyand distribution agreement with Sular’s manufacturer, Bayer. Sular is aonce-a-day treatment for hypertension that competes in the market forantihypertensive prescription medications.

We believe that Sularoffers certain advantages over other antihypertensive medications based uponits proven efficacy and safety, and its demonstrated ability to providetwenty-four hour blood pressure control as compared to other brandedantihypertensives.

Nisoldipine, the activeingredient in Sular, belongs to a group of medicines called calcium channelblockers. Calcium channel blockers prevent calcium from entering certain typesof muscle cells. Because the muscle cells need calcium to contract, calciumchannel blockers prevent the cells from contracting and cause them to relax.Nisoldipine selectively relaxes the muscles of small arteries causing them todilate but has little or no effect on muscles or the veins of the heart.

*Fortamet and Altoprev*

In March 2005 welicensed and purchased certain rights to the type 2 diabetes prescriptionmedication Fortamet and the cholesterol lowering medication Altoprev from AndrxLaboratories. As part of the transaction, we acquired the worldwide rights tosell Fortamet and Altoprev. We also entered into a long-term manufacturing andsupply agreement with Andrx Laboratories for the manufacture and supply ofFortamet and Altoprev.

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Fortamet is a patented,once-a-day extended-release tablet used in the management of type 2 diabetes.It contains metformin HCl, which is an oral anti-hyperglycemic drug that hasthe effect of lowering blood glucose. We believe that Fortamet is advantageousin the market because it is the only 1000mg once-a-day extended releasemetformin. Like all metformins, Fortamet has a blackbox warning (a warningdesigned to advise people of potential serious risks) associated with lacticacidosis.

Altoprev is a patentedonce-a-day treatment for high cholesterol. It consists of a lovastatinextended-release tablet containing a cholesterol lowering agent isolated from astrain of Aspergillus Terreus. We believe that Altoprev is advantageous in themarket because it offers once-a day administration in multiple starting doses(20mg, 40mg or 60mg). Moreover, Altoprev’s extended release delivery system allows lower peak levels of lovastatinacid plasma concentrations.

*Triglide*

We obtained exclusive U.S.marketing rights in 2004 to a novel fenofibrate formulation that employs one ofSkyePharma’s proprietary solubilization technologies, which we labeled Triglide.In May 2005, we announced that the U.S. Food and Drug Administration hadapproved Triglide, as an oral treatment for lipid disorders such as elevatedtriglycerides. Triglide is being manufactured and supplied by SkyePharma.Triglide is a fenofibrate manufactured using IDD-P technology.

*Nitrolingual*

In February 2000, webegan marketing Nitrolingual, a product for which we acquired exclusivedistribution rights in the U.S. from Pohl-Boskamp. In October 2004, thedistribution agreement was renewed and was then amended in 2005. The amendedagreement expires January 31, 2010 and may be renewed thereafter forsubsequent two-year renewal periods.

Nitrolingual is an oralspray of nitroglycerin used for the acute relief or prevention of chest painassociated with angina pectoris that results from coronary artery disease.Pohl-Boskamp holds a patent that expires in 2010 on the formulation ofNitrolingual that we license on an exclusive basis. The primary competitor toNitrolingual is nitroglycerin, which is generally prescribed in tablet form.Unlike nitroglycerin tablets, which begin to lose their potency immediatelyupon opening the bottle, Nitrolingual maintains its potency for two years fromdate of manufacture. Each metered dose of Nitrolingual provides consistentdelivery of nitroglycerin. Also, Nitrolingual has advantages over nitroglycerintablets pertaining to storage and handling.

During the second quarterof 2003, we launched a 60-dose application bottle of Nitrolingual. The 60-dosebottle is smaller and more convenient to carry for some patients than our 200-dosebottle. We believe that the 60-dose bottle benefits patients who havemild angina and whose episodes are occasional. We believe the smaller bottle isan advantageous companion product to the 200-dose bottle.

*Prenate Elite and OptiNate*

Prescription prenatalvitamins are generally recommended before, during and after pregnancy so thatthe mother and the fetus receive adequate amounts of essential vitamins andminerals. In recent years, our Prenate line has been a market leader forprescription prenatal vitamins based upon total prescriptions written in theU.S.

In April 2004 welaunched Prenate Elite, an extension of our Prenate line. Prenate Elite is aprescription multivitamin/multimineral nutritional supplement indicated for usein improving the nutritional status of women throughout pregnancy and in thepostnatal period. It contains 16 key vitamins and minerals, together with asingle milligram of folate in a combination of folic acid and Metafolin® . Folic acid, a water-soluble B vitamin, hasbeen shown to help prevent serious birth defects in babies.

We introduced OptiNate inMarch, 2005 as a line extension to our Prenate line. OptiNate is a prescriptionmultivitamin/multimineral nutritional supplement indicated for use in improvingthe 

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nutritionalstatus of women throughout pregnancy and in the postnatal period. It contains16 key vitamins and minerals, together with a single milligram of folate in acombination of folic acid and Metafolin® .Omega-3 fatty acids such as those found in OptiNate can be especiallybeneficial to a baby’s brain and eye development. We believe OptiNate has anadvantage in the market because its omega-3 fatty acid capsule is aprescription prenatal vitamin with an all-natural vegetarian sourced capsule.

*Ponstel*

In April 2000, weacquired exclusive U.S. rights to market, distribute and sell Ponstel fromPfizer, formerly Warner-Lambert Company. Ponstel is used for the relief of mildto moderate pain for patients 14 years of age and older if therapy will befor less than one week and for primary dysmenorrhea, which is pain associatedwith menstruation. One class of frequently prescribed pain relievers isnonsteroidal anti-inflammatory drugs, or NSAIDs. Ponstel is a well known NSAIDfor treating dysmenorrhea and we believe that its advantages are itsnon-addictive qualities, low stomach-related side effects and efficacy. Likeall NSAIDs, Ponstel has a blackbox warning associated with cardiovascularthrombotic events, myocardial infarction, and stroke.

**Other Products**

In December 2001, weacquired U.S. rights to Furadantin from Dura Pharmaceuticals, an affiliate ofElan Pharmaceuticals. Furadantin is indicated for the treatment of urinarytract infections and is prescribed primarily by pediatricians. Furadantin is aproduct well-suited for children because it is formulated in liquid suspensionform and has a fruit-flavored taste. Furadantin contains nitrofurantoin, whichhas little bacterial resistance.

In June 2000, weacquired worldwide rights to market, distribute and sell Cognex from Pfizer, aswell as rights to a new unapproved controlled release version of Cognex calledCognex CR. Cognex is indicated for the treatment of mild to moderate dementiaassociated with Alzheimer’s disease. Alzheimer’s disease is a progressive,degenerative disease that attacks the brain and results in impaired memory,cognition and behavior.

In January 1999, weacquired exclusive U.S. rights to Robinul and Robinul Forte, which is ahigher-strength dosage of Robinul, from Wyeth. Both Robinul and Robinul Fortebelong to a class of drugs known as anticholinergics that reduce the motion ofthe gastrointestinal tract and decrease stomach secretions. The FDA has approvedboth products for use as a therapy in conjunction with other therapeutics inthe treatment of peptic ulcers. In the first quarter of 2005, in an effort tocombat generic competition, we engaged a distributor that launched a genericversion of our Robinul and Robinul Forte brands into the marketplace and weceased actively promoting the Robinul line.

Our Tanafed line iscomprised of liquid cold and allergy products, which consist of Tanafed DP andTanafed DMX. Tanafed DP is a cold and allergy suspension for children that isdosed twice a day and Tanafed DMX offers the same benefits and contains a coughsuppressant. In 2004 and 2005 Tanafed DP and Tanafed DMX were knocked-off andas a result, we have ceased actively promoting the Tanafed line.

We sell Zoto-HC ear dropsfor the treatment of swimmer’s ear infections and Zebutal capsules for thetreatment of tension headaches.

Our other products for thetreatment of cough, cold and allergy were Mescolor tablets and Protuss Liquid(including Protuss D). These products were discontinued as of December 31,2004.

**RegulatoryClassification**

Sular, Furadantin, Cognex,Ponstel, Triglide, Altoprev, Fortamet, Nitrolingual, Robinul and Robinul Fortehave  FDA approved New Drug Applications(NDAs). The FDA also approved an abbreviated NDA for Zebutal. Prenate Elite andOptiNate, prescription vitamins, Tanafed DP, Tanafed DMX and Zoto-HC do nothave approved NDAs.

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**Research andDevelopment**

Our research anddevelopment efforts are currently focused primarily on developing lineextensions to our current products. Research and development expenses consistprimarily of costs incurred to develop formulations, engage contract researchorganizations to conduct clinical studies, test products under development andengage medical and regulatory consultants. We expense all research anddevelopment costs as incurred. Research and development costs were$2.1 million, $1.5 million and $4.1 million for the years ended December 31,2003, 2004 and 2005, respectively.

Research and developmentexpense increased $2.6 million to $4.1 million for the year ended December 31,2005, compared to $1.5 million for the year ended December 31, 2004. Thisincrease is primarily related to greater activity in lifecycle managementinitiatives for our products. From 2002 through 2005, research and developmentexpenses also included the development of branded products. Historically,research and development expenses for branded product activities included,among other things, costs related to personnel, overhead, professionalservices, filing fees and raw materials, but primarily included the cost oflaboratory services, clinical investigators and clinical research organizationsthat were responsible for conducting the clinical trials required to support aproduct application with the FDA and preparing NDAs. Research and developmentexpenses are periodically evaluated to take into consideration, among otherthings, our level of profitability and cash flows.

**Sales and Marketing**

To maximize theeffectiveness of our selling efforts, our sales force targets high-prescribingprimary care physicians and select specialty physicians. Our sales force seeksto develop close relationships with these physicians and respond to their needsand their patients’ needs. Since 2004, we have expanded our sales and marketingforce from approximately 360 to approximately 525 professionals nationwide. In January 2006,we created a separate specialty sales force consisting of approximately 75sales professionals calling on OBGYN practioners and cardiologists, which arein addition to our approximately 450 primary care sales force professionals.

We sell our products topharmaceutical wholesalers (who in turn distribute to pharmacies), chain drugstores, other retail merchandisers and, on a limited basis, directly topharmacies. For the years ended December 31, 2003, 2004 and 2005, sales toour top three pharmaceutical wholesalers accounted for approximately 69%, 78%and 63% respectively, of all of our sales. The following wholesalers eachaccounted for 10% or more of all of our sales for the years ended December 31,2003, 2004 and  2005: McKessonCorporation (29%, 31% and 30%, respectively), Cardinal Health, Inc. (22%,25% and 23%, respectively), and AmerisourceBergen Corporation (18%, 22% and 10%respectively).

The Company has two maintypes of arrangements with wholesalers of its products: (a) ordinarycourse arrangements with health benefit providers, such as managed carecontractors and pharmacy benefit managers (“Standard Arrangements”), and (b) agreementswith three drug wholesale companies—Inventory Management Agreements (“IMAs”).The Standard Arrangements are ordinary course and are not material in size ornature. Pursuant to those arrangements, the Company provides discounts tovarious health benefit providers nationwide for purchases of the Company’sproducts, although such providers have no obligation to order any products atany time and the Company is under no obligation to offer or provide thediscounts. The Company has utilized such Standard Arrangements for severalyears and expects to continue to do so in the future. The Company’s three IMAswere entered into in 2003 with three national drug wholesale companies—McKessonCorporation, Cardinal Health, Inc. and AmerisourceBergen Corporation.Pursuant to our IMAs, we provide purchase price discounts for purchases of ourproducts in order to provide incentives for such companies to stabilize andmanage their inventory levels, which in turn allows us to better stabilize andcontrol our inventory pipeline. Each IMA may be terminated by either party upon60 days prior written notice.

 

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In December 2004, we entered into a Distributionand Inventory Management Services Agreement with Cardinal Health continuing ourexisting relationship with Cardinal Health. Under the agreement, CardinalHealth, among other things, provides us with certain distribution and inventorymanagement services, including accounts receivable management, customer servicesupport, consolidated deliveries to providers, and contract and chargebackadministration. This agreement calls for Cardinal Health to maintain the inventorylevels specified in the agreement. In order to minimize product shortages andmaximize product availability, Cardinal Health agreed to institute an automatedbalancing system on our products and optimize ordering during backordersituations or limited product availability. We have the right to cancel anyorder exceeding certain levels of products sold. The agreement also providesthat Cardinal Health prepares and provides to the Company, inventory and salesreports detailing the status and movement of our products in Cardinal Health’sinventory, monitors customer order patterns, provides events managementservices, and provides support for new product launches. In January 2006,we amended our agreement with Cardinal. The amended agreement enables us totake advantage of a centralized purchasing location. Under the amendedagreement, certain of Cardinal’s purchasing and inventory requirements wererevised as was Cardinal’s rights to make limited purchases of our products atprices in effect prior to any announced price increases.

In December 2004, we entered into an amendment toour Inventory Management Agreement with McKesson Corporation. Among other termsand conditions, the amendment provides that McKesson maintain specifiedinventory levels. The amendment also provides that McKesson prepare, andprovide to us, inventory reports detailing the status and movement of ourproducts in McKesson’s inventory. The amendment acknowledges that the agreementby McKesson to provide the reports and to maintain certain inventory levels isin consideration for providing McKesson with economic relief from priceincreases instituted by the Company. Except as modified by the amendment, theterms and conditions, including any contractual obligations to provide services,of the agreement underlying and amended by the amendment remain in full forceand effect. In December 2005, we further amended our Inventory ManagementAgreement with McKesson. The amended agreement enables us to take advantage ofa centralized purchasing location. Under the amended agreement, certain ofMcKesson’s purchasing and inventory requirements were revised as was McKesson’srights to make limited purchases of the Company’s products at prices in effectprior to any announced price increases.

We have a group of sales professionals that focusesexclusively on building relationships and contracting with managed-careorganizations that can be leveraged across markets. We continue to strengthenthis group to gain access to formularies and develop long-term workingrelationships with managed care organizations.

Thepercentage of total sales contributed by product lines for the prior threeyears is as set forth below.

| ** **          | ** ** | **For the Year Ended  December 31,(1)** | ** ** |
|---------------------|------------|-------------------------------------------------------------|------------|
| ** **          | ** ** | **2005**                                                    | ** ** | **2004** | ** ** | **2003** | ** ** |
| Cardiovascular      |       |                                                        | 67         | % |   |   | 50 | % |   |   | 46 | % |   |
| Women’s Health |       |                                                        | 22         | % |   |   | 15 | % |   |   | 18 | % |   |
| Non Promoted        |       |                                                        | 11         | % |   |   | 35 | % |   |   | 36 | % |   |

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(1)          Percentagesfor the years ended December 31, 2004 and 2003 are based on our 2005promoted products.

**Seasonality**

Although our business isgenerally non-seasonal, sales of certain products, such as cough and coldproducts, increase between October and March due to the cold and fluseason. We expect the impact of 

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seasonalityto continue to decrease as we acquire or obtain licenses for products thattreat chronic conditions. However, we anticipate that the seasonality maycontinue to affect sales of certain existing products for the foreseeablefuture. Sales of our cough and cold products for the years endedDecember 31, 2003, 2004 and 2005 accounted for 19%, 11% and 2% of ourtotal sales, respectively.

**Third-Party Agreements**

*Sular*

In March 2002, we acquired exclusive U.S. rightsto distribute and sell Sular from AstraZeneca PLC and Bayer Health. We paid$184.3 million in cash, including $0.6 million in acquisition costs,plus the assumption of liabilities of $1.9 million related to the returnof product shipped prior to the acquisition date. In December 2002, weincreased our estimates for assumed liabilities by $0.7 million. Under theasset purchase agreement, we acquired the regulatory approval to sell Sular inthe U.S., current inventory, licensing rights to certain intellectual property,marketing materials for the promotion, advertising and marketing of Sular inthe U.S., study materials relating to clinical studies of Sular, and certain ofAstraZeneca’s contracts relating to the marketing, sale and distribution ofSular. We were required to pay AstraZeneca up to an additional$20.0 million upon achievement of certain sales milestones through February 2005.As of December 31, 2004, we calculated that we owed AstraZeneca$5.0 million for reaching these milestones which we paid in March 2005.We do not owe nor did we make any other milestone payments in 2005.

In March 2002, we also entered into a ten-yearagreement with Bayer, which appoints us as the exclusive party to sell anddistribute Sular in the U.S., provides us with the rights to sell Sular undercertain patents and other technical information owned by Bayer, assigns us theSular trademark, and provides for the manufacture and supply of Sular to us. Wepay Bayer for the manufacture and supply of Sular on a unit basis. The unitprice to us for Sular may adjust based upon changes in the net revenue per unitthat we recognize in the sale of Sular. We must also pay Bayer an additional$10.0 million upon the achievement of a certain sales milestone for Sularif a sales threshold is achieved during the ten year term of the agreement. In December 2005,we amended our agreement with Bayer. The amended agreement modified theapplicable milestones and increased protection from foreign exchange ratefluctuations. In January 2006, we owed $5.0 million to Bayer under theamended agreement. This payment was made in January 2006. Under theamended agreement, we must purchase minimum quantities of Sular from Bayerthrough March 2007 and we must obtain the consent of Bayer prior toselling another product containing the active ingredient in Sular.

Subject to obtaining theconsent of Bayer prior to conducting clinical trials for new cardiovascularindications for Sular and in the event that we receive an NDA approval forthese new uses, we may deduct a percentage of the costs incurred to obtain suchapproval, up to a certain amount, from our payments to Bayer under the amendedagreement for five years following such approval. Bayer will have access to anydata that we obtain pursuant to such trials and we will grant Bayer aroyalty-free license to use such data outside of the U.S.

*Fortamet andAltoprev*

In March 2005, we licensed and purchased certainrights to the type 2 diabetes prescription medication Fortamet and thecholesterol medication Altoprev from Andrx Laboratories. We paid $50.0 millionfor Fortamet at closing and have paid $35.0 million for Altoprev, a portion ofwhich is subject to Andrx’s continuing ability to satisfy certain manufacturingservice levels. We (i) purchased the Fortamet and Altoprev trademarks,worldwide marketing rights to Fortamet and Altoprev, certain Fortametinventory, and marketing materials for the promotion, advertising and marketingof Fortamet and Altoprev, (ii) assumed certain of Andrx’s contractsrelating to the sale of Fortamet and Altoprev and 

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(iii) will pay Andrxa percentage of the net revenues associated with Fortamet and Altoprev on anongoing basis. We also entered into an exclusive license agreement for theregulatory approvals to sell Fortamet and Altoprev in the United States.

We also entered into along-term manufacturing and supply agreement appointing Andrx as manufacturerof Fortamet and Altoprev. The terms of the agreement require us to pay Andrxfor the manufacture of Fortamet and Altoprev on a per unit basis for a ten yearterm, subject to Andrx’s ability to terminate as of the conclusion of theseventh year. The unit price may adjust based on changes in the cost of theactive pharmaceutical ingredients as well as changes in an annual inflationaryindex.

*Triglide*

In May 2004, we entered into an agreement with SkyePharmaPLC granting us the exclusive license for a term of at least 15 years to marketand distribute a fenofibrate product in the U.S. that was approved by the FDAin May 2005. We have since commenced marketing and distribution of thisproduct, labeled Triglide. We have also obtained the right of first refusal tonegotiate a license to develop and commercialize a future cardiovascularproduct utilizing the SkyePharma delivery technology. We paid $20.0 million toSkyePharma for these rights. We utilize our sales force to market the productand pay SkyePharma 25% of the product’s net sales which includes cost of goodssold. Further, SkyePharma was obligated to contribute $2.5 million toward oursales and marketing efforts and provided us with free product samples for theyear ended December 31, 2005, and was required to provide up to anadditional $2.5 million in 2006. Over the term of the agreement, upon ourachievement of certain sales levels, SkyePharma can receive up to$30.0 million in additional milestone payments.

In February 2005, weamended the agreement with SkyePharma. This amendment provided for SkyePharmato deliver the fenofibrate product so that we could launch the product in thethird****quarter of 2005. To provide additionalassistance with our launch of the product, SkyePharma agreed to provideadditional marketing support. In January 2006, we further amended ouragreement with SkyePharma. In this amended agreement, SkyePharma increased itscontribution toward our sales and marketing efforts from $5.0 million to $11.3million and the parties further defined their obligations with respect to thepayment for samples.

*Nitrolingual*

In July 1999, weacquired exclusive U.S. rights to distribute, market and sell Nitrolingual fromPohl-Boskamp beginning in February 2000. This agreement was amended,effective July 2005. The amended agreement expires January 31, 2010but may be renewed for additional two year periods. We must also pay a royaltyon net sales of the product. Also, Pohl-Boskamp can terminate our distributionagreement for Nitrolingual if a company with a product competitive withNitrolingual acquires direct or indirect influence or control over us. Ouragreement with Pohl-Boskamp prohibits us from selling other products which areindicated for the relief of angina pectoris.

*Prenate Line*

In August 2001, we purchased the Prenate line ofprescription prenatal vitamins from Sanofi-Synthelabo. We acquired all ofSanofi-Synthelabo’s regulatory permits and licenses and contract rights relatedto Prenate. The purchase price for the acquired assets was $52.5 millionin cash plus the assumption of certain liabilities and payment for productinventory, subject to post-closing adjustments.

We also assumed Sanofi-Synthelabo’s Prenate-relatedcontracts, including a contract with Patheon, Inc., to manufacture PrenateAdvance tablets and the core tablets for Prenate GT, and a contract with BannerPharmacaps to manufacture Prenate GT using its patented manufacturing processto create gelatin-enrobed tablets. Banner Pharmacaps had agreed not to use thismanufacturing process to make any 

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other prenatal vitamins.Under the terms of the supply agreement with Banner Pharmacaps, as amended, wepaid Banner Pharmacaps a royalty on net sales. The agreement with Banner wasterminated in December 2004 as the Company discontinued Prenate GT andPrenate Advance.

The manufacturingagreement with Patheon, Inc. was initially entered into withSanofi-Synthelabo, Inc. in October 1999 and had a term of five years.We finalized a new manufacturing agreement with Patheon for Prenate Elite in2005, which expires in January 2009. OptiNate is presently manufactured byPatheon and other third-parties.

*Ponstel*

In April 2000, we acquired exclusive rights tomarket, distribute and sell Ponstel in the U.S. from Pfizer. In December 2000,we signed an agreement with Westward Pharmaceuticals to manufacture Ponstel. Westwardbegan supplying the product to us in the second quarter of 2003.****This agreement was renewed for an additional one-year termin 2005 and expires in April 2006.

We must purchase all ofour requirements for Ponstel from Westward and are subject to minimum purchaserequirements. We must pay Westward a price for Ponstel based on a multiple of Westward’sdirect cost of goods sold in the manufacture and supply of the product. Inaddition, we must pay Westward milestone payments, as long as no generics havebeen introduced, upon certain anniversary dates of FDA approval of themanufacture of Ponstel by Westward.

*Other Products*

*Furadantin.**  *In December 2001, we acquired the U.S.rights to Furadantin from Elan Pharmaceutical. The purchase price for theacquired assets was approximately $15.8 million in cash. Under the agreement,we acquired the assets relating to Furadantin, including the NDA, trademark andrelated inventory.

In December 2001, we also entered into a supplyagreement with Elan to manufacture and supply Furadantin to us through May 2003.In August 2002, we entered into a manufacturing agreement with OSG NorwichPharmaceuticals to manufacture Furadantin for us. OSG became qualified tomanufacture the product in November 2003. Beginning January 2004, wewere required to purchase a minimum amount of inventory annually from OSGNorwich Pharmaceutical. This agreement expires in August 2007 and may beextended for an additional two-year term.

In May 2003, we entered into a supply agreementwith Vinchem, Inc. to supply us the active ingredient in Furadantin. Thisagreement expires May 2010, and is renewable for successive one-yearterms. Generally, our other products are manufactured under manufacturing andsupply agreements which require that we purchase all of our requirements forthese products from the manufacturers which are a party to these agreements,including specified minimum purchase quantities of the product for each year.Except for agreements regarding our Zoto-HC products, these agreementsgenerally state that the product supplier will provide products only to us.

*Cognex.**  *In June 2000, we acquired worldwiderights to market, distribute and sell Cognex as well as rights to a newunapproved version of Cognex called Cognex CR from Pfizer. We paid$3.5 million in cash for Cognex. We must pay Pfizer up to$1.5 million in additional purchase price if we obtain FDA approval tomarket Cognex CR in the U.S. At this time, we are preliminarily exploringopportunities to develop and seek FDA approval to market Cognex CR. In theevent that we voluntarily stop selling Cognex for 60 days or more, otherthan for reasons outside our control, the Federal Trade Commission may orderthat Cognex revert back to Pfizer and be divested to another purchaser. WestwardPharmaceuticals supplies Cognex. This agreement expires March 2008, butmay be renewed for an additional two-year term. We are seeking a new supplierto supply us with the active ingredient in Cognex. Based on our current salesprojections, we 

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believe that we haveadequate supplies of the active ingredient in Cognex for the foreseeablefuture. However, if sales exceed our current projections or if we are unable tolocate a new supplier of the active ingredient in Cognex, our ability to sellCognex would be limited and our net income would be reduced.

*Robinuland Robinul Forte.**  *InJanuary 1999, we acquired exclusive rights in the U.S. to Robinul andRobinul Forte tablets from Wyeth. We must pay royalties on net sales under ourlicense agreement with Wyeth. We entered into agreements with Mikart, dated April 23,1999 and January 21, 2001, for Mikart to become qualified under applicableregulations to manufacture and supply our requirements for Robinul. Mikart wasapproved by the FDA to manufacture Robinul on December 3, 2001 and begansupplying the Robinul products to us in December 2001. Under theseagreements, Mikart will manufacture the products for five years from the timeMikart became a qualified manufacturer plus renewal terms of one year untileither party elects not to renew. The agreement with Mikart requires that wepurchase certain designated minimum quantities.

In January 2002, we entered into a licenseagreement with Wyeth-Ayerst Canada Inc. and Whitehall-Robins Inc.under which we acquired rights to manufacture, have manufactured for us, marketand sell Robinul and Robinul Forte in Canada. If we begin to sell Robinul inCanada, we will pay Wyeth-Ayerst Canada a royalty on net sales of Robinul inCanada.

*TanafedDP and Tanafed DMX.**  *Prior to the fourthquarter of 2001, we had marketed Tanafed Suspension, a liquid cold and allergyproduct, to pediatricians. In January 2002, we launched Tanafed DM, a lineextension to Tanafed Suspension, that contains a cough suppressant. During thesecond quarter of 2002, we experienced significant erosion of sales of TanafedSuspension and Tanafed DM due to increased substitution of knock-off productsby pharmacies. In response, we launched Tanafed DP and Tanafed DMX, two lineextensions to Tanafed Suspension and Tanafed DM, and we ceased selling TanafedSuspension and Tanafed DM in the fourth quarter of 2002.

In June 2002, we entered into an exclusivedistribution agreement with Unisource granting us exclusive rights to sellTanafed DP and Tanafed DMX in North America and for Unisource to supply TanafedDP and Tanafed DMX to us through June 2007, subject to an automatic threeyear renewal. The agreement requires us to purchase all of our Tanafed DP andTanafed DMX requirements from Unisource and subjects us to minimum purchaserequirements. We must pay Unisource for the manufacture and supply of TanafedDP and Tanafed DMX based upon fixed unit costs.

In June 2002, weentered into an agreement with Jame Fine Chemicals, Inc. for a 10 yearexclusive license to make, have made, use, distribute, market, promote,advertise and sell pharmaceutical formulations containing the ingredientsdextromethorphan tannate and dexchlorpheniramine tannate. Tanafed DP andTanafed DMX products contain dexchlorpheniramine tannate and Tanafed DMXcontains dextromethorphan tannate. The agreement became effective upon thefirst sale of product containing the ingredients, which occurred in August 2002.We paid a license fee of $0.5 million in cash in connection with the firstsale. We paid a maximum royalty of $2.5 million in installments through March 2005.As of December 31, 2005, $0.3 million of this royalty is refundableto us. A nonrefundable royalty commenced in January 2005. As a result ofthe entry of knock-offs into the marketplace, as of December 31, 2005, weceased actively promoting the Tanafed line.

**Products Under Development**

We seek to maximize thevalue of drugs by developing new patentable formulations, using new deliverymethods and seeking regulatory approval for new indications. Through the use ofthese distinct formulations and patent-protected delivery systems, we plan tocreate a marketing advantage over competing drugs. Some of these developmentprojects include line extensions which allow us to extend the life cycles ofour products. We expect the strength of extensive literature-based clinicaldata on the active ingredients in our products under development, currentacceptance and usage of the active ingredients in 

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theseproducts by healthcare professionals and the safety profile of the activeingredients in approved products will reduce development costs and risksassociated with FDA approval. Although we have increased our developmentinfrastructure, we typically contract with third parties to formulate, developand manufacture materials needed for clinical trials and to perform scale-upwork. We select third-party contractors that we believe have the capability tocommercially manufacture the products. By selecting qualified third parties capableof both developing formulations and providing full-scale manufacturingservices, we believe we will be able to shorten development and scale-up timesnecessary for production. The key advantage to this approach is that thethird-party contractor will have the equipment, operational parameters andvalidated testing procedures already in place for the commercial manufacture ofour products.

**Manufacturersand Single Source Suppliers**

We use third-party manufacturers for the production ofour products for development and commercial purposes. Given the generalunder-utilization of resources, the availability of excess capacity formanufacturing in the marketplace and the lower cost of outsourcing, we intendto continue to outsource our manufacturing for the near term. Some of ourproducts are currently available only from sole or limited suppliers. Thesethird-party manufactured products include products that have historicallyaccounted for a significant portion of our revenues.

We are dependent on third parties for the supply ofthe raw materials necessary to develop and manufacture our products, includingthe active and inactive pharmaceutical ingredients used in our products. We arerequired to identify the supplier of all the raw materials for our products inthe drug applications that we file with the FDA. If raw materials for aparticular product become unavailable from an approved supplier specified in adrug application, we would be required to qualify a substitute supplier withthe FDA, which would likely interrupt manufacturing of the affected product. Tothe extent practicable, we attempt to identify more than one supplier in eachdrug application. However, some raw materials are available only from a singlesource and, in some of our drug applications, only one supplier of rawmaterials has been identified, even in instances where multiple sources exist.

In addition, we obtain a significant portion of ourraw materials from foreign suppliers. Arrangements with international rawmaterial suppliers are subject to, among other things, FDA regulation, variousimport duties, foreign currency risk and other government clearances. Acts ofgovernments outside the U.S. may affect the price or availability of rawmaterials needed for the development or manufacture of our products. Inaddition, any changes in patent laws in jurisdictions outside the U.S. may makeit increasingly difficult to obtain raw materials for research and developmentprior to the expiration of the applicable U.S. or foreign patents.

Under some of ouragreements, the manufacturers or other third parties own rights to the productsthat we have under our marketing licenses. We have not entered into agreementsfor alternative manufacturing sources for any of our products. Further, undersome of our agreements, we are required to purchase a minimum amount of rawmaterials and/or order a minimum amount of manufactured products. Generally, wemust pay a shortfall penalty if we do not meet our minimum requirements.

**Trademarks**

Because of the large number of products on the marketwhich compete with our products, we believe that our product brand names are animportant factor in establishing product recognition. We have registered FirstHorizon Pharmaceutical as a trademark in the U.S.

Our products are soldunder a variety of brands for which we own U.S. registered trademarks,including Sular (and an associated design), Fortamet, Altoprev, Prenate, Ponstel,Furadantin (and an associated design), Zoto-HC (and an associated design) andZebutal. We own the U.S. rights to the 

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Cognextrademark and its international counterparts. We also have filed U.S. trademarkapplications for the trademarks Triglide (and an associated design), DHA250(and an associated design), OptiNate and Prenate Elite (and an associated design).Further, we have been licensed rights to use the trademarks Nitrolingual andRobinul from Pohl-Boskamp and Wyeth, respectively. Maintenance of ourtrademarks requires that we enforce our rights by preventing infringement bythird parties, and we may not have the resources to stop others from infringingour trademarks.

**Patents**

We consider the protection afforded by patentsimportant to our business. We intend to seek patent protection in the U.S. andselected foreign countries where deemed appropriate for products we develop.There can be no assurances that any patents will result from our patentapplications, that any patents that may be issued will protect our intellectualproperty or products or that any issued patents will not be challenged by thirdparties. In addition, if we do not avoid infringement of the intellectualproperty rights of others, we may have to seek a license to sell our products,defend an infringement action or challenge the validity of the intellectualproperty in court, all of which could be expensive and time consuming.

In certain cases, a thirdparty owns rights to the products that we have under our marketing licenses.For example, our supplier of Sular has a patent on the composition of its coatcore tablet. This patent may provide us with a competitive advantage becausethe patent creates a barrier to entry to other companies that might otherwiseseek to develop similar products.

*Sular*

Pursuant to ourdistributorship agreement with Bayer, we are afforded patent protection arisingfrom Bayer’s patent covering the composition of Sular’s coat core tablet. Thispatent expires in 2008. The expiration of this Bayer patent could result in theintroduction of additional competition, which could cause a material decline inthe sale and price of Sular. In 2002, we filed three patent applicationsrelating to Sular’s active ingredient and its uses. We have abandoned two ofthese applications. The remaining patent application is still pending.

*Fortamet andAltoprev*

Pursuant to a licenseagreement with Andrx entered into in March 2005, we have an exclusiveworldwide license to the patent rights associated with Fortamet and Altoprev inthe United States.

*Triglide*

Pursuant to our 2004agreement with SkyePharma, we have an exclusive license to the patent rightsassociated with Triglide in the United States.

*Nitrolingual*

By virtue of ourdistribution agreement with Pohl-Boskamp for Nitrolingual, we are affordedpatent protection arising from Pohl-Boskamp’s 1993 U.S. patent relating to theproduct. This patent expires in 2010.

*Prenate andOptiNate*

Pursuant to an agreementwith our Metafolin® supplier, we have licensed certain patentrights associated with reduced folates. Two of such patents expire in 2017 andthe third expires in 2018.

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*Other Products*

*Cognex.**  *We own certain patent rights relating to theuse of an active ingredient in Cognex to treat conditions associated withAlzheimer’s disease. The U.S. patents expire from 2008 through 2013.

*Robinuland Robinul Forte.**  *In 2003 we filed apatent application relating to glycopyrrolate, which is the active ingredientin Robinul and Robinul Forte. This patent application remains pending.

*Tanafed DP and TanafedDMX.**  *On January 21,2003, we were issued a patent covering compositions for Tanafed DP and TanafedDMX. This patent expires in 2021. In June 2004, we filed another patentapplication covering additional compositions for Tanafed DP and Tanafed DMX.This application is still pending. On September 14, 2004, we were issued apatent covering additional tannate technologies. This patent expires in 2021.

**Competition**

The market for drugs is highly competitive with manyestablished manufacturers, suppliers and distributors which are activelyengaged in all phases of the business. We believe that competition in the saleof our products is based primarily on efficacy, reimbursement coverage, brandawareness, availability, product safety, and price. Our brand namepharmaceutical products may be subject to competition from alternate therapiesduring the period of patent protection and thereafter from generic or othercompetitive products. All of our products compete with generic and othercompetitive products in the marketplace.

Competing in the branded product business requires usto identify and quickly bring to market new products embodying technologicalinnovations. Successful marketing of branded products depends primarily on theability to communicate the efficacy, safety and value to healthcareprofessionals in private practice, group practices and managed careorganizations. We anticipate that our branded product offerings will supportour existing lines of therapeutic focus. Based upon business conditions andother factors, we regularly reexamine our business strategies and may from timeto time reallocate our resources from one therapeutic area to another, withdrawfrom a therapeutic area or add an additional therapeutic area in order tomaximize our overall growth opportunities.

Some of our products compete with one or more productsmarketed by very large pharmaceutical companies which have much greaterfinancial resources for marketing, selling and developing their products. Ourcompetitors in branded products include but are not limited to the major brandname manufacturers of pharmaceuticals such as Pfizer, Inc., Merck &Co., Inc., Abbott Laboratories, Inc., KV Pharmaceuticals Co.,AstraZeneca PLC and Teva Pharmaceuticals Inc Ltd. Based on total assets, annualrevenues and market capitalization, we are considerably smaller than these andother national competitors in the branded product area. These competitors, aswell as others, have been in business for a longer period of time, have agreater number of products on the market and have greater financial and otherresources than we do. If we directly compete with them for the same marketsand/or products, their financial and market strength could prevent us fromcapturing a meaningful share of those markets.

We also compete with otherpharmaceutical companies for product line acquisitions as well as for newproducts and acquisitions of other companies. These competitors include ForestLaboratories, Inc., Medicis Pharmaceutical Corporation, WatsonPharmaceuticals, Inc., King Pharmaceuticals, Inc., ShirePharmaceuticals Group plc, Biovail Corporation, Barr Pharmaceuticals, Inc.,Solvay Pharmaceuticals, Inc., Reliant Pharmaceutical, LLC,  Kos Pharmaceuticals, Inc. and othercompanies that acquire branded products from other pharmaceutical companies.These companies may have greater resources and abilities than we have.

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**Government Regulation**

According to the Federal Food, Drug, and Cosmetic Act(“FDC Act”), new drugs are subject to pre-market approval by the FDA.Applicable federal law will govern the development of new products, indicationsand/or line extensions; some of which may require the submission of an NDA or asupplemental NDA (“sNDA”) (or an abbreviated NDA (“ANDA”) if applicable), andapproval by the FDA.

The steps requiredfor approval of an NDA or sNDA may include:

·       extensivepre-clinical toxicology and pharmacology studies,

·       submissionto the FDA of an investigational new drug application (“IND”), which mustbecome effective before human clinical trials can be commenced,

·       aseries of preliminary clinical studies to demonstrate safety (Phase I) andoptimal dosing and pharmacologic effects (Phase II),

·       adequateand well-controlled human clinical trials (Phase III) to establish thesafety and effectiveness of the product,

·       submissionof an NDA or an sNDA to the FDA (typically six to eighteen month internal FDAreview cycle),

·       presentationof the NDA data to an FDA Advisory Panel for its recommendation, and

·       FDAapproval of the NDA or sNDA prior to any commercial sale or shipment of theproduct.

Pre-clinical studies generally include laboratoryevaluation of product chemistry and formulation, as well as toxicological andpharmacological animal studies, to assess quality and safety and provide abasis for design of the human clinical trials. An applicant submits the resultsof the pre-clinical studies with chemistry, manufacturing and controlinformation and pharmacology and toxicology data in support of the proposedclinical study design to the FDA as a part of an IND and for review by the FDAprior to the commencement of human clinical trials. Unless the FDA saysotherwise, the IND will become effective 30 days following its receipt bythe FDA. However, the FDA may place an IND on “clinical hold” until theapplicant generates and supplies the FDA with additional data, which prohibitsthe applicant from commencing the proposed clinical trials until the “clinicalhold” has been removed by the FDA.

Clinical trialsinvolve the administration of the IND to humans under the clinical studyprotocols that were submitted to the FDA as part of the IND. The conduct of theclinical trials is subject to extensive regulation including compliance withgood clinical practices, obtaining informed patient consent, sponsor monitoringand auditing of the clinical, laboratory and product manufacturing sites as wellas review and approval of each study by an Institutional Review Board. Clinicaltrials are typically conducted in three sequential Phases, although Phases mayoverlap. In Phase I, the investigational new drug usually is administeredto 20-50 healthy human subjects and is tested for safety. Phase IIusually involves studies in a limited patient population (50-200patients) to:

·       determinethe initial effectiveness of the investigational new drug for specificindications,

·       determinedosage tolerance and optimal dosage, and

·       identifypossible adverse effects and safety risks.

When an investigational new drug is found to beeffective and to have an acceptable safety profile in its Phase II evaluation,Phase III trials are undertaken to further evaluate clinical effectiveness andto further test for safety within an expanded patient population of usually 200or more patients. The FDA reviews both the clinical plans and the results ofthe trials and may require the study to be discontinued at 

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any time if there aresignificant safety issues or lack of efficacy. In some cases, the FDA canrequest Phase IV clinical studies to be conducted as a condition of approval ofthe NDA, although the Phase IV studies will be conducted within a designatedtime period following NDA approval. These studies can be designed to obtainadditional safety and efficacy data, detect new uses for or abuses of a drug,or determine effectiveness for labeled indications under conditions ofwidespread usage. These studies can involve significant additional expenses,and failure to perform these Phase IV studies within the FDA-stated timeframecan result in the FDA withdrawing the NDA approval.

Once the FDA has approved an NDA, the holder of theNDA may request changes to the product or manufacturing process through asupplement to the original NDA, termed an sNDA. The format, content andprocedures applicable to NDA supplements are generally the same as those forNDAs. However, the information required to be provided to the FDA in asupplement is only that which is needed to support the requested change. If theNDA or sNDA is based on new clinical investigations that are essential to theapproval of the application, other than bioavailability studies, it may qualifyfor a three-year period of marketing exclusivity, distinct from any applicablepatent protection that may exist. In such a case, the FDA may accept forfiling, but will not approve a generic product for three years from the date ofthat application’s approval. The FDA may also require user fees in excess of$0.3 million for prescription drug NDAs or sNDAs. Supplements proposing toinclude a new indication for use in pediatric populations are not subject touser fees unless the supplement contains clinical data.

Another form of an NDA is the so-called “505(b)(2)”NDA, which applicants submit pursuant to Section 505(b)(2) of the FDCAct. This type of NDA permits an applicant to cross-reference to safety andeffectiveness studies that the applicant has not conducted or been granted aright of reference by the sponsor of the animal or human studies, submitted ina prior NDA or in the literature which utilized the same drug. In addition, theFDA recommends a 505(b)(2) NDA for a modification, such as a new dosageform or drug delivery form, of a previously approved drug (but not that held bythe 505(b)(2) applicant), which requires more than merely bioequivalencedata. This 505(b)(2) NDA is similar to a full NDA, except that, underconditions prescribed by the FDA, it may be supported in whole or in part byone or more animal and human study investigations in the originator NDA orthose published in scientific literature in lieu of the applicant’s clinicaltrials. This type of NDA application is submitted to market potential productline extensions or new uses of already-approved products. Payment of user feesmay also be required by the FDA.

In addition, if we submit a 505(b)(2) NDA orANDA, the FDA will require us to certify as to any patent which covers the drugfor which we seek approval. If there is a patent in existence, we are requiredto make a certification commonly referred to as a “paragraph IVcertification,” and to give notice to the patent holder of our intent to marketthe drug. If the patent holder makes an infringement claim within a specifiedtime period, then the FDA will not approve our marketing application for30 months or until the patent litigation is resolved, whichever occurssooner. In addition, distinct from patent considerations, approval of a generictype of ANDA could be delayed because of the existence of five or three yearsof marketing non-patent exclusivity afforded by the FDA for the innovator drugor 180 days of non-patent exclusivity afforded to the first applicant tosubmit an ANDA with a paragraph IV certification. However, in certainproscribed cases, this non-patent exclusivity may not prevent the submissionand approval of competitor ANDAs, but a patent holder can still sue forinfringement under traditional patent law.

The least burdensome application for new drug approvalis the ANDA, which may apply to a new drug that is shown to be bioequivalent toa drug that was previously approved by the FDA for safety and effectiveness. Anapplicant may submit an ANDA for products that are the same as an approved originatordrug regarding active ingredient(s), route of administration, dosage form,strength and conditions of use recommended on the labeling. The ANDA requiresonly bioequivalence data and other technical and manufacturing information, buttypically no safety and effectiveness studies.

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Even after obtaining regulatory approval, suchapproval may require post-marketing (Phase IV) testing and surveillance tomonitor the safety of the product. In addition, the product approval may bewithdrawn if compliance with regulatory standards is not maintained or ifissues arise following initial marketing. At present, companies cannot exportpharmaceutical products that cannot be lawfully sold in the U.S. unless certainstatutorily prescribed conditions are met.

FDA regulations require that we report adverse eventssuffered by patients, submit new marketing and promotional materials, complywith regulations regarding product marketing, submit changes we plan to make tothe product manufacturing or labeling and comply with recordkeepingrequirements and requirements relating to the distribution of drug samples tophysicians. Failure to comply with the FDA requirements may result in themanufacture, sales, marketing and distribution of our products being suspended,and we may be prevented from obtaining FDA approval of new products.

Our third-party manufacturers must adhere to FDAregulations relating to current good manufacturing practice (“cGMP”)regulations, which include requirements relating to organization of personnel, buildingsand facilities, equipment, control of components and drug product containersand closures, production and process controls, packaging and labeling controls,holding and distribution, laboratory controls, records and reports, andreturned and salvaged products. Ongoing compliance with cGMP procedures,labeling and other regulatory requirements are monitored through periodicinspections and market surveillance by state and federal agencies, includingthe FDA. It is also our obligation to periodically monitor the FDA complianceof our third-party manufacturers. Failure by our third-party manufacturers tocomply with these rules could result in sanctions being imposed, includingfines, injunctions, civil penalties, suspension or withdrawal of FDA approvals,seizures or recalls of products, operating restrictions and criminalprosecutions. In addition, we rely upon our third-party manufacturers toprovide many of the documents that we use to comply with our FDA reportingrequirements for all products we sell.

In addition, we are subject to fees under thePrescription Drug User Fee Act which applies to NDAs, new drug products andsNDAs for new uses, except that we may, in certain limited circumstances,qualify for a waiver of the fee for our first NDA. We will be responsible forpaying these fees for NDAs, sNDAs and subsequent submissions, unless we receiveapproval from the FDA for a waiver, reduction or refund. We are also subject toregulation under other federal and state laws, including the OccupationalSafety and Health Act and other environmental laws and regulations, nationalrestrictions on technology transfer and import, export and customs regulations.In addition, some of our products that contain controlled substances, such asour previously marketed Protuss and Protuss-D, are subject to Drug EnforcementAdministration requirements relating to storage, distribution, importation andsampling procedures. We have registered with the Drug EnforcementAdministration under the Controlled Substances Act which establishes, amongother things, registration, security and recordkeeping requirements. We mustalso comply with federal and state anti-kickback and other healthcare fraud andabuse laws.

In addition, whether ornot we obtain FDA approval, we must obtain approval of a pharmaceutical productby comparable governmental regulatory authorities in foreign countries prior tothe commencement of clinical trials and subsequent marketing of such product inthese countries. The approval procedure varies from country to country, and thetime required may be longer or shorter than that required for FDA approval.

**Orphan Drug Designation**

We may request orphan drugstatus for some of our products under development. Orphan drug designation maybe granted to those products developed to treat diseases or conditions thataffect fewer than 200,000 persons in the U.S. or that affect more than 200,000persons in the U.S. and for which there is no reasonable expectation that thecost of developing and making a drug in the U.S. for such disease or 

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conditionwill be recovered from sales in the U.S. of such drug. Under the law, thedeveloper of an orphan drug may be entitled to seven years of marketexclusivity following the approval of the product by the FDA, exemption fromuser fee payments to the FDA and a tax credit for the amount of money spent onhuman clinical trials. However, should there be a competitor with a similarmolecular entity pursuing the same intended clinical use, we must be the firstto receive FDA marketing approval in order to receive market exclusivity underthe Orphan Drug Act. Although we may receive market exclusivity under theOrphan Drug Act, the FDA will allow the sale of a molecularly equivalent drugwhich is clinically superior to or a molecular entity different from anotherapproved orphan drug, even if it is for the same indication, during theseven-year exclusive marketing period. It is also possible that a competitormay attempt to undermine any exclusivity provided to us by promoting a product foran off-label use that is the otherwise protected product. We cannot be certainthat any of our products under development would ultimately receive orphan drugdesignation, or that the benefits currently provided by this designation, if wewere to receive it, will not subsequently be amended or eliminated. Orphan drugdesignation does not convey any advantage in, or shorten the duration of, theregulatory review and approval process.

**Reimbursement**

Our ability to market our products successfullydepends in part on the extent to which reimbursement for the costs of theproducts will be available from government health administration authorities,private health insurers and managed care organizations in the U.S. and in anyforeign markets where we may sell our products. Third-party payors, includingMedicaid and Medicare Part D,  canaffect the pricing or relative attractiveness of our products by regulating thereimbursement they provide on our products and competing products. Insurancecarriers may not reimburse healthcare providers for use of our products for newindications. Domestic and foreign government and third-party payors areincreasingly attempting to contain healthcare costs by limiting both coverageand the level of reimbursement for new pharmaceutical products.

Third-party payorsregularly challenge the pricing of medical products and services bysubstituting cheaper products on their approved lists. We face an increasedrisk of third-party payors substituting or competing with the drugs in our productportfolio. If third-party payors remove any of these products from their listsor choose not to pay for our product prescriptions, patients and pharmacies maynot continue to choose our products.

**Insurance**

We maintain a productliability insurance policy. Our property and casualty insurance policy providesfor payment for lost inventory and lost sales in the event of loss from damageto our property as well as business interruption coverage.

**Employees**

We had 568 full-timeemployees as of December 31, 2005, including 474 sales employees in thefield and 94 in management, marketing, finance and administration. We alsomaintain active independent contractor relationships with various individualswith whom we have consulting agreements. We believe our employee relations aregood. None of our employees are subject to a collective bargaining agreement.

**ITEM 1A.**        RISKFACTORS

An investment in our common stock involves a highdegree of risk. You should carefully consider the following risk factors andall other information contained in this Annual Report. The risks anduncertainties described below are not the only ones we are facing risks anduncertainties may become important factors that affect us.

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If any of the followingrisks occur, our business, financial condition or results of operations couldbe materially and adversely affected. In that case, the trading price of ourcommon stock could decline.

**Risks Related to Our Business**

***Our operating results are substantially dependent uponthe contribution of Sular, which has been below our acquisition expectationssince we acquired the product and which has adversely affected our operatingresults.***

We acquired Sular in March 2002 and have notrealized the sales growth for Sular that we anticipated when we acquired it. Asa result, our growth has suffered. According to IMS Health’s NationalPrescription Audit PlusTM data, total Sular prescriptions increased 16.1% forthe year ended December 31, 2005 compared to the year ended December 31,2004. Although we have revised our operational plan to focus on maximizingsales of our existing products, particularly Sular, we may not be able toincrease Sular prescriptions.

***The potential growth rate for Sular may be limited bythe contraction of the market for the class of drugs to which Sular belongs.***

The calcium channelblocker products market is contracting. This contraction may be due to thefollowing, all or any of which may have an adverse effect on the sales ofSular:

·       publishedstudies showing that other classes of drugs treating hypertension have healthbenefits in addition to controlling blood pressure;

·       theintroduction of new classes of drugs treating hypertension; and

·       areduction in the number of companies actively promoting calcium channelblockers, which, in turn, has led to there being less available informationregarding calcium channel blockers.

***Competitors could offer a product competitive withSular and our other products.***

A patent addressing the composition of the activeingredient in Sular expired in 1998 and a patent covering the manufacturingprocess expired in 2004. Therefore, a competitor could introduce a productcompetitive with Sular containing its same active ingredient, although Sularremains protected under a patent addressing its coat core tablet. Any suchcompeting product may reduce our potential sales of Sular. Further, if, and asthe patent protection for our other products expires, competitors couldintroduce competitive products which may reduce our sales of such products.

***Sales of our Robinul products have been adverselyaffected by the introduction of generic products.***

In December 2004, generics to our Robinul andRobinul Forte products were introduced into the marketplace. These products areexpected to have an adverse effect on future revenues of our Robinul products.

***We may not be able to successfully integrate Fortamet,Altoprev and Triglide into our existing operations.***

In March 2005, we acquired from AndrxLaboratories certain rights related to the drug products Fortamet and Altoprevand engaged Andrx to manufacture and supply us with Fortamet and Altoprev. Wealso received FDA approval for Triglide, a fenofibrate formulation for which weobtained exclusive rights from SkyePharma in 2004. Our ability to successfullyintegrate Fortamet, Altoprev and Triglide into our existing operations and toachieve our expected level of return from sales thereof depends on numerousfactors.

The integration of theseproducts into our existing operations requires that we make adjustments to oursales and administrative functions. For example, we have hired and may continueto hire additional sales representatives and adjusted our marketing strategy toinclude these newly launched products. Furthermore, we have adjusted ouradministrative processes to facilitate the sales of these products, 

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includinghiring additional administrative support personnel at our headquarters. If ourintegration of the products into our existing operations is unsuccessful ordelayed, then we may not achieve the expected level of return from our sales ofthese products. This could result in a material adverse effect on our resultsfrom operations. Further, to the extent we become unable to timely hireadditional sales representatives to sell these products, we may not achieveexpected sales.

While we expect to extendour existing product lines and to increase our sales of existing products byoffering a more complete line of treatment alternatives through our acquisitionof certain rights to the Fortamet, Altoprev and Triglide products, there can beno assurance that these expected synergies can be achieved. In addition, if weexperience difficulty in integrating the products into our existing operationsor marketing them through our existing sales channels or as part of ourexisting product lines, we may incur significant unplanned costs to completethe integration of the products. If we do not realize the expected synergiesfrom acquiring the products or we incur unexpected costs to integrate them intoour existing operations, then we may experience a material adverse effect toour results of operations.

Further, there can be noassurance that either Andrx or SkyePharma will supply us with a sufficientquantity of products to meet our demand for finished goods, products andsamples or that the products provided will meet our specifications. If we areunable to obtain a sufficient quantity or the products provided do not meet ourspecifications, then our ability to fulfill orders for the products could beadversely effected. The 60 mg Altoprev product has experienced manufacturingissues. If the issues recur and cannot be resolved, our ability to acquire theproduct for sale and sampling will be adversely affected. In addition, the FDAis currently investigating Andrx, the manufacturer of Altoprev and Fortamet, forpotential good manufacturing practice violations. Our ability to acquire andsell Altoprev and Fortamet could be adversely impacted by this investigation. Atthis time, we do not know when the FDA will conclude its investigation. Ourability to engage a third party to manufacture and supply us with Fortamet andAltoprev is restricted to a very limited set of circumstances under our currentagreement with Andrx, and we do not have the right to engage a third party tomanufacture Triglide under our agreement with SkyePharma. If we are unable toprovide customers with the quantity of products ordered or to provide customerswith high quality products on a consistent basis, then our relationships withour customers could be adversely affected. This could result in a materialadverse effect on our results from operations.

***Pohl-Boskamp canterminate our rights to Nitrolingual Pumpspray.***

Nitrolingual Pumpspray isone of our key products. Pohl-Boskamp can terminate our distribution agreementfor Nitrolingual Pumpspray if a company with a product competitive withNitrolingual Pumpspray acquires direct or indirect influence or control over us.Pohl-Boskamp’s termination of our distribution agreement could have a materialadverse impact on our financial results.

***In the future, wemay not be able to increase our sales of promoted products sufficiently tocompensate for the decrease in sales of our non-promoted products.***

We have suffered decliningsales of our non-promoted products, including our Robinul and Tanafed lines,which accounted for 26% of our total sales, or $38.8 million, for the yearended December 31, 2004 and 2% of our total sales, or $5.2 million,for the year ended December 31, 2005. We plan to compensate for this declinein revenues by increasing sales of our existing actively promoted products andacquiring new products. However, we may not be able to increase sales ofactively promoted products or locate attractive acquisition candidates andsuccessfully complete an acquisition to offset the declining sales ofnon-promoted products.

***If we are unable tointroduce line extensions of our existing products, we may not achieve oursales plan.***

Part of our operatingplan includes the introduction of line extensions of our existing products tocreate marketing advantages and extend the life cycles of our products. If weare unable to introduce line 

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extensionsfor any reason, including our, or our third party developers’, inability toobtain necessary FDA approval, we may not achieve our sales plan and/or revenuegrowth.

***Introductions ofline extensions of our existing products may require that we make unexpectedchanges in our estimates for future product returns and reserves for obsoleteinventory which would adversely affect our operating results.***

From time-to-time we mayseek to introduce line extensions on an unexpected and expedited basis beforewe are able to reduce the levels of inventories of product which may berendered obsolete or otherwise adversely affected by the line extension. Thismay require us to increase our estimate for returns of product on hand atwholesalers, which is recorded as a reduction of our net revenues, and increaseour reserve for obsolete inventory in our warehouse which is recorded as a costof revenues. Accordingly, the introduction of line extensions may adverselyaffect our operating results.

***Our ability to growwill suffer if we do not acquire or license rights to new products andintegrate them successfully.***

Wedepend on acquisitions of rights to products from others as our primary sourcefor new products. Risks in acquiring and integrating new products include thefollowing:

·       wemay not be able to locate new products that we find attractive andcomplementary to our business;

·       theprice to acquire or obtain a license for these products may be too costly tojustify the acquisition;

·       wemay not be able to successfully integrate newly acquired products into ourexisting operations or the cost of integration may exceed our expectations; and

·       wemay not realize our anticipated return on investment from our sales of any suchnewly acquired products.

We often face significantcompetition from other pharmaceutical companies in acquiring rights toproducts, which makes it more difficult to find attractive products onacceptable terms. In addition, integration of new products into our existingstructure may require unanticipated investments of time and resources or anexpansion of our sales force. If we are unable to acquire or license rights tonew products or are unsuccessful in integrating such products, our ability togrow will suffer and our operating results may be adversely affected.

***As part of ourgrowth strategy, we may acquire businesses, which will subject us to additionalrisks.***

As anelement of our growth strategy, we may acquire businesses with products thatcomplement our current products, and we have evaluated and discussed suchopportunities with interested parties in the past. In addition to the risksthat we face in locating and consummating new product acquisitions, we face thefollowing risks, the occurrence of any or all of which may adversely affect ourbusiness:

·       wemay realize substantial acquisition-related expenses, including theamortization of long-lived assets, which would reduce our net income in futureyears;

·       ourinvestigation of potential acquisition candidates may not reveal problems andliabilities associated with the businesses, technologies or products that weacquire;

·       wemay assume liabilities that increase our risks;

·       wemay not be able to fully integrate the acquired business or products into ourown; and

·       wemay underestimate the costs necessary to integrate and operate the acquiredbusiness.

In addition, if we conductacquisitions using convertible debt or equity securities, the increased numberof shares may be dilutive to our shareholders, and may result in lower earningsper share.

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***We may incurcharges for intangible asset impairment.***

When we acquire the rightsto manufacture and sell a product, we record the aggregate purchase price,along with the value of the product related liabilities we assume, asintangible assets. We use the assistance of valuation experts to help usallocate the purchase price to the fair value of the various intangible assetswe have acquired. Then, we must estimate the economic useful life of each ofthese intangible assets in order to amortize their cost as an expense in ourstatement of operations over the estimated economic useful life of the relatedasset. The factors that drive the actual economic useful life of apharmaceutical product are inherently uncertain, and include patent protection,physician loyalty and prescribing patterns, competition by products prescribedfor similar indications, future introductions of competing products not yet FDAapproved, the impact of promotional efforts and many other issues. We use allof these factors in initially estimating the economic useful lives of ourproducts, and we also continuously monitor these factors for indications of appropriaterevisions.

In assessing therecoverability of our intangible assets, we must make assumptions regardingestimated undiscounted future cash flows and other factors. If the estimatedundiscounted future cash flows do not exceed the carrying value of theintangible assets we must determine the fair value of the intangible assets. Ifthe fair value of the intangible assets is less than its carrying value, animpairment loss will be recognized in an amount equal to the difference. Ifthese estimates or their related assumptions change in the future, we may berequired to record impairment changes for these assets. We review intangibleassets for impairment at least annually and whenever events or changes incircumstances indicate that the carrying amount of an asset may not berecoverable. If we determine that an intangible asset is impaired, a non-cashimpairment charge would be recognized.

As circumstances after anacquisition can change, the value of intangible assets may not be realized byus. If we determine that an impairment has occurred, we would be required towrite-off the impaired portion of the unamortized intangible assets, whichcould have a material adverse effect on our results of operations in the periodin which the write-off occurs. In addition, in the event of a sale of any ofour assets, we cannot be certain that our recorded value of such intangibleassets would be recovered.

***We may encounterproblems in the manufacture or supply of our products that could limit ourability to sell our products.***

We depend entirely onthird parties to manufacture and supply our products. Third parties manufactureand supply all of our products, and we do not currently have manufacturingfacilities, personnel or access to raw materials to independently manufactureour products. Except for any contractual rights and remedies which we may havewith our manufacturers and suppliers, we have no control over the availabilityof our products or their quality or cost to us. We do not maintain alternativemanufacturing sources for any of our products, and we may not be able to locatealternative manufacturers on commercially acceptable terms in the event of amanufacturing interruption or termination of an existing manufacturingagreement.

In addition, third partyintellectual property rights limit our ability to manufacture and supply ourproducts. For example, due to the patent held on Nitrolingual by our supplier,Pohl-Boskamp, no alternative source for Nitrolingual exists. Similarly, thirdparties hold the patents for the composition of the coat core tablet for Sular,the patent rights for Fortamet and Altoprev, the patent rights for Triglide,the patent rights for the manufacturing process for raw materials in Tanafed DPand Tanafed DMX, and the patent rights to Metafolin® ,an active ingredient in Prenate Elite and OptiNate. In the event that thesesuppliers ceased to supply product to us, we may not be able to locate anothermanufacturer or supplier who would be able to manufacture or supply theproducts without violating such patents or who could manufacture the productson commercially reasonable terms.

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We may encounter interruptions in our supply of Cognex.We are seeking a new supplier to supply us with the active ingredient inCognex. Based on our current sales projections, we believe that we haveadequate supplies of the active ingredient in Cognex for the foreseeablefuture. However, if sales exceed our current projections or if we are unable tolocate a new supplier of the active ingredient in Cognex, our ability to sellCognex would be limited and our profitability would be reduced.

Our third-party manufacturing agreements for themajority of our products require that we purchase our product requirements fromthe manufacturers that are a party to those agreements. This prevents ourentering into more advantageous manufacturing agreements with other manufacturersfor these products, except in very limited circumstances.

***We face generic and other strong competition thatcould lower prices and unit sales, and competitors have recently introduced newproducts and therapies that could make some of our products obsolete.***

Many of our products compete with generic productsthat could decrease our sales or force us to lower prices. In addition, some ofour products are not protected by patents and face competition from lessexpensive products. Competitors could develop new products to compete withthese products or could develop generic versions of products with which ourproducts compete. Third-party payors can require substitution and pharmacistscan substitute generic or other competitive products for our products even ifphysicians prescribe them. Government agencies, third-party payors andpharmacies often put pressure on patients to purchase generic or other productsinstead of brand-name products as a way to reduce healthcare costs. Any furtherincrease in the amount of generic and other competition against any one or moreof our products could further lower prices and unit sales which could adverselyaffect our results of operations.

In addition, our products compete against productssold over-the-counter or by prescription that in some cases are marketed bymuch larger pharmaceutical companies with greater financial resources formarketing and manufacturing. For example, Pfizer sells a hypertension productcalled Norvasc which, as of December 31, 2005 had a 45.5% share of thecalcium channel blocker market (based on prescriptions according to IMS Health’sNational Prescription Audit PlusTM data), and introduced a combination ofNorvasc with its popular cholesterol-reducing product Lipitor, called Caduet,which could prove to be an attractive alternative to our product Sular. Also, acompetitor is developing a lingual nitroglycerin spray similar to ourNitrolingual product, which could divert prescriptions and reduce sales ofNitrolingual. Also, based on the regulatory status of our Prenate Elite,OptiNate, Robinul, Tanafed, Zebutal, and Zoto-HC products, barriers to entryfor products competing with our products are low, which makes it easier forcompetitors to enter the market. Competitors may continue to develop newproducts and surgeons may continue to develop new surgical procedures to treatangina. Competitors are also developing new products to treat short term painand have recently developed new pain therapies. These new products andprocedures may reduce demand for our products. The high level of competition inour industry could force us to reduce the price at which we sell our productsor require us to spend more to market our products, or both.

***A small number of customers account for a largeportion of our sales and the loss of one of them, or changes in theirpurchasing patterns, could result in reduced sales or adversely impact ourfinancial performance.***

For the year ended December 31, 2004, sales toMcKesson Corporation represented 31%, Cardinal Health Inc. represented 25% andAmerisourceBergen Corporation represented 22% of our total sales. For the yearended December 31, 2005, sales to McKesson Corporation represented 30%,Cardinal Health Inc. represented 23% and AmerisourceBergen Corporationrepresented 10% of our total sales. The small number of wholesale drugdistributors, consolidation in this industry or financial difficulties of thesedistributors could result in the combination or elimination of warehouses,which could temporarily increase returns of our products or, as a result ofdistributors reducing inventory levels, delay the purchase of our products.

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In late 2002, our wholesaler customers purchasedexcessive amounts of inventory of our products in anticipation of future priceincreases. This adversely impacted our sales in the first half of 2003. Inresponse, in the second and third quarters of 2003, we entered into inventorymanagement agreements with our three largest wholesale customers which offerincentives to the wholesaler to maintain level amounts of inventory. Thesewholesalers may choose to forego the incentives and to maintain more inventorythan contractually allowed. While we have instituted inventory managementcontrols with our wholesaler customers, the controls rely upon data supplied byour wholesaler customers. We cannot be certain that the data supplied by ourwholesaler customers will be accurate or that the controls will be effective.If the wholesaler information is unreliable and our controls are not effective,it could have a material adverse effect on our inventory management andfinancial performance.

***If our products under development fail in clinicalstudies, if we fail or encounter difficulties in obtaining regulatory approvalfor new products or new uses of existing products, or if our developmentagreements are terminated, we will have expended significant resources for noreturn.***

We rely on third parties to formulate, develop andmanufacture the materials needed for clinical trials for our products under development.We also rely on third parties to conduct clinical trials for us. If ourproducts are not successful in clinical trials or we do not obtain FDAmarketing approval, we will have expended significant resources with no return.

For example, we have filed an IND with the FDA fordevelopment product FHPC-02 and a Phase I clinical trial has beencompleted. If we cannot obtain FDA approval for this or other products which wemay seek to develop in the future, our sales growth may suffer.

We may not receiveFDA approvals for products and/or ongoing clinical studies might be delayed orhalted for various reasons, including:

·       ourproducts are not shown to be effective;

·       wedo not comply with requirements concerning the investigational new drugapplication requirements or protection of the rights and welfare of humansubjects;

·       patientsexperience unacceptable side effects or die during clinical trials;

·       patientsdo not enroll in the studies at the rate we expect; and

·       productsupplies are delayed, are not sufficient to treat the patients in the studiesor are not sufficiently stable.

***If third-party payors do not adequately reimbursepatients for our products, doctors may not prescribe them.***

Because our products are sold by prescription, wedepend on third-party payors, such as the government, private healthcareinsurers and managed care organizations, to include these products on theirlists of products for which third-party payors will reimburse patients.Third-party payors regularly challenge the pricing of medical products andservices by substituting cheaper products on their approved lists. Because ourZebutal, Tanafed line, Zoto, Robinul line, Ponstel and Furadantin products aresusceptible to generic competition and because of products that compete withSular, Prenate, Nitrolingual Pumpspray, Altoprev, Fortamet, Triglide andPonstel, we face an increased risk of third-party payors substituting theseproducts. If third-party payors remove any of these products from their listsor choose not to pay for our product prescriptions, patients and pharmacies maynot continue to choose our products.

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***We rely on data obtained from IMS which could beinaccurate.***

We rely on operational data obtained from IMS, anindustry accepted data source. IMS data may not accurately reflect actualprescriptions (for instance, we believe IMS data does not capture all productprescriptions from some non-retail channels) or trade levels of inventory. IfIMS data turns out to be inaccurate or unreliable and our controls are noteffective, there could be an adverse effect on our ability to properly manageinventory and to our financial performance.

***We depend on highly trained management, and we may notbe able to keep current management or hire qualified management personnel inthe future.***

We currently have a limited number of key executive,regulatory, technical and management personnel. We may need to identify andattract new executive, operational and marketing personnel, and we may havedifficulty hiring personnel at an acceptable cost. While we periodicallyaddress succession planning and the possibility of key employees retiring, ourfailure to successfully identify and attract such personnel, as and whenneeded, could limit our ability to continue our business at its current level and/orgrow our business.

***The incurrence of debt could reduce our growth andprofitability.***

In March 2004, we issued a total of $150 million1.75% senior subordinated contingent convertible notes due 2024 in transactionsthat were exempt from registration under the Securities Act. The notes are due March 8,2024 and accrued interest is payable semi-annually in arrears on March 8and September 8 of each year, commencing on September 8, 2004. Inaddition to the interest on the notes, after March 8, 2007, we will alsopay contingent interest during specified six month periods if the averagetrading price of the notes per $1,000 principal amount for the five day tradingperiod ending on the third trading day immediately preceding the first day ofthe applicable six month period equals $1,200 or more. During any period whencontingent interest is payable, it will be payable at a rate equal to 0.5% perannum.

In February 2003, we entered into a creditfacility for a $20.0 million revolving loan with various lenders and LaSalleBank National Association, as administrative agent. We may borrow under therevolving loan and incur other debt to finance acquisitions to implement ourgrowth strategy and/or for general corporate purposes. Borrowings are securedby substantially all of the Company’s assets. We anticipate that we may amendthis credit facility or replace it with a new facility primarily to increaseour available borrowings so as to facilitate future product acquisitiontransactions. As of December 31, 2005, we had no outstanding borrowingsunder our credit facility.

Significant debt could (1) limit our operatingflexibility as a result of requirements by lenders, (2) require us to usea large portion of our cash flow from operations for debt service payments thatcould reduce profits and would reduce the availability of our cash flow to fundoperations, product acquisitions, the expansion of our sales force andfacilities and research and development efforts and (3) limit acquisitionsof products or companies due to restrictive covenants under our senior securedcredit facility with which we must comply as long as it is in effect.

We expect to need additional funds to acquire orobtain licenses for new products, develop and test new products and potentiallyto acquire other businesses. We may seek funding through public and privatefinancing and may seek to incur debt, issue shares of our stock, or both,either to finance a transaction or as consideration for a transaction. Adequatefunds for these purposes, whether through the financial markets or from othersources, may not be available when we need them or on terms acceptable to us.Insufficient funds could cause us to delay, scale back or abandon some or allof our product acquisitions, licensing opportunities, marketing programs,product development programs, potential business acquisitions and manufacturingopportunities.

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***The regulatory status of some of our products makesthese products subject to increased competition and*** other risks.

The regulatory status of some of our products mayallow third parties to more easily introduce competitive products, and may makeit more difficult for us to sell certain of our products in the future.Currently, an FDA program allows us, in our opinion, to manufacture and marketcertain of our products, and permits others to manufacture and market similarproducts, without submitting safety or efficacy data. In some cases, we do nothold rights in patents protecting us against such competitive pressures. Thisresults in increased competition because other companies can enter the marketwithout having to submit safety and efficacy data to sell competing products.On several occasions, the FDA has considered changing the classification ofcertain single entity and combination product types of drugs from prescriptionto over-the-counter use, and which permit sponsors to utilize foreignover-the-counter experience data to establish a product as safe and effectivefor over-the-counter use in the U.S. If the FDA does change the classification,we might have to reformulate certain of our products or submit safety andefficacy data on those products, which could be costly, or we might have todiscontinue selling certain products if the FDA does not approve our marketingapplication. We could lose third-party reimbursement for these products andface increased competition.

In addition, the FDA considers certain products to benew drugs, but has indicated its intent to exercise enforcement discretion andnot pursue regulatory action unless certain conditions occur. If theseconditions were to materialize, or the FDA disagreed with our conclusions aboutthe regulatory status of these products, we might be required to submit an NDAand/or cease marketing until the FDA grants approval to do so. The FDA couldalso, at any time, promulgate new regulations or policies to require thesubmission of an NDA for each of these products.

***Our business is heavily regulated by governmentalauthorities, and failure to comply with such regulation or changes in suchregulations could negatively affect our results.***

Many government authorities regulate our business,including, among others, the FDA, the SEC, foreign regulatory authorities, theDrug Enforcement Administration, the Consumer Product Safety Commission, theFederal Trade Commission, the Occupational Safety and Health Administration,the Centers for Medicare and Medicaid Services, the Environmental ProtectionAgency, the Department of Labor, state, local and foreign governments and theInternal Revenue Service. We may incur significant expenses to comply withregulations imposed by these authorities. Also, our future results could benegatively impacted by changes in governmental regulation over thepharmaceutical industry, including regulation of Medicare, Medicaid and similarprograms, by reducing our revenue and profits and/or increasing our costs andexpenses in order to comply with such regulation. In addition, all of ourthird-party manufacturers, third-party sample distributors and product packagingcompanies are subject to inspection by the FDA and, in appropriate cases, theDrug Enforcement Administration and foreign regulators. Some of our third-partymanufacturers have received warning letters from the FDA concerningnoncompliance with manufacturing requirements. If our third-party manufacturersand other supply and distribution chain partners do not comply with FDAregulations in the future, they may not deliver products to us or deliversamples to our representatives, or we may have to recall products. Even ifdeficiencies observed by the FDA do not relate to our products, our third-partymanufacturers, third-party sample distributors and product packaging companiesmay be delayed in manufacturing and supplying our products to us in a timely manneruntil they address their compliance issues with the FDA.

Our warehouse facility is also subject to inspectionby the FDA and the Drug Enforcement Administration. If we do not comply withFDA and Drug Enforcement Administration regulations, we may not be able to sellproduct to our customers.

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***An adverse judgment in the securities class actionlitigation in which we and certain directors and executive officers aredefendants could have a material adverse effect on our results of operationsand liquidity.***

We, along with certain former and current officers anddirectors, are named defendants in a consolidated securities lawsuit initiatedon August 22, 2002 in the United States District Court for the NorthernDistrict of Georgia. Plaintiffs in the class action litigation alleged ingeneral terms that we violated Sections 11 and 12(a)(2) of the SecuritiesAct of 1933, as amended, (the “Securities Act”), and that we violated Sections10(b) and 20(a) of the Securities Exchange Act of 1934, as amended,(the “Exchange Act”), and Rule 10b-5 promulgated thereunder. In anamended complaint, plaintiffs claimed that we issued a series of materiallyfalse and misleading statements to the market in connection with our publicoffering on April 24, 2002 and thereafter relating to alleged “channelstuffing” activities. The amended complaint also alleged controlling personliability on behalf of certain of our officers under Section 15 of theSecurities Act and Section 20 of the Exchange Act. Plaintiffs sought anunspecified amount of compensatory damages in an amount to be proven at trial.

On September 29, 2004, the U.S. District Courtfor the Northern District of Georgia dismissed, without prejudice, the classaction lawsuit. Although the class action lawsuit was dismissed, the courtgranted the plaintiffs the opportunity to amend their complaint provided thatthe plaintiffs pay all of the defendants’ fees and costs associated with filingthe motions to dismiss the lawsuit. Plaintiffs did not file a second amendedcomplaint as permitted, but instead filed a motion asking the District Court toreconsider its September 29, 2004 order and lift the condition that theymust pay defendants’ fees and costs before further amendment. On June 22,2005, the District Court denied plaintiffs’ motion and gave them anotheropportunity to amend if they pay defendants’ fees and costs. Plaintiffs chosenot to file a second amended complaint. Instead, plaintiffs filed an appeal tothe United States Court of Appeals for the Eleventh Circuit. This appealcurrently is pending. Although the outcome of these proceedings is not certain,an adverse judgment against us in thislitigation could have a material adverse effect on our results of operationsand liquidity.

***We are subject to risks associated with taxation inmultiple jurisdictions.***

We are subject to taxation in the U.S. and in certainforeign jurisdictions. Our effective tax rate and tax liability are determinedby a number of factors, including the amount of taxable income in particularjurisdictions, the tax rates in these jurisdictions, tax treaties betweenjurisdictions, the extent to which we transfer funds to and repatriate fundsfrom our subsidiaries and future changes in laws. An adverse interpretation orruling by one of the taxing authorities in a jurisdiction in which we operateor a change in law could increase our tax liability or result in the impositionof penalty payments, which could adversely impact our operating results.

***If we do not secure or enforce patents and otherintellectual property rights, we could encounter increased competition thatwould adversely affect our operating results.***

We do not hold patent rights covering all of theproducts we are distributing and do not in some cases have the right to enforcepatents our licensors hold. Patent rights do not protect our Robinul, Ponsteland Furadantin products from competition. We obtained exclusive distributionrights in the U.S. to distribute our Fortamet, Altoprev, Triglide,****Nitrolingual, Tanafed DP and Tanafed DMX products but haveno or only limited rights to enforce the patents relating to these products. Weobtained exclusive U.S. distribution rights to Sular from Bayer. Bayer holdsthe patent for the composition of the coat core tablet for Sular. Anyexclusivity afforded by any of these patents or rights could cease because wehave no rights or only limited rights to enforce patents or to requireenforcement actions by the owners of the patents. Proceedings involving ourrights in patents or patent applications could result in adverse decisions. Inaddition, the confidentiality agreements required of our employees and thirdparties may not provide adequate protection for our trade secrets, know-how andother proprietary information which we rely on 

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to develop and sell ourproducts. If any of our employees or third parties disclose any of our tradesecrets or know-how, we could encounter increased competition.

***Our products could infringe the intellectual propertyrights of third parties, which could require us to pay license fees or defendlitigation that would be expensive or prevent us from selling products.***

The manufacture, use or sale of our products mayinfringe on the patent, trademark and other intellectual property rights of others.Patent and trademark infringement problems occur frequently in connection withthe sale and marketing of pharmaceutical products. If we do not avoid allegedinfringement of the intellectual property rights of others, we may need to seeka license to sell our products, defend an infringement action or challenge thevalidity of the intellectual property in court, all of which could be expensiveand time consuming. In addition, if we are found liable for infringing apatent, we may have to stop selling one or more of our products and paydamages. It could be very costly if we have to defend the patents or trademarkscovering our products or if we were found liable for infringement which couldincrease our costs and reduce our margins and net income.

***Product liability claims and product recalls couldlimit sales and increase costs.***

Side effects could occur from the use of our products.Side effects or marketing or manufacturing problems pertaining to any of ourproducts could result in material product liability claims or adversepublicity. The defense of these claims would be expensive, and could result inwithdrawal of approval to market the product or recall of the product. Theseproblems often occur with little or no notice in connection with the sale ofpharmaceutical products.

***We face an exchange risk on foreign currency.***

Our purchases of Nitrolingual from Pohl-Boskamp, ourpurchases of Triglide from Skyepharma and our purchases of Sular fromBayer are made in Euros or are otherwise impacted by fluctuations in the USdollar—Euro exchange rate.Although we did not enter into any forward contracts in 2005, we may seek toeliminate risks from foreign currency fluctuations after the time of shipmentof product by entering into forward contracts for these purchases of inventoryat the time of product shipments. The Company’s earnings and cash flows couldbe adversely affected in the future by the relationship of the U.S. dollar withforeign currencies and there can be no assurance that any hedging activity willbe successful in protecting us from exchange risk.

***We face market risk that we could be adverselyaffected by certain fluctuations in interest rates.***

The fair value of our investment portfolio would benegatively affected by an increase in interest rates. Since the majority of theCompany’s investments are fixed rate interest-bearing securities and thereforesubject to the market risk of loss in market value from an increase in rates ora change in the underlying risk of the issuers of the notes, the Company’sfuture earnings and cash flows could be affected adversely if the Company wereto sell the securities prior to their maturity date. We had realized lossesfrom the sale of investments for the year ended December 31, 2005 of $0.7million. At December 31, 2005, the Company had total net unrealized lossesfrom marketable securities of $2.0 million.

In connection with borrowings incurred under thecredit facility with LaSalle Bank, we could experience market risk with respectto changes in the general level of the interest rates and their effect upon ourinterest expense. Borrowings under this facility bear interest at variablerates. Because such rates are variable, an increase in interest rates willresult in additional interest expense and a reduction in interest rates willresult in reduced interest expense. Accordingly, our present exposure tointerest rate fluctuations is primarily dependent on rate changes that mayoccur while borrowings under the senior secured credit facility areoutstanding.

The Company’s long-termfixed interest rate debt is comprised of the Old Notes, which are also subjectto market risk. All other things being equal, the fair market value of theCompany’s fixed rate debt 

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willincrease as rates decline and will decrease as rates rise. The fixed rate OldNotes outstanding, totaling $150.0 million at December 31, 2005, hada fair value of $138.1 million based on quoted market rates as of such date.

**Risks Related to our Common Stock**

***Our stock price has been volatile.***

The market price for our securities has been highlyvolatile. Various factors, including factors that are not related to ouroperating performance, may cause significant volume and price fluctuations inthe market. The following factors, among others, may cause fluctuations in ourstock price:

·       failureto meet our financial estimates or expectations of securities analysts;

·       failureto increase prescriptions of our products;

·       theintroduction of knock-offs or generics to our products;

·       fluctuationsin operating results;

·       ratesof product acceptance;

·       timingor delay of regulatory approvals;

·       volatilityin the pharmaceutical and specialty pharmaceutical market and stocks;

·       ifour third-party manufacturers experience interruptions in the supply ofraw materials, encounter delays in shipping or encounter regulatory problems;

·       developmentsin or disputes regarding patent or other proprietary rights; and

·       generaleconomic, market and political conditions not related to our business.

***Existing officers, directors and our principalstockholder own a substantial block of our common stock.***

Existing officers, directors and our principalstockholder own a substantial number of shares of our common stock that mayallow them to elect directors and direct the outcome of matters requiringstockholder approval. As of December 31, 2005, our officers, directors andour principal stockholder beneficially owned approximately 22.4% of ouroutstanding common stock. As of December 31, 2005, Kapoor-PharmaInvestments, L.P. beneficially owned approximately 17.4% of our outstandingcommon stock. Accordingly, Kapoor-PharmaInvestments holds significant control or influence over our policies and acts.John N. Kapoor, Ph.D., the Chairman of the Board of Directors, is President andsole stockholder of EJ Financial Enterprises, Inc. EJ FinancialEnterprises is the managing general partner of Kapoor-Pharma Investments.In addition, a trust of which Dr. Kapoor is trustee is a partner of Kapoor-PharmaInvestments.

***Anti-takeover provisions could discourage a thirdparty from making a takeover offer that could be beneficial to stockholders.***

Some of theprovisions in our restated certificate of incorporation and bylaws, ourshareholder protection rights plan, and the anti-takeover provisions underDelaware law could delay or prevent a third party from acquiring us orreplacing members of our Board of Directors, even if the acquisition or thereplacements would be beneficial to our stockholders. These provisions couldalso reduce the price that certain investors might be willing to pay for sharesof our common stock and/or New Notes and result in the market price being lowerthan it would be without these provisions. Our charter and other documentscontain anti-takeover devices including:

·       staggered director termssuch that only one of the three classes of directors is elected each year;

·       ashareholder rights plan that is designed to protect us from coercive takeoverattempts;

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·       asupermajority provision requiring at least two-thirds of the shares entitled tovote to approve an amendment of our bylaws;

·       providingour Board of Directors with the authority to issue shares of “blank-check”preferred stock without stockholder approval under any terms, conditions,rights and preferences that the Board determines; and

·       an advance noticerequirement for nominations of directors or proposals for consideration atstockholder meetings.

**ITEM 1B. UNRESOLVED STAFF COMMENTS**

There are no materialunresolved written comments that were received from the Securities and ExchangeCommission staff 180 days or more before the end of our fiscal year relating toour periodic or current reports under the Exchange Act.

**ITEM 2. PROPERTIES**

In December 2001, we entered into a lease for a101,120 square foot office and warehouse facility in Alpharetta, Georgia. Ourfacility includes space for offices and a warehouse. This lease expires in May 2009.In December 2005, we entered into a lease for a 2,485 square foot officein Dublin, Ireland. This lease expires in September 2010.

On February 7, 2006, the Company enteredinto a lease agreement with 485 Properties, LLC to lease 50,994 square feet ofoffice space at Corporate Center V, an office tower located in Atlanta,Georgia. The eight year lease term, cancelable after five years, will commenceon or before July 15, 2006 pending the satisfactory completion of certaintenant improvements. Lease rates begin at $1.0 million per year and escalateduring the term to $1.2 million for the eighth year.

The Company will relocateits corporate and administrative functions to the new premises from its currentfacilities but will continue to maintain its warehouse function at its currentfacilities pending the identification of new warehouse facilities. The Companywill seek to sublet its current facilities in Alpharetta, Georgia to thirdparties.

**ITEM 3. LEGAL PROCEEDINGS**

We, along with certain former and current officers anddirectors, were named defendants in a consolidated securities lawsuit initiatedon August 22, 2002 in the United States District Court for the NorthernDistrict of Georgia. Plaintiffs in the class action litigation alleged ingeneral terms that we violated Sections 11 and 12(a)(2) of the SecuritiesAct of 1933 and that we violated Sections 10(b) and 20(a) of theSecurities Exchange Act of 1934 and Rule 10b-5 promulgatedthereunder. In an amended complaint, Plaintiffs claimed that we issued a seriesof materially false and misleading statements to the market in connection withour public offering on April 24, 2002 and thereafter relating to alleged “channelstuffing” activities. The amended complaint also alleged controlling personliability on behalf of certain of our officers under Section 15 of theSecurities Act of 1933 and Section 20 of the Securities Exchange Act of1934. Plaintiffs sought an unspecified amount of compensatory damages in anamount to be proven at trial.

On September 29, 2004, the U.S. District Courtfor the Northern District of Georgia dismissed, without prejudice, the classaction lawsuit. Although the class action lawsuit was dismissed, the courtgranted the plaintiffs the opportunity to amend their class action lawsuitprovided that the plaintiffs pay all of the defendants’ fees and costsassociated with filing the motions to dismiss the class action lawsuit. Plaintiffsdid not file a second amended complaint as permitted, but instead filed amotion asking the District Court to reconsider its September 29, 2004 orderand lift the condition that they must pay 

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defendants’ fees and costsbefore further amendment. On June 22, 2005, the District Court deniedplaintiffs’ motion and gave them another opportunity to amend if they paydefendants’ fees and costs. Once again, plaintiffs chose not to file a secondamended complaint. Instead, plaintiffs filed an appeal to the United StatesCourt of Appeals for the Eleventh Circuit. This appeal currently is pending.

The Company is alsoinvolved with other various routine legal proceedings incident to the ordinarycourse of business. None of these proceedings are expected to have a materialadverse effect on the consolidated financial statements.

**ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITYHOLDERS**

No matters were submitted to a vote of ourstockholders during the quarter ended December 31, 2005.

 

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**PART II**

**ITEM5.**                MARKET FORREGISTRANT’S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OFEQUITY SECURITIES

Ourcommon stock began trading on the Nasdaq National Market on May 31, 2000.Our trading symbol is “FHRX.” The following table lists, for the periodsindicated, the high and low sale prices per share for our common stock asreported on the Nasdaq National Market.

| ** **     | ** ** | **High** | ** ** | **Low** | ** ** |
|----------------|------------|----------|------------|---------|------------|
| **2004**       |       |     |       |    |       |
| First Quarter  |       | $        | 19.47      |    | $          | 10.48 |   |
| Second Quarter |       | 19.98    |       | 13.71   |       |
| Third Quarter  |       | 20.20    |       | 14.80   |       |
| Fourth Quarter |       | 26.41    |       | 18.55   |       |
|                |            |          |            |         |            |  |  |

 

| ** **     | ** ** | **High** | ** ** | **Low** | ** ** |
|----------------|------------|----------|------------|---------|------------|
| **2005**       |       |     |       |    |       |
| First Quarter  |       | $        | 21.28      |    | $          | 15.20 |   |
| Second Quarter |       | 19.63    |       | 16.01   |       |
| Third Quarter  |       | 22.64    |       | 18.70   |       |
| Fourth Quarter |       | 20.65    |       | 14.01   |       |
|                |            |          |            |         |            |  |  |

 

On February 17, 2006,the last reported sale price for our common stock on the Nasdaq National Marketwas $18.95 per share. As of February 17,2006, there were approximately 185****holders of record of our commonstock.

**EquityCompensation Plan Information**

Thefollowing table provides information as of December 31, 2005 with respectto shares of our common stock that may be issued under existing equitycompensation plans.

| ** **                                             | ** ** | **Number of securities to  be issued upon exercise  of outstanding options,  warrants and rights  (a)** | ** **    | **Weighted-average  exercise price of  outstanding options,  warrants and rights  (b)** | ** ** | **Number of securities  remaining available for  future issuance under  equity compensation  plans(1) (excluding  securities reflected in  column(a))  (c)** | ** ** |
|--------------------------------------------------------|------------|-----------------------------------------------------------------------------------------------------------------------------------------------------------|---------------|------------------------------------------------------------------------------------------------------------------|------------|----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|
| 2003 Non-Qualified  Stock Option Plan                  |       |                                                                                                                                                      | 554,637       |                                                                                                             |       |                                                                                                                                                                                                           | $          | 8.69 |   |   |   | 360,166 |   |   |
| 2002 Stock Plan Approved  by Stockholders(1)           |       |                                                                                                                                                      | 2,268,524     |                                                                                                             |       |                                                                                                                                                                                                           | 13.48      |   |   |   | 1,024,193 |   |   |
| 2000 Stock Plan Approved  by Stockholders         |       |                                                                                                                                                      | 280,775       |                                                                                                             |       |                                                                                                                                                                                                           | 19.94      |   |   |   | — |   |   |
| 1997 Stock Option Plan  Approved by Stockholders       |       |                                                                                                                                                      | 18,000        |                                                                                                             |       |                                                                                                                                                                                                           | 4.92       |   |   |   | — |   |   |
| Employee Stock Purchase  Plan Approved by Stockholders |       |                                                                                                                                                      | N/A           |                                                                                                             |       |                                                                                                                                                                                                           | N/A        |   |   |   | — |   |   |
| Employee Stock  Ownership Plan                         |       |                                                                                                                                                      | —        |                                                                                                             |       |                                                                                                                                                                                                           | —     |   |   |   | 1,000,000 |   |   |
| **Total**                                              | ** ** | ** **                                                                                                                                                | **3,121,936** |                                                                                                             |       |                                                                                                                                                                                                           |       |   | ** ** | ** ** | **2,384,359** |   |   |

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(1)          Theaggregate number of shares of our common stock available under the 2002 StockPlan for grants of options, grants of stock awards and stock sales during anyfiscal year is generally (i) 1,500,000 shares, increased by (ii) sevenpercent (7%) of the outstanding shares of common stock on the last day of theimmediately preceding fiscal year, as such number is determined to calculatethe fully diluted earnings per share of such preceding fiscal year and as suchnumber may be further adjusted pursuant to certain corporate transactions, ifapplicable, reduced by (iii) the number of shares of common stock forwhich grants of awards have been made under the 2002 Stock Plan.

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**Dividend Policy**

We have not declared orpaid any cash dividends since our inception. We currently intend to retain ourfuture earnings, if any, for use in the operation and expansion of our businessand do not anticipate paying any cash dividends in the foreseeable future. Ourcurrent credit facility prohibits the payment of any dividends or otherdistributions on any shares of our stock. For further discussion of our currentcredit facility, see “Management’s Discussion and Analysis of FinancialCondition and Results of Operation.”

**Share BuybackProgram**

The Company adopted a newshare repurchase program effective August 3, 2005, that authorizes therepurchase of up to $20.0 million of its outstanding shares of common stockover its twelve month term with no periodic sub-limits on the amount ofrepurchases. This plan replaces all prior share repurchase plans and willexpire on August 2, 2006.

Thefollowing table presents the total number of our shares repurchased during thefourth quarter of 2005 and the average price paid per share:

| **Fiscal Period**                          | ** ** | ** ** | ** **  | **Total  Number of  Shares  Purchased** | ** ** | **Average  Price  Per Share** | ** ** | **Total Number of  Shares Purchased as  Part of Publicly  Announced Plans(1)** | ** ** | **Approximate Dollar  Value of Shares  that May Yet Be  Purchased Under  the Plans** | ** ** |
|-------------------------------------------------|------------|------------|-------------|----------------------------------------------|------------|------------------------------------|------------|-------------------------------------------------------------------------------------------------------------------|------------|------------------------------------------------------------------------------------------------------------------------------|------------|
| October 1  through October 31, 2005   |       |       | —      |                                         |       |                               | $          | —                                                                                                            |       |                                                                                                                         |       | — |   |   |   | $ | 20,000,000 |   |   |
| November 1  through November 30, 2005 |       |       | 300,000     |                                         |       |                               | $          | 14.79                                                                                                             |       |                                                                                                                         |       | 300,000 |   |   |   | $ | 15,563,420 |   |   |
| December 1  through December 31, 2005 |       |       | —      |                                         |       |                               | $          | —                                                                                                            |       |                                                                                                                         |       | — |   |   |   | $ | 15,563,420 |   |   |
| Total                                           | ** ** | ** ** | **300,000** |                                         | ** ** | ** **                         | **$**      | **14.79**                                                                                                         |       | ** **                                                                                                                   | ** ** | **300,000** |   |   |   |   |   |   |

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(1)          TheCompany purchased 300,000 shares of common stock during the fourth quarter of2005 at an average cost of $14.79 per share under its share repurchase programwhich was publicly announced on July 27, 2005. This share repurchaseprogram became effective August 3, 2005.

**Treasury Stock**

In December 2004, ourBoard of Directors authorized the company to purchase 1,000,000 shares ofcommon stock at an average price of $23.19 per share. The shares were purchasedand converted to treasury stock. We acquired these shares in part, to establisha pool of authorized shares that will be available for contribution to theEmployee Stock Ownership Plan over time as we in our discretion deem appropriate.In February 2006, the Company distributed 200,000 shares to employeesunder the Employee Stock Ownership Plan.

**EmployeeStock Ownership Plan**

In 2005, the Company beganan Employee Stock Ownership Plan, which provides benefits to substantially allemployees. The annual contribution, if any, to the trust is at the discretionof the Board of Directors of the Company. In February 2006, the Companydistributed 200,000 shares to employees under this plan.

**ITEM6.**                SELECTED FINANCIALDATA

Thefollowing selected financial data is qualified by reference to and should beread in conjunction with our financial statements and the related notes andother financial information included elsewhere in this Annual Report and “Management’sDiscussion and Analysis of Financial Condition and Results of Operations.” Theselected financial data has been derived from our financial statements whichhave been audited by BDO Seidman, LLP, independent registered public accountingfirm, as of and for the year 

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ended December 31, 2005, Deloitte &Touche LLP, independent registered public accounting firm, as of and for theyear ended December 31, 2002, 2003 and 2004 and by Arthur Andersen LLP,independent auditors, as of and for the year ended December 31, 2001. Theseresults may not be indicative of future results. Our results of operationsinclude contributions from products we acquired only from their respectiveacquisition date. We acquired Fortamet in March 2005, Altoprev in March 2005,Triglide in 2004, Sular in March 2002, Furadantin in December 2001,the Prenate line of products in August 2001, Ponstel in April 2000,Cognex in April 2000, Nitrolingual Pumpspray in July 1999, and theRobinul line of products in January 1999. In 2003, we recorded a$4.2 million impairment on our Cognex intangible assets.

| ** **                        | ** ** | **Year Ended December 31,**                          | ** ** |
|-----------------------------------|------------|---------------------------------------------------------------------|------------|
| ** **                        | ** ** | **2005**                                                            | ** ** | **2004** | ** ** | **2003** | ** ** | **2002** | ** ** | **2001** | ** ** |
| ** **                        | ** ** | **(In thousands, except per shares data)** | ** ** |
| **Statement of Operations Data:** |       |                                                                |       |   |   |   |   |   |   |   |   |
| Net revenues                      |       | $                                                                   | 216,358    |   | $ | 151,967 |   | $ | 95,305 |   | $ | 115,178 |   | $ | 69,290 |   |
| Net income (loss)                 |       | $                                                                   | 39,209     |   | $ | 26,554 |   | $ | (1,738 | ) | $ | 6,166 |   | $ | 10,723 |   |
| Net income (loss) per  share:     |       |                                                                |       |   |   |   |   |   |   |   |   |
| Basic                             |       | $                                                                   | 1.12       |   | $ | 0.74 |   | $ | (0.05 | ) | $ | 0.19 |   | $ | 0.44 |   |
| Diluted                           |       | $                                                                   | 0.97       |   | $ | 0.66 |   | $ | (0.05 | ) | $ | 0.18 |   | $ | 0.41 |   |

 

| ** **                       | ** ** | **As of December 31,** | ** ** |
|----------------------------------|------------|---------------------------------------|------------|
| ** **                       | ** ** | **2005**                              | ** ** | **2004** | ** ** | **2003** | ** ** | **2002** | ** ** | **2001** | ** ** |
| ** **                       | ** ** | **(In thousands)**               | ** ** |
| **Balance  Sheet Data:**         |       |                                  |       |   |   |   |   |   |   |   |   |
| Cash and cash  equivalents       |       | $                                     | 17,043     |   | $ | 36,586 |   | $ | 33,722 |   | $ | 47,409 |   | $ | 53,458 |   |
| Marketable  securities           |       | 82,757                                |       | 160,636 |   | 9,996 |   | — |   | — |   |
| Total assets                     |       | 529,705                               |       | 498,484 |   | 325,153 |   | 352,932 |   | 170,150 |   |
| Total debt                       |       | 150,000                               |       | 150,000 |   | — |   | — |   | — |   |
| Total stockholders’  equity |       | 340,136                               |       | 308,409 |   | 305,777 |   | 305,683 |   | 143,364 |   |
|                                  |            |                                       |            |  |  |  |  |  |  |  |  |  |  |  |  |  |

 

**ITEM7.**                MANAGEMENT’SDISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

The following discussionand related financial data should be read in conjunction with the consolidatedfinancial statements and related notes included elsewhere in this AnnualReport.

**FORWARD-LOOKINGSTATEMENTS**

This Annual Reportcontains forward-looking statements within the meaning of the Private SecuritiesLitigation Reform Act of 1995. These statements involve a number of risks anduncertainties. Although our forward-looking statements reflect the goodfaith judgment of our management, these statements can only be based on factsand factors currently known by us. Consequently, forward-lookingstatements are inherently subject to risks and uncertainties, and actualresults and outcomes may differ materially from results and outcomes discussedin the forward-looking statements.

Forward-lookingstatements can be identified by the use of forward-looking words such as “believes,”“expects,” “hopes,” “may,” “will,” “plan,” “intends,” “estimates,” “could,” “should,”“would,” “continue,” “seeks,” “pro forma,” “reasonably likely” or “anticipates,”or other similar words (including their use in the negative), or by discussionsof future matters such as the development of new products, technologyenhancements, possible changes in legislation and other statements that are nothistorical. These statements include but are not limited to statements underthe captions “Business,” “Risk Factors” and “Management’s Discussion andAnalysis of Financial Conditions and Results of Operations” as well as allother sections in this Annual Report.

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Risksand uncertainties that could cause our forward-looking statements to fail tooccur include, but are not limited to the following:

·       Wemay not attain expected revenues and earnings;

·       Ifwe are unsuccessful in obtaining third party payor contracts for our products,we may experience reductions in sales levels and may fail to reach anticipatedsales levels;

·       Ifdemand for our products exceeds our initial expectations or the ability of oursuppliers to provide demand-meeting quantities of product and samples, ourfuture ability to sell these products could be adversely impacted;

·       Thepotential growth rate for our promoted products may be limited by slower growthfor the class of drugs to which our promoted products belong and unfavorableclinical studies about such class of drugs;

·       Wemay encounter problems in the manufacture or supply of our products, for whichwe depend entirely on third parties;

·       Strongcompetition exists in the sale of our promoted products, which could adverselyaffect expected growth of our promoted products’ sales or increase our costs tosell our promoted products;

·       Wemay not be able to protect our competitive position for our promoted productsfrom patent infringers;

·       Altoprevhas experienced manufacturing issues. If the issues recur and cannot be resolved,our ability to acquire the product for sale and sampling will be adverselyaffected;

·       Salesof our Tanafed and Robinul products have been adversely affected by theintroduction of knock-off and generic products, respectively;

·       Anissued FDA notice may cause us to incur increased expenses and adversely affectour ability to continue to market and sell our Tanafed products;

·       Wemay incur unexpected costs in integrating new products into our operations;

·       Wemay be unable to develop or market line extensions for our products includingPrenate, Sular, Triglide, Altoprev and Fortamet, or, even if developed, obtainpatent protection for our line extensions; further, introductions by us of lineextensions of our existing products may require that we make unexpected changesin our estimates for future product returns and reserves for obsoleteinventory; if these risks occur, our operating results would be adverselyaffected;

·       Ourlicensor/supplier can terminate our rights to commercialize Nitrolingual and the60 dose size of this product has not yet met our expectation;

·       Wedepend on a small senior management group, the departure of any member of whichwould likely adversely affect our business;

·       Anadverse interpretation or ruling by one of the taxing jurisdictions in which weoperate could adversely impact our operating results;

·       Asmall number of customers account for a large portion of our sales and the lossof one of them, or changes in their purchasing patterns, could result insubstantially reduced sales, substantially and adversely impacting ourfinancial results;

·       Ifthird-party payors do not adequately reimburse patients for our products,doctors may not prescribe them;

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·       Sideeffects or marketing or manufacturing problems with our products could resultin product liability claims which could be costly to defend and could result inthe withdrawal or recall of products from the market;

·       Werely on operational data obtained from IMS, an industry accepted data source.IMS data may not accurately reflect actual prescriptions (for instance, webelieve IMS data does not capture all product prescriptions from somenon-retail channels);

·       Anadverse judgment in the securities class action litigation in which we andcertain current and former directors and executive officers are defendantscould have a material adverse effect on our results of operations andliquidity;

·       Ifwe fail to obtain, or encounter difficulties in obtaining, regulatory approvalfor new products or new uses of existing products, or if our developmentagreements are terminated, we will have expended significant resources for noreturn;

·       Ourbusiness and products are highly regulated; the regulatory status of some ofour products makes these products subject to increased competition and otherrisks, and we run the risk that we, or third parties on whom we rely, couldviolate the governing regulations;

·       Ifgeneric competitors that compete with any of our products are introduced ourrevenues may be adversely affected; and

·       Someunforeseen difficulties may occur.

The risk factors describedabove as well as in the “Business”, “Risk Factors” and “Management’s Discussionand Analysis of Financial Condition and Results of Operations” sections are notexhaustive. We may not have correctly identified and appropriately assessed allfactors affecting our business and the publicly available and other informationwith respect to these matters may not be complete and correct. Additional risksand uncertainties not presently known to us or that we currently believe to beimmaterial also may adversely impact us. Should any risks and uncertaintiesdevelop into actual events, these developments could have material adverseeffects on our business, financial condition, and results of operations. Forthese reasons, we caution you not to place undue reliance on ourforward-looking statements.

**Overview**

FirstHorizon Pharmaceutical Corporation, or the Company, is a specialtypharmaceutical company that markets, develops and sells brand name prescriptionproducts. Our key products focus on two therapeutic categories, Cardiology andWomen’s Health. Our key marketed products include:

| Cardiology   | ** ** | ** **    | ** ** | Women’s Health | ** ** | ** ** |
|--------------|------------|---------------|------------|---------------------|------------|------------|
| Sular        |       | Prenate Elite |
| Triglide     |       | OptiNate      |
| Fortamet     |       | Ponstel       |
| Altoprev     |       |          |
| Nitrolingual |       |          |

 

Our current operating planfocuses first on maximizing the sales of our existing product portfolio. Wealso plan to accelerate growth by launching line extensions to our currentproducts and by acquiring or licensing approved products or late stagedevelopment product and other businesses. We plan to focus on products thatcomplement our Cardiology and Women’s Health categories that will allow us toleverage our existing sales force infrastructure.

We currently market andsell 15 products, eight of which are actively promoted and accounted forapproximately 89% of our total sales for the year ended December 31, 2005.We promote our products 

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throughour nationwide sales and marketing force in approximately 525 territories,targeting high-prescribing primary care physicians, endocrinologists,cardiologists, obstetricians and gynecologists.

**Results ofOperations**

***Years Ended December 31,2005 and December 31, 2004***

*Net Revenues.**  *Net revenues increased$64.4 million, to $216.4 million for 2005, compared to $152.0 millionfor 2004. Unit sales increased 34.5% as compared to the prior year. Thisincrease was primarily the result of price increases on our products and the successfulexpansion of our product mix to include Altoprev, Fortamet, Triglide andOptiNate. In addition to the expansion in products, during 2005,  the Company increased its sales force fromapproximately 360 sales professionals to approximately 470 sales professionalsand increased its emphasis on managed care contracts.

**Product Overview**

| ** **       | ** ** | **Change in total dispensed prescriptions for  the year ended December 31, 2005 compared  to the year ended December 31, 2004(a)** | ** ** | **Change in new dispensed prescriptions for  the year ended December 31, 2005 compared  to the year ended December 31, 2004(a)** | ** ** |
|------------------|------------|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|
| Sular            |       |                                                                                                                                                                                                                    | 16.1       | %                                                                                                                                                                                                                     |       |   | 16.9 | % |   |
| Fortamet(b)      |       |                                                                                                                                                                                                                    | N/A        |                                                                                                                                                                                                                  |       |   | N/A |   |   |
| Altoprev         |       |                                                                                                                                                                                                                    | (19.5      | )%                                                                                                                                                                                                                    |       |   | (32.8 | )% |   |
| Triglide(c)      |       |                                                                                                                                                                                                                    | N/A        |                                                                                                                                                                                                                  |       |   | N/A |   |   |
| Nitrolingual(d)  |       |                                                                                                                                                                                                                    | (6.9       | )%                                                                                                                                                                                                                    |       |   | (9.3 | )% |   |
| Prenate Elite(e) |       |                                                                                                                                                                                                                    | N/A        |                                                                                                                                                                                                                  |       |   | N/A |   |   |
| OptiNate(f)      |       |                                                                                                                                                                                                                    | N/A        |                                                                                                                                                                                                                  |       |   | N/A |   |   |
| Ponstel          |       |                                                                                                                                                                                                                    | 13.7       | %                                                                                                                                                                                                                     |       |   | 17.0 | % |   |

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(a)           Source: IMS Health’sNational Prescription Audit PlusTM data.

(b)          Fortametwas launched in May, 2004, by Andrx Corporation. As a result, comparative datais not available for 2004.

(c)           Triglidewas launched in July 2005. As a result, comparative data is not availablefor 2004.

(d)          Webelieve that IMS data does not capture prescriptions of Nitrolingual from someof the non-retail channels and prescription trends in the non-retail channelwhich may have a significant impact on the reported change.

(e)           PrenateElite was launched in March 2004. As a result, comparative data is notavailable for 2004.

(f)             OptiNatewas launched in March 2005. As a result, comparative data is not availablefor 2004.

Netrevenues from our Cardiology products (namely Sular, Fortamet, Altoprev,Triglide and Nitrolingual) increased $69.2 million, to $144.5 million for theyear ended December 31, 2005, compared to $75.3 million year endedDecember 31, 2004. Thisincrease was primarily a result of the addition of our new products, Altoprevand Fortamet, commencing in April 2005, the launch of Triglide inJuly 2005, price increases on our products and total prescription growthof Sular.

Net revenues from ourpromoted Women’s Health products (namely Prenate Elite, OptiNate and Ponstel)increased $24.4 million, to $46.6 million for the year ended December 31,2005, compared to $22.2 million for the year ended December 31, 2004respectively. This increase was due primarily to price increases on ourproducts, an increase in total prescriptions for Prenate Elite and Ponstel andthe successful launch of OptiNate in March 2005.

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Net revenues from our non-promoted products (adjustedfor our 2005 promoted product mix) decreased $29.2 million, to $25.3 millionfor the year ended December 31, 2005, compared to $54.5 million for theyear ended December 31, 2004. This decrease was a result of anintroduction of a generic and knock-offs of the Tanafed and Robinul lines.

In March 2004, we announced the launch of PrenateElite, the next generation of the Prenate line of prenatal vitamins. We beganpromoting and selling Prenate Elite in April 2004. Prenate Elite hascaptured a market share of 12.8% of new prescriptions and 13.4% of totalprescriptions of prenatal vitamins in December 2005 (Source: IMS Health’sNational Prescription Audit PlusTM data). Additionally, the launch of OptiNatein March 2005 has captured 7.2% of new prescriptions of prenatal vitaminsand 7.2% of total prescription in December 2005 (Source: IMS Health’sNational Prescription Audit PlusTM data).

*Costof Revenues.**  *Costof revenues increased $4.2 million, to $33.3 million for the yearended December 31, 2005, compared to $29.1 million for the year endedDecember 31, 2004. The increase in cost of revenues was related to thechange in product mix and an increase in sales which resulted in an increase inunits sold by 34.5% as compared to the prior year.

*GrossMargin.**  *Grossmargins for 2005 were 85%, compared to 81% for 2004. This increase in grossmargin was the result of the change in product mix from the prior yearprimarily as the result of acquisitions completed in 2005 and the successfullaunch of Triglide and OptiNate. Also contributing to the increased grossmargins were price increases implemented during the year.

*Selling,General and Administrative Expenses.**  *Selling, general and administrativeexpenses increased $30.6 million, to $97.4 million for the year ended December 31, 2005,compared to $66.8 million for the year ended December 31, 2004. Thisincrease was primarily related to the increase in our sales force, theassociated costs for the launch of our new products and an increase in royaltyexpense of $9.5 million and commission expense of $4.5 millionrelated to the increased net revenues.

*Depreciationand Amortization.**  *Depreciationand amortization expense increased $5.8 million, to $22.7 million forthe year ended December 31, 2005 compared to $16.9 million for 2004.This increase was primarily related to the increase in amortizable intangibleassets as a result of the license of Fortamet, Altoprev and Triglide.

The Company believes there are no intangible assetimpairments and there were no other asset write-downs as of December 31,2005.

*Researchand Development Expense.**  *Research and development expense increased $2.6 million,to $4.1 million for the year ended December 31, 2005, compared to$1.5 million for the year ended December 31, 2004.  This increase was primarily related to greateractivity in the development program for lifecycle management initiatives forour products.

*InterestExpense.**  *Interestexpense increased $0.5 million, to $3.0 million for the year ended December 31,2005, compared to $2.5 million for the year ended December 31, 2004.This increase was due to borrowings under the Company’s line of credit during2005, and a complete year of interest on the $150.0 million contingentconvertible notes described below.

In March 2004, we issued a total of$150.0 million, 1.75% contingent convertible senior subordinated notes.The notes are due March 8, 2024 and accrued interest is payablesemi-annually in arrears on March 8 and September 8 of each year,commencing on September 8, 2004. In addition to the interest on the notes,after March 8, 2007, we will also pay contingent interest during specifiedsix-month periods if the average trading price of the notes per $1,000principal amount for the five day trading period ending on the third tradingday immediately preceding the first day of the applicable six-month periodequals $1,200 or more. During any period when contingent interest is payable,it will be payable at a rate equal to 0.5% 

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per annum. The netproceeds from this issuance after deducting offering expenses wereapproximately $145.4 million.

The holders of the convertible notes may convert thenotes into shares of our common stock at a conversion rate of 45.1467 sharesper $1,000 principal amount of the notes, which is equivalent to a conversionprice of $22.15 per share, subject to anti-dilution adjustments, before theclose of business on March 8, 2024. Holders may convert their convertiblenotes only under the following circumstances: (1) during any calendarquarter commencing after June 30, 2004, if the closing sales price of ourcommon stock exceeds 120% of the conversion price for at least 20 trading daysin the 30 consecutive trading days ending on the last trading day of thepreceding calendar quarter; (2) if the notes have been called forredemption; (3) during the five trading day period immediately followingany nine consecutive trading day period in which the trading price of the notesper $1,000 principal amount for each day of that period was less than 95% ofthe product of the closing price of our common stock and the number of sharesof common stock issuable upon conversion of $1,000 principal amount of thenotes; or (4) the occurrence of specified corporate transactions.

We have the option to redeem the notes beginning March 13,2007 at a price equal to 100% of their aggregate principal amount, plus accruedand unpaid interest, including contingent interest, if any.

The holders of the notes have the option to require usto repurchase the notes on March 8 of 2009, 2014 and 2019, and upon achange in control, at a price equal to 100% of their aggregate principalamount, plus accrued and unpaid interest, including contingent interest, ifany.

*InterestIncome.**  *Interestincome decreased $0.6 million, to $3.2 million for the year ended December 31,2005, compared to $3.8 million for the year ended December 31, 2004.The decrease in interest income for the year is primarily due to a decrease inthe average cash and marketable securities balance resulting from theacquisitions of Fortamet, Altoprev and Triglide.

*Other.**  *Other loss increased $0.7 million, to $0.7 millionfor the year ended December 31, 2005, compared to $0.0 million for theyear ended December 31, 2004. The decrease in other loss is the result ofthe sale of marketable securities for the purchase of the licensing rights forAltoprev and Fortamet.

*(Provision) Benefit forIncome Taxes.**  *Incometaxes were provided for at a rate of 32.8% for the year ended December 31, 2005 compared to 31.9% forthe year ended December 31, 2004. This increase is related to the changesin jurisdications in which we do business and the effect of the international operations.

**YearsEnded December 31, 2004 and December 31, 2003**

*NetRevenues.**  *Netrevenues increased $56.7 million, to $152.0 million for 2004,compared to $95.3 million for 2003. This increase was primarily the resultof management’s redefined corporate strategy, which included an increase insales force from approximately 250 sales professionals to approximately 360sales professionals and an increased emphasis on hospital and managed carecontracts. These changes resulted in an 11.7% increase in Sular total dispensedprescriptions according to IMS Health’s National Prescription Audit PlusÔdata and the successful launch of Prenate Elite, which was the newest member tothe Prenate family, in April 2004. Prenate Elite captured 11.7% of themarket share for new prescriptions and 11.1% of the market share of totalprescriptions for the month of December 2004, according to IMS Health’sNational Prescription Audit PlusÔ data.

In 2003, revenues were also adversely affected as aresult of the company’s limitation on sales in order to reduce the level ofwholesaler inventory for the first half of the year. In late 2002, ourwholesaler customers purchased what we believe to be excessive levels ofinventory of our products in anticipation of future price increases. Thisadversely impacted our sales in the first half of 2003. As a result of limitingshipments to wholesalers in the first half of 2003 and thereby attempting toreduce the amount of inventory 

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held by the wholesalers,unit sales decreased 29% from the first half of 2002 compared to the first halfof 2003.

Prior to developing systems in 2003, we first learnedof the wholesalers increasing the trade levels of inventory in mid-December 2002upon receiving the IMS Health Pipeline Report, which was a report provided byIMS Health Incorporated that provides information on inventory levels held bycertain major wholesalers. This report indicated that wholesaler inventorylevels were higher than we expected. This additional inventory was purchased bythe wholesalers prior to our January 2003 product price increases,allowing these wholesaler customers to increase the prices they charge theirretail customers in the first quarter of 2003, thereby improving their marginsfor these products. In response, in the second and third quarters of 2003, weentered into inventory management agreements with our three largest wholesalecustomers to encourage the wholesaler’s to maintain on average one month ofinventory.

Net revenues for the yearended December 31, 2003, also included a decrease of $3.4 million foran accrual for estimated future returns of the Tanafed Suspension and TanafedDM products which we discontinued in April 2003.

**Product Overview**

| ** **       | ** ** | **Change in total dispensed prescriptions for  the year ended December 31, 2004 compared  to the year ended December 31, 2003(a)** | ** ** | **Change in new dispensed prescriptions for  the year ended December 31, 2004 compared  to the year ended December 31, 2003(a)** | ** ** |
|------------------|------------|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|
| Sular            |       |                                                                                                                                                                                                                    | +11.7      | %                                                                                                                                                                                                                     |       |   | +23.1 | % |   |
| Nitrolingual(b)  |       |                                                                                                                                                                                                                    | (2.5       | )%                                                                                                                                                                                                                    |       |   | (2.3 | )% |   |
| Prenate Elite(c) |       |                                                                                                                                                                                                                    | N/A        |                                                                                                                                                                                                                  |       |   | N/A |   |   |
| Tanafed line     |       |                                                                                                                                                                                                                    | (23.7      | )%                                                                                                                                                                                                                    |       |   | (25.5 | )% |   |
| Robinul line     |       |                                                                                                                                                                                                                    | +2.1       | %                                                                                                                                                                                                                     |       |   | (0.4 | )% |   |
| Ponstel          |       |                                                                                                                                                                                                                    | (10.1      | )%                                                                                                                                                                                                                    |       |   | (8.8 | )% |   |

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(a)           Source: IMS Health’sNational Prescription Audit PlusÔ data

(b)          We believe that IMS datadoes not capture prescriptions of Nitrolingual from some of the non-retailchannels and prescription trends in the non-retail channel which may have asignificant impact on the reported change.

(c)           Prenate Elite waslaunched in April 2004. As a result, comparative data is not available for2003.

Product sales of Sular were approximately$57.1 million for 2004 compared to $24.1 million for 2003. Theincrease was primarily a result of total prescription growth, significanthospital growth, the impact of recent managed care plan additions and priceincreases.

Product sales of the promoted Women’s Health products(namely Prenate Elite, Ponstel, the Robinul line and the Tanafed line), wereapproximately $60.9 million for 2004 compared to approximately$44.7 million for 2003. The increase was primarily a result of totalprescription growth from the launch of Prenate Elite, significant hospitalgrowth, the impact of recent managed care plan additions and price increases.

In March 2004, we announced that we werelaunching Prenate Elite, the next generation of the Prenate line of prenatalvitamins. We began promoting and selling Prenate Elite in April 2004. Netrevenues of Prenate Elite were $12.9 million for the year ended December 31,2004. Prenate Elite captured a market share of 11.7% of new prescriptions and11.1% of total prescriptions as of December 31, 2004 (Source: IMS Health’sNational Prescription Audit PlusÔdata), Metafolin®, is an active form of folate that does not need to bemetabolized to the same extent as folic acid. Net revenues of Prenate GT and 

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Prenate Advance were$2.1 million for the period from January 2004 through April 2004when the products were discontinued and $11.8 million for the year ended December 31,2003.

*Costof Revenues.**  *Costof revenues increased $11.4 million, to $29.1 million for the yearended December 31, 2004, compared to $17.7 million for the year endedDecember 31, 2003. The increase in costs was due primarily to the increasein net revenues. As a result of a change in our sales forecast, cost ofrevenues for the year ended December 31, 2003 included an increasedallowance for obsolete and excess inventory of $3.5 million. These chargeswere primarily for our non-promoted products, excess Sular and Tanafedinventory and short dated Prenate GT inventory. Cost of revenues for the yearended December 31, 2004 do not include a comparable allowance for obsoleteand excess inventory.

*GrossMargin.**  *Grossmargins for 2004 and 2003 were 81%. Net sales for 2004 included a higherproportion of hospital and managed care prescriptions which have a lower perunit revenue. This was offset by 2003 cost of revenues including the increasedallowance for obsolete and excess inventory of $3.5 million. Cost ofrevenues for the year ended December 31, 2004 do not include a comparableallowance for obsolete and excess inventory.

*Selling,General and Administrative Expenses.**  *Selling, general and administrativeexpenses increased $9.0 million, to $66.8 million for the year ended December 31,2004, compared to $57.8 million for the year ended December 31, 2003.This increase is primarily related to the increase in sales force, increasedaccounting fees related to the Sarbanes-Oxley requirements, as well asincreased royalties related to the increased sales. This increase was partiallyoffset by lower selling expenses resulting from the Company’s revised strategyand operating plan.

*Depreciationand Amortization.**  *Depreciationand amortization expense increased $0.4 million, to $16.9 million for2004, compared to $16.5 million for 2003. This increase resulted fromhigher depreciation expense related to our implementation of a disasterrecovery system and a new sales tracking system in 2004.

*ImpairmentCharge.**  *Inthe second quarter of 2003, the Company formulated a new sales and marketingstrategy upon the Company hiring Mr. Patrick Fourteau as its thenPresident and Chief Operating Officer. This new strategy resulted in thediscontinuation of the pursuit of a line extension for Cognex as well as thesubsequent plans to promote the product. As part of this new strategy, usingmarket research, the Company updated its forecasts of Cognex sales projectionsto reflect a life cycle through June 2013, the period of time that theCompany expects it will continue to sell the product in the future. As aresult, the estimated useful life of Cognex was decreased from a remaining lifeof 17 years to 10 years, and using the estimated future undiscountedcash flows over the useful life of the product, the intangible asset related toCognex was not projected to be recoverable.

To determine a fair value of the intangible assetrelated to Cognex, the Company performed an internal analysis utilizing anumber of factors, including information from an independent valuation. TheCompany’s analysis resulted in an impairment charge of $4.2 million beingrecorded as of June 30, 2003. The methodologies used to determine a fairvalue for Cognex included a combination of a market approach, which used amarketable multiple methodology and a comparable transaction methodology, aswell as an income approach, using a discounted cash flow methodology.

The Company believes there were no other intangibleasset impairments and there were no other asset write-downs as of December 31,2004.

*Researchand Development Expense.**  *Research and development expense decreased$0.6 million, to $1.5 million for the year ended December 31,2004, compared to $2.1 million for the year ended December 31, 2003.The decrease in expense was primarily a result of costs incurred in 2003associated with manufacturing transfers for our Ponstel, Cognex and Furadantinproducts and development costs for 

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the Prenate line. Researchand development expenses for the year ended December 31, 2004 do notinclude comparable expenses.

*InterestExpense.**  *Interestexpense increased $2.3 million, to $2.5 million for the year ended December 31,2004, compared to $0.2 million for the year ended December 31, 2003.This increase was due to the issuance of a total of $150.0 million, 1.75%senior subordinated contingent convertible notes in March 2004. For theyear ended December 31, 2003, the Company had no debt outstanding.

*InterestIncome.**  *Interestincome increased $3.4 million, to $3.8 million for the year ended December 31,2004, compared to $0.4 million for the year ended December 31, 2003.This increase in interest income for year ended December 31, 2004 wasprimarily due to a higher average cash and marketable securities balances as aresult of the proceeds from the issuance of the contingent convertible seniorsubordinated notes in March 2004, as well as positive cash flows generatedfrom operations during 2004.

*(Provision) Benefit forIncome Taxes.**  *Incometaxes were provided for at a rate of 31.9% for the year ended December 31,2004 compared to 37.5% for the year ended December 31, 2003. This decreasein the effective rate for the year ended December 31, 2004 is due to thechange in the mix of tax jurisdictions, both domestic and international as aresult of our implementation of international operations where our income wasearned, as well as a change in the ratio of non-deductible expenses to pre-taxincome.

**Liquidity and Capital Resources**

Our liquidity requirements arise from working capitalrequirements, product development activities, funding of acquisitions and debtservice. We expect to need additional funds to acquire or obtain licenses fornew products, develop and test new products and potentially to acquire otherbusinesses, which may increase our cost of capital. We may seek funding throughpublic and private financing and may seek to incur debt, issue shares of ourstock, or both, either to finance a transaction or as consideration for a transaction.Adequate funds for these purposes, whether through the financial markets orfrom other sources, may not be available when we need them or on termsacceptable to us. Insufficient funds could cause us to delay, scale back orabandon some or all of our product acquisitions, licensing opportunities,marketing programs, product development programs, potential businessacquisitions and manufacturing opportunities. We have historically met thesecash requirements through cash from operations, borrowings and the issuance ofcommon stock.

Our cash and cash equivalents were $17.0 million at December 31,2005, compared to $36.6 million at December 31, 2004. Net cash provided byoperating activities for the year ended December 31, 2005 was$20.3 million. This providing of cash resulted from the net income for theyear of $39.2 million (adjusted for non-cash depreciation and amortizationof $22.7 million, non-cash deferred income tax benefit of $4.2 million),decrease in income tax receivable of $4.9 million as a result of increasedtaxable income, increase in accrued expenses and other liabilities of$2.6 million, and other miscellanous non-cash transactions of $2.3million. These providers of cash were partially offset by an increase inaccounts receivable of $24.5 million which resulted from our increasedsales, other current assets and other assets of $15.5 million relatedprimarily to increased samples for our new products, inventories of$13.1 million related to increased levels for our products and a decreasein accounts payable of $2.5 million.

Our cash and cash equivalents were $36.6 millionat December 31, 2004, compared to $33.7 million at December 31,2003. Net cash provided by operating activities for the year ended December 31,2004 was $49.5 million. This providing of cash resulted from the netincome for the year of $26.6 million, non cash depreciation andamortization of $16.9 million, non-cash tax transactions of$12.5 million, increase in accounts payable of $8.9 million, increasein accrued expenses and other liabilities of $2.4 million and non-cashinterest expense of $0.3 million. These providers of cash were partiallyoffset by an increase in 

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accounts receivable of$8.1 million, other current assets and other assets of $4.7 million,inventories of $4.6 million and income taxes receivable of$0.6 million.

We maintain supply agreements with third partysuppliers for all of our products. Some of these supply agreements containminimum purchase requirements. For most of these supply agreements, we believethat our inventory requirements and related purchases of inventory will exceedthe minimum purchase requirement in 2005. In those cases in which we do notbelieve our purchases will exceed the minimum purchase requirements, we areseeking to negotiate waivers or modifications of the minimum purchaserequirements.

Net cash used in investing activities for the yearended December 31, 2005 was $31.2 million, compared to net cash used ininvesting activities for the year ended December 31, 2004 which was$161.3 million. The primary use of cash for investing activities was thepurchase of product licenses of $106.0 million for Triglide, Fortamet andAltoprev, the purchase of marketable securities of $20.6 million and thepurchase of plant and equipment of $2.2 million. This use of cash was partiallyoffset by the sales of marketable securities of $97.6 million which wasused primarily for the purchase of Triglide, Fortamet and Altoprev.

Net cash used in investing activities for the yearended December 31, 2004 was $161.3 million, compared to net cash usedin investing activities for the year ended December 31, 2003 which was$11.8 million. The primary use of cash for investing activities was thepurchase of marketable securities of $152.4 million. In addition, anotheruse of investing cash during the second quarter of 2004, resulted from theagreement entered into with SkyePharma PLC, granting us the exclusive licenseto market and distribute a cardiovascular product in the United States. Theagreement required us to pay $5.0 million to SkyePharma PLC upon signingthe agreement and up to an additional $15.0 million was payablethereafter, all of which were contingent upon milestones related to FDAapproval. We have incurred an additional $0.4 million in acquisition costsrelated to the SkyePharma PLC agreement. We also used $3.5 million for thepurchase of property and equipment, primarily for a new sales force automationsystem. Our business strategy includes the acquisition or licensing ofpharmaceutical products and businesses that we believe represent attractivegrowth opportunities for us in the future. We regularly evaluate acquisitionopportunities. Subject to our liquidity and capital resources at any particulartime, we may incur commitments in the future to acquire or licensepharmaceutical products and businesses.

Net cash used by financing activities for the yearended December 31, 2005 was $4.5 million, compared to cash providedby financing activities of $114.0 million for the year ended December 31,2004. The primary use of cash from financing activities in 2005 was therepurchase of common stock of $6.5 million. This was partially offset by proceedsfrom the issuance of common stock of $2.0 million.

Net cash provided by financing activities for the yearended December 31, 2004 was $114.0 million, compared to cash used byfinancing activities of $0.6 million for the year ended December 31,2003. The primary provider of cash from financing activities was the proceedsfrom the issuance of long-term debt of $150.0 million and from theissuance of common stock, primarily from the exercise of stock options, of$11.5 million. These providers of cash were offset by $5.0 million inincurred financing costs related to the debt issuance, $19.2 million forthe repurchase of common stock which was subsequently retired and$23.2 million for the acquisition of treasury stock which was acquired inpart, to establish a pool of authorized shares that will be available forcontribution to the Employee Stock Ownership Plan over time as the Company inits discretion deems appropriate.

We believe that our cash on hand, cash we expect togenerate from our operations and availability under our revolving creditfacility will be sufficient to fund these working capital requirements, atleast for the next twelve months. However, in the event that we makesignificant acquisitions, we may need to raise additional funds through additionalborrowings or the issuance of debt or equity securities, or both. Some of oursupply agreements contain minimum purchase requirements. We do not expect thatmeeting those 

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requirements will resultin the acquisition of excessive inventory. We expect we will also experiencegrowth in our accounts receivable as our sales increase.

In March 2004, we issued a total of$150.0 million of our 1.75% contingent convertible senior subordinatednotes. The notes are due March 8, 2024 and accrued interest is payablesemi-annually in arrears on March 8 and September 8 of each year,commencing on September 8, 2004. In addition to the interest in the notes,after March 8, 2007, we will also pay contingent interest during specifiedsix-month periods if the average trading price of the notes per $1,000principal amount for the five day trading period ending on the third tradingday immediately preceding the first day of the applicable six-month periodequals $1,200 or more. During any period when contingent interest is payable,it will be payable at a rate equal to 0.5% per annum. The net proceeds fromthis issuance after deducting offering expenses were approximately$145.4 million.

The holders of the convertible notes may convert thenotes into shares of our common stock at a conversion rate of 45.1467 sharesper $1,000 principal amount of the notes, which is equivalent to a conversionprice of $22.15 per share, subject to anti-dilution adjustments, before theclose of business on March 8, 2024. Holders may convert their convertiblenotes only under the following circumstances: (1) during any calendarquarter commencing after June 30, 2004, if the closing sales price of ourcommon stock exceeds 120% of the conversion price for at least 20 trading daysin the 30 consecutive trading days ending on the last trading day of thepreceding calendar quarter; (2) if the notes have been called forredemption; (3) during the five trading day period immediately followingany nine consecutive trading day period in which the trading price of the notesper $1,000 principal amount for each day of that period was less than 95% ofthe product of the closing price of our common stock and the number of sharesof our common stock issuable upon conversion of $1,000 principal amount of thenotes; or (4) the occurrence of specified corporate transactions.

We have the option to redeem the notes beginningMarch 13, 2007 at a price equal to 100% of their aggregate principalamount, plus accrued and unpaid interest, including contingent interest, ifany.

The holders of the notes have the option to require usto repurchase the notes on March 8 of 2009, 2014 and 2019, and upon achange in control, at a price equal to 100% of their aggregate principalamount, plus accrued and unpaid interest, including contingent interest, ifany.

On February 11, 2003, we entered into a credit agreementfor a $20.0 million senior secured revolving credit facility with variouslenders and LaSalle Bank National Association, as Administrative Agent.Effective August 11, 2003, we extended the maturity date of the facilityto August 11, 2006. Subject to the satisfaction of certain borrowing baserequirements, we may from time-to-time borrow monies under the revolvingfacility for working capital requirements and general corporate purposes.Borrowings are secured by substantially all of our assets. Borrowings bearinterest at our option at the base rate in effect from time to time plus anapplicable margin or the Eurodollar rate, plus an applicable margin. Theapplicable margin will vary dependent upon our leverage ratio in effect fromtime-to-time. As of February 24, 2006, we had no borrowings outstandingunder this facility. Fees payable under the revolving facility include aone-time commitment fee of 0.685% of the stated amount of the facility, anunused commitment fee based on funds committed but not borrowed under therevolving facility at rates which vary dependent upon our leverage ratio ineffect from time-to-time and letter of credit fees equal to 0.25% per annum of theface amount of letters of credit issued and outstanding under the revolvingfacility. The revolving facility may be prepaid from time-to-time or terminatedat our discretion without penalty.

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The revolving loancontains various restrictive covenants, including covenants relative tomaintaining financial ratios and earnings levels, limitations on acquisitions,dispositions, mergers and capital expenditures, limitations on incurringadditional indebtedness and a prohibition on payment of dividends and certainissuances of our capital stock. As of December 31, 2005 and December 31,2004, we were in compliance with these financial covenants.

In July 2002, weannounced a share repurchase program. This program authorized us to repurchaseup to $8.0 million in common stock until July 2003. Through July 2003,the Company repurchased 823,400 shares of its common stock at an aggregate costof approximately $2.1 million. In August 2003, the Company’s Board ofDirectors authorized the repurchase of up to an additional $7.9 million ofcommon stock and extended the repurchase program to August 2004. In September 2003,the Company repurchased 162,225 shares of common stock at an aggregate cost ofapproximately $1.0 million. Through December 2003, the Company hadrepurchased a total of 985,625 shares of common stock at an aggregate cost ofapproximately $3.1 million. During the six months ended June 2004,the Company repurchased a total of 260,000 shares of common stock at anaggregate cost of approximately $4.6 million. All of these shares wereretired.

In July 2004, theCompany’s Board of Directors authorized a $20.0 million share repurchaseprogram. The new program, which authorizes the repurchase of up to $5 millionof common stock per quarter, became effective in August 2004, terminatingand replacing the $10.0 million share repurchase program authorized by theCompany’s Board of Directors in fiscal 2002. This share repurchase programexpired in August 2005.

In the third quarter of2004, as part of the then-effective share repurchase program, the Company’sBoard of Directors increased the per quarter repurchase cap and authorized theCompany to repurchase a total of 731,580 shares of common stock, inclusive of the500,000 shares of common stock repurchased from one of Dr. Kapoor’s familypartnerships, at an aggregate cost of approximately $13.4 million. Theseshares have been retired. In the fourth quarter of 2004, as part of the planthat became effective in August 2004, the Company repurchased 65,427shares of common stock. These shares have been retired.

In December 2004, theCompany, with Board of Directors approval, purchased one million shares ofcommon stock at an aggregate cost of approximately $23.2 million which wasat a fair market value equal to the December 10, 2004 closing price of theCompany’s common stock as reported by Nasdaq from certain executives and boardmembers and a significant shareholder of the Company. The Company acquiredthose shares in part, to establish a pool of authorized shares that will beavailable for contribution to the Company’s Employee Stock Ownership Plan overtime as the Company in its discretion deems appropriate.

The Company adopted a newshare repurchase program effective August 3, 2005, that authorizes therepurchase of up to $20.0 million of its outstanding shares of common stockover the next twelve months with no periodic sub-limits on the amount ofrepurchases. This plan replaces all prior share repurchase plans and willexpire on August 2, 2006.

In the first quarter of2005, the Company repurchased 127,169 shares of common stock at an average costof $16.44 per share, or $2.1 million. In the fourth quarter of 2005, theCompany repurchased 300,000 shares of common stock at an average cost of $14.79per share, or $4.4 million. These shares have been retired.

We expect that ourexisting sources of working capital or liquidity will be sufficient to enableus to execute our main operational goals of maximizing the sales of ourexisting products and acquiring companies having such products, acceleratinggrowth by launching line extensions to our current products and acquiring orlicensing approved products or late stage development products, as well as anycapital requirements necessary to meet these operational goals.

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**ContractualObligations (in thousands)**

| ** **                       | ** ** | **Payment due by period** | ** ** |
|----------------------------------|------------|------------------------------------------|------------|
| **Contractual Obligations** | ** ** | ** **                               | ** ** | **Total** | ** ** | **2006** | ** ** | **    2007 - 2008        ** | ** ** | **    2009 - 2010   ** | ** ** | **Thereafter** | ** ** |
| Operating lease  obligations     |       | $                                        | 19,491     |   | $ | 4,902 |   |   | $ | 8,805 |   |   |   | $ | 2,304 |   |   | $ | 3,480 |   |
| Purchase  obligations            |       | 41,340                                   |       | 29,082 |   |   | 7,864 |   |   |   | 4,163 |   |   | 231 |   |
| Long-term  debt obligations      |       | 150,000                                  |       | — |   |   | — |   |   |   | — |   |   | 150,000 |   |
| Total                            |       | $                                        | 210,831    |   | $ | 33,984 |   |   | $ | 16,669 |   |   |   | $ | 6,467 |   |   | $ | 153,711 |   |
|                                  |            |                                          |            |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

 

Operating leaseobligations include $3.2 million and $5.4 million in 2006 and 2007-2008,respectively for our corporate fleet vehicles. Also included is the annuallease payment of $0.7 million per annum through May 2009 for the homeoffice space and $25,000 per annum through September 2007 for the Irishoffice space.

On February 7,2006, the Company entered into a lease agreement with 485 Properties, LLCto lease 50,994 square feet of office space at Corporate Center V, an officetower located in Atlanta, Georgia. The eight year lease term, cancelable afterfive years, will commence on or before July 15, 2006 pending thesatisfactory completion of certain tenant improvements. Lease rates begin at$1.0 million per year and escalate during the term to $1.2 million for theeighth year. The lease payments under this lease are included in the abovechart under operating lease obligations.

The Company will relocateits corporate and administrative functions to the new premises from its currentfacilities but will continue to maintain its warehouse function at its currentfacilities pending the identification of new warehouse facilities. The Companywill seek to sublet its current facilities to third parties.

Purchase obligations forinventory are based on the unit contractual obligations at the unit cost as of December 31,2005. Unit prices are subject to increase upon notification by the supplier inthe event of increased costs incurred by the supplier.

Long-term debt obligationsdo not include interest payments of $2.6 million per year.

Contractual obligations donot include certain contingent payments related to milestones on licensing andpurchasing agreements, as the conditions for payment have not been met.

**Off-BalanceSheet Arrangements**

We do not have anyoff-balance sheet arrangements that have or are reasonably likely to have acurrent or future effect on our financial condition, changes in financialcondition, revenues or expenses, results of operations, liquidity, capitalexpenditures, or capital resources that are material to investors.

**Inflation**

We have experienced onlymoderate price increases under our agreements with third-partymanufacturers as a result of raw material and labor price increases. We havegenerally passed these price increases along to our customers.

**Seasonality**

Although our business isgenerally non-seasonal, sales of certain products, such as cough and coldproducts, increase between October and March due to the cold and fluseason. We expect the impact of seasonality to continue to decrease as weacquire or obtain licenses for products that treat chronic conditions. However,we anticipate that the seasonality may continue to affect sales of certainexisting products for the foreseeable future. Sales of our cough and coldproducts for the years ended 

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December 31,2003, 2004 and 2005 accounted for 19%, 11% and 2%, respectively, of our totalsales for such year.

**CriticalAccounting Policies**

Weview our critical accounting policies to be those policies which are veryimportant to the portrayal of our financial condition and results ofoperations, and require management’s most difficult, complex or subjectivejudgments. The circumstances that make these judgments difficult or complexrelate to the need for management to make estimates about the effect of mattersthat are inherently uncertain. We believe our critical accounting policies areas follows:

·       *Allowance for doubtful accounts.*   Weare required to estimate the level of accounts receivable recorded on ourbalance sheet which will ultimately not be paid. Among other things, this assessmentrequires analysis of the financial strength of our customers, which can behighly subjective, particularly in the recent difficult general economicenvironment. Our policy is to estimate bad debt expense based on priorexperience supplemented by a periodic customer specific review when needed. Ifwe over or under estimate the level of accounts receivable that will not bepaid, there may be a material impact to our financial statements.

·       *Sales deductions.*   We provide volumerebates, contractual price reductions with drug wholesalers and insurancecompanies, and certain other sales related deductions on a regular basis. Theexact level of these deductions is not always immediately known and thus wemust record an estimate at the time of sale. Our estimates are based onhistorical experience with similar programs, and since we have a relativelysmall customer base, customer specific historical experience is often useful indetermining the estimated level of deductions expected to be refunded to ourcustomers when sales incentives are offered. If we over or under estimate thelevel of sales deductions, there may be a material impact to our financialstatements.

·       *Product returns.*   In thepharmaceutical industry, customers are normally granted the right to returnproduct for a refund if the product has not been used prior to its expirationdate, which is typically two to three years from the date of manufacture. Ourreturn policy allows product returns for products within an eighteen-monthwindow from six months prior to the expiration date and up to twelve monthsafter the expiration date. Our return policy conforms to industry standardpractices. We believe that we have sufficient data to estimate future returnsover the revised time period at the time of sale. Management is required toestimate the level of sales which will ultimately be returned pursuant to ourreturn policy, and record a related reserve at the time of sale. These amountsare deducted from our gross sales to determine our net revenues. Our estimatestake into consideration historical returns of a given product, product specificinformation provided by our customers and information obtained regarding thelevels of inventory being held by our customers, as well as overall purchasingpatterns by our customers. Management periodically reviews the reservesestablished for returns and adjusts them based on actual experience. If we overor under estimate the level of sales which will ultimately be returned, theremay be a material impact to our financial statements.

·       *Liabilities assumed with the acquisition of productrights.*   In connection with the acquisition of product rights,we assume certain liabilities for returns of product shipped by the sellerprior to the acquisition date. At the acquisition date, we estimate the amountof the assumed liabilities based on actual sales return data from the sellerand include that amount in the allocation of the total purchase price. Wereview the estimated liability on an annual basis. If we over or under estimateliabilities assumed, there may be a material impact to our financialstatements.

·       *Intangible assets*.   When we acquirethe rights to manufacture and sell a product, we record the aggregate purchaseprice, along with the value of the product related liabilities that we assume,as 

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intangible assets.We use the assistance of valuation experts to help us allocate the purchaseprice to the fair value of the various intangible assets that we have acquired.Then, we must estimate the economic useful life of each of these intangibleassets in order to amortize their cost as an expense in our statement ofoperations over the estimated economic useful life of the related asset. Thefactors that drive the actual economic useful life of a pharmaceutical productare inherently uncertain, and include patent protection, physician loyalty andprescribing patterns, competition by products prescribed for similarindications, future introductions of competing products not yet FDA approved,the impact of promotional efforts and many other issues. We use all of thesefactors in initially estimating the economic useful lives of our products, andwe also continuously monitor these factors for indications of appropriaterevisions.

Inassessing the recoverability of its intangible assets, we must make assumptionsregarding estimated future cash flows and other factors. If the estimatedundiscounted future cash flows do not exceed the carrying value of theintangible assets, we must determine the fair value of the intangible assets.If the fair value of the intangible assets is less than its carrying value, animpairment loss will be recognized in an amount equal to the difference. Wereview intangible assets for impairment at least annually and whenever eventsor changes in circumstances, indicate that the carrying amount of an asset maynot be recoverable. Such events or circumstances may include but are notlimited to, lack of promotional sensitivity, the introduction of competitiveproducts and changes in government regulations. If we determine that anintangible asset is impaired, a non-cash impairment charge would be recognized.If we should incur an impairment loss, there may be a material impact to thefinancial statements.

·       *Income Taxes*.   Income taxes areprovided for under the liability method. This approach requires the recognitionof deferred tax assets and liabilities for the expected future tax consequencesof differences between the tax basis of assets or liabilities and their carryingamounts in the consolidated financial statements. A valuation allowance isprovided for deferred tax assets if it is more likely than not that these itemswill either expire before we are able to realize their benefit or if futuredeductibility is uncertain.

Developingthe provision for income taxes requires significant judgment and expertise ininternational, federal and state income tax laws, regulations and strategies,including the determination of deferred tax assets and liabilities and, ifnecessary, any valuation allowances that may be required for deferred taxassets. Our judgments and tax strategies are subject to audit by various taxingauthorities. While we believe we have provided adequately for our income taxliabilities in our consolidated financial statements, adverse determinations bythese taxing authorities could have a material adverse effect on ourconsolidated financial condition and results of operations.

·       *Inventory obsolescence.*   Our products have shelf livesranging from 24 to 48 months. We must estimate the amount of inventoryrecorded on our balance sheet that will not be sold prior to expiration. Thisestimate requires analysis of forecasted demand for our products, our promotionalfocus, amounts of our products currently held by our customers and the impacton our products of competing products. If we over or under estimate the amountof inventory that will not be sold prior to expiration, there may be a materialimpact to our financial statements.

**RecentAccounting Pronouncements**

In July 2005, the Financial Accounting Standards Board (“FASB”) issuedan exposure draft of a proposed interpretation, *Accountingfor Uncertain Tax Positions-an Interpretation of FASB Statement No. 109*(“SFAS No. 109”). This interpretation would apply to all open taxpositions accounted for in accordance with SFAS No. 109, including thoseacquired in business combinations. It is a proposed asset recognition approachto apply a dual threshold for uncertain tax positions. The interpretation wouldallow the recognition of a tax benefit when it is probable that it could besustained upon audit. The 

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interpretationdefines “probable” as it is defined in SFAS No. 5, “*Accountingfor Contingencies*.” While they have not addressed the effectivedate, it will not be effective for year-ended 2005 under their current plans.The Company is currently reviewing the effect, if any, the proposed guidancewill have on its financial statements.

In May 2005, the FASBissued Statement 154, *“Accounting Changes andError Corrections, a replacement of APB Opinion No. 20 and FASB Statement No. 3.” *The standard requiresretrospective application to prior periods’ financial statements of a voluntarychange in accounting principle unless it is deemed impracticable, unless thechange in accounting  relates to theprinciple method of depreciation, amortization or depletion for long-lived,non-financial assets in which case the change is accounted for as a change inaccounting estimate that is affected by a change in accounting principle. Thestandard is effective for accounting changes and corrections of errors madeoccurring in fiscal years beginning after December 15, 2005. The adoptionof Statement of Financial Accounting Standards (“SFAS”) No. 154 is notexpected to have a material impact on the Company’s financial position orresults of operations.

In December 2004, theFinancial Accounting Standards Board (“FASB”) issued Statement 153, *“Exchanges of Nonmonetary Assets, an amendment of APBOpinion No. 29.”* The standard is based on the principle thatexchanges of nonmonetary assets should be measured based on the fair value ofthe assets exchanged and eliminates the exception under ABP Opinion No. 29for an exchange of similar productive assets and replaces it with an exceptionfor exchanges of nonmonetary assets that do not have commercial substance. Thestandard is effective for nonmonetary exchanges occurring in fiscal periodsbeginning after June 15, 2005. The adoption of SFAS no. 153 did nothave a material impact on the Company’s financial position or results ofoperations.

In December 2004, theFASB issued Statement 123 (revised 2004), *“Share-BasedPayment.”* The standard eliminates the disclosure-only election underFAS 123 and requires the recognition of compensation expense for stockoptions and other forms of equity compensation based on the fair value of theinstruments on the date of grant. SFAS 123R is effective for equitycompensation expense in fiscal years beginning after December 15, 2005 andwe will adopt it prospectively on January 1, 2006. See Note 1 for thedisclosures of the pro forma dilutive impact on net income and earnings pershare of expensing stock options based on the Black-Scholes Model.

**ITEM7A.   QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK**

The Company is exposed tocertain market risks that arise in the ordinary course of business.A discussion of the Company’s primary market risk exposure is presentedbelow.

**ForeignCurrency Exchange Risk**

Our purchases ofNitrolingual from Pohl-Boskamp, our purchases of Triglide from Skyepharma andour purchases of Sular from Bayer are made in Euros or are otherwiseimpacted by fluctuations in the US dollar—Euro exchange rate. Although we didnot enter into any forward contracts in 2005, we may eliminate risks fromforeign currency fluctuations after the time of shipment of product by enteringinto forward contracts for these purchases of inventory at the time of productshipments. The Company’s earnings and cash flows could be adversely affected inthe future by the relationship of the U.S. dollar with foreign currencies.

**Market Risk onInvestments**

The fair value of ourinvestment portfolio would be negatively affected by an increase in interestrates. Since the majority of the Company’s investments are fixed rate interest-bearingsecurities and therefore subject to the market risk of loss in market valuefrom an increase in rates or a change in the underlying risk of the issuers ofthe notes, the Company’s future earnings and cash flows could be affectedadversely if 

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theCompany were to sell the securities prior to their maturity date. There were$0.7 million in realized losses from sale of investments in the year ended December 31,2005. At December 31, 2005, the Company had total net unrealized lossesfrom marketable securities of $2.0 million.

**MarketRisk on Variable Rate Debt**

In connection withborrowings incurred under the senior secured revolving credit facility arrangedby LaSalle Bank, N.A., we could experience market risk with respect to changesin the general level of the interest rates and its effect upon our interestexpense. Borrowings under this facility bear interest at variable rates.Because such rates are variable, an increase in interest rates will result inadditional interest expense and a reduction in interest rates will result inreduced interest expense. Accordingly, our present exposure to interest ratefluctuations is primarily dependent on rate changes that may occur while borrowingsunder the senior secured credit facility are outstanding. As of February 17,2006 there was no debt outstanding under this facility.

**MarketRisk on Fixed Rate Debt**

The Company’s long-termfixed interest rate senior subordinated contingent convertible notes are alsosubject to market risk. Fixed rate debt outstanding at December 31, 2005was $150 million with an interest rate of 1.75%. All other things beingequal, the fair market value of the Company’s fixed rate debt will increase asrates decline and will decrease as rates rise. The fixed rate notes outstandingtotaling $150.0 million at December 31, 2005 had a fair value of$138.1 million based on quoted market rates.

**ITEM8.   FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA**

The information requiredby this item is set forth at the pages indicated in Item 15(a) below.

**ITEM9.   CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING ANDFINANCIAL DISCLOSURE**

On March 22, 2005,our audit committee unanimously voted to terminate the engagement of Deloitte &Touche LLP as the Company’s independent registered public accounting firm, andto engage BDO Seidman, LLP as our independent registered public accounting firm.On March 28, 2005, we filed a Form 8-K describing this action.

**ITEM9A.   CONTROLS AND PROCEDURES**

**Evaluationof Disclosure Controls and Procedures**

We maintain a set ofdisclosure controls and procedures that are designed to ensure that informationrequired to be disclosed in the reports that we file under the SecuritiesExchange Act of 1934, as amended (“Exchange Act”), is recorded, processed,summarized and reported within the time periods specified in the SEC’s rules andforms. We carried out an evaluation under the supervision and with theparticipation of management, including our President and Chief ExecutiveOfficer and our Chief Financial Officer, of the effectiveness of the design andoperation of First Horizon’s disclosure controls and procedures pursuant to Rule 13a-15(e) ofthe Exchange Act as of the end of the period covered by this report. OurPresident and Chief Executive Officer and Chief Financial Officer concludedthat our disclosure controls and procedures were effective as of December 31,2005.

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**Management’sReport on Internal Control over Financial Reporting**

**Statement of management’s responsibility forestablishing and maintaining adequate internal control over financial reportingfor the Company.**

Our management isresponsible for establishing and maintaining adequate internal control overfinancial reporting for the Company.

**Statement of management’s assessment of theeffectiveness of the Company’s internal control over financial reporting as ofthe end of the Company’s most recent fiscal year.**

Ourinternal control over financial reporting includes those policies andprocedures that pertain to the maintenance of records that, inreasonable detail, accurately and fairly reflect transactions and dispositionsof assets; provide reasonable assurances that transactions are recorded asnecessary to permit preparation of financial statements in accordance with U.S.generally accepted accounting principles, and that receipts and expendituresare being made only in accordance with authorizations of management and thedirectors of the Company; and provide reasonable assurance regarding preventionor timely detection of unauthorized acquisition, use or disposition of theCompany’s assets that could have a material effect on our financial statements.Based on our evaluation of our internalcontrol over financial reporting for the period for which this report is filed,our management, including our President and Chief Executive Officer and ChiefFinancial Officer, concluded that our internal control over financial reportingwas effective as of December 31, 2005. However, because of the inherentlimitations in all control systems, no evaluation of controls can provideabsolute assurance that all control issues within First Horizon have been orwill be detected. Even effective internal control over financial reporting canonly provide reasonable assurance with respect to financial statementpreparation. Furthermore, because of changes in conditions, the effectivenessof internal control over financial reporting may vary over time. Ourmanagement, including our President and Chief Executive Officer and ChiefFinancial Officer, does not expect that our controls and procedures willprevent all errors.

**Statement identifying the framework used by managementto evaluate the effectiveness of the Company’s internal control over financialreporting.**

In order to ensure thatour internal control over financial reporting is effective, management isresponsible for regularly assessing such controls and did so most recently forits financial reporting as of December 31, 2005. We are committed to acontinuing process of identifying, evaluating and implementing improvements tothe effectiveness of our disclosure and internal controls and procedures. Ourmanagement based its assessment of the effectiveness of our internal controlover financial reporting on criteria for effective internal control overfinancial reporting set forth by the Committee of Sponsoring Organizations ofthe Treadway Commission (COSO) in the Internal Control—Integrate Framework. Thescope of management’s assessment of the effectiveness of internal control overfinancial reporting includes all of our businesses.

**Statement that the registered public accounting firmthat audited the Company’s financial statements included in the annual reporthas issued an attestation report on management’s assessment of the Company’sinternal control over financial reporting.**

Our Board of Directors,acting through its Audit Committee, is responsible for the oversight of ouraccounting policies, financial reporting and internal control. The AuditCommittee of the Board of Directors is comprised entirely of outside directorswho are independent of management. The independent registered public accountingfirm and the internal auditors have full and unlimited access to the AuditCommittee, with or without management, to discuss the adequacy of internalcontrol over financial reporting, and any other matters which they believeshould be brought to the attention of the Audit Committee.

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Our management has issueda report of its assessment of internal control over financial reporting whichis included herein. BDO Seidman, LLP, our independent registered publicaccounting firm, audited management’s assessment of the effectiveness ofinternal control over financial reporting and, based on that audit, issuedtheir report which is included below.

**Changes in internal control our financial reporting.**

Our management has notidentified any changes in our internal controls over financial reporting duringour fourth fiscal quarter of 2005 that have materially affected, or arereasonably likely to materially affect, our internal controls over financialreporting.

**Reportof Independent Registered Public Accounting Firm**

To the Board of Directorsand Stockholders ofFirst Horizon Pharmaceutical CorporationAtlanta, Georgia

We have audited management’sassessment, included in the accompanying Management’s Report on InternalControl Over Financial Reporting included at Item 9A, that First HorizonPharmaceutical Corporation and subsidiaries (the “Company”) maintainedeffective internal control over financial reporting as of December 31,2005, based on criteria established in *InternalControl—Integrated Framework* issued by the Committee of SponsoringOrganizations of the Treadway Commission. The Company’s management isresponsible for maintaining effective internal control over financial reportingand for its assessment of the effectiveness of internal control over financialreporting. Our responsibility is to express an opinion on management’sassessment and an opinion on the effectiveness of the Company’s internalcontrol over financial reporting based on our audit.

We conducted our audit inaccordance with the standards of the Public Company Accounting Oversight Board(United States). Those standards require that we plan and perform the audit toobtain reasonable assurance about whether effective internal control overfinancial reporting was maintained in all material respects. Our audit includedobtaining an understanding of internal control over financial reporting,evaluating management’s assessment, testing and evaluating the design andoperating effectiveness of internal control, and performing such otherprocedures as we considered necessary in the circumstances. We believe that ouraudit provides a reasonable basis for our opinion.

A company’s internal control over financial reportingis a process designed by, or under the supervision of, the company’s principalexecutive and principal financial officers, or persons performing similarfunctions, and effected by the company’s board of directors, management, andother personnel to provide reasonable assurance regarding the reliability offinancial reporting and the preparation of financial statements for externalpurposes in accordance with generally accepted accounting principles. Acompany’s internal control over financial reporting includes those policies andprocedures that (1) pertain to the maintenance of records that, inreasonable detail, accurately and fairly reflect the transactions anddispositions of the assets of the company; (2) provide reasonableassurance that transactions are recorded as necessary to permit preparation offinancial statements in accordance with generally accepted accountingprinciples, and that receipts and expenditures of the company are being madeonly in accordance with authorizations of management and directors of thecompany; and (3) provide reasonable assurance regarding prevention ortimely detection of unauthorized acquisition, use, or disposition of thecompany’s assets that could have a material effect on the financial statements.

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Because of the inherent limitations of internalcontrol over financial reporting, including the possibility of collusion orimproper management override of controls, material misstatements due to erroror fraud may not be prevented or detected on a timely basis. Also, projectionsof any evaluation of the effectiveness of the internal control over financialreporting to future periods are subject to the risk that the controls maybecome inadequate because of changes in conditions, or that the degree of compliancewith the policies or procedures may deteriorate.

In our opinion, management’s assessment that theCompany maintained effective internal control over financial reporting as of December 31,2005, is fairly stated, in all material respects, based on the criteriaestablished in *Internal Control—IntegratedFramework* issued by the Committee of Sponsoring Organizations of theTreadway Commission. Also in our opinion, the Company maintained, in allmaterial respects, effective internal control over financial reporting as of December 31,2005, based on the criteria established in *InternalControl—Integrated Framework* issued by the Committee of SponsoringOrganizations of the Treadway Commission.

We have also audited, in accordance with the standardsof the Public Company Accounting Oversight Board (United States), theconsolidated financial statements and the financial statement schedule as ofand for the year ended December 31, 2005 of the Company and our reportdated February 22, 2006 expressed an unqualified opinion on thoseconsolidated financial statements and financial statement schedule.

/s/ BDO Seidman LLPAtlanta, GeorgiaFebruary 22, 2006

**ITEM 9B. OTHER INFORMATION**

None.

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**PART III**

**ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT**

This information isincorporated by reference from our Proxy Statement for the 2006 Annual Meetingof Stockholders under the headings “Proposal 1—Election of Class BDirectors,” and “Proposal 1—Directors and Executive Officers” in our Proxy Statementfor our 2006 Annual Meeting of Stockholders or in a subsequent amendment tothis Report. Information regarding compliance by our directors and executiveofficers and owners of more than 10% of First Horizon’s common stock with thereporting requirements of Section 16(a) of the Securities ExchangeAct of 1934, as amended, will be set forth in and incorporated by referencefrom our Proxy Statement for the 2006 Annual Meeting of Stockholders under theheading “Section 16(a) Beneficial Ownership Reporting Compliance” orin a subsequent amendment to this Report.

**ITEM 11. EXECUTIVE COMPENSATION**

This information isincorporated by reference from our Proxy Statement for the 2006 Annual Meetingof Stockholders under the heading “Executive Compensation” or in a subsequentamendment to this Report.

**ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIALOWNERS AND MANAGEMENT AND RELATED STOCKHOLDER MATTERS**

This information isincorporated by reference from our Proxy Statement for the 2006 Annual Meetingof Stockholders under the heading “Security Ownership of Certain BeneficialOwners and Management” or in a subsequent amendment to this Report. See also Part II,Item 5 “Market for Registrant’s Common Equity and Related Stockholder Matter-EquityCompensation Plan Information” of this Report.

**ITEM 13. CERTAIN RELATIONSHIPS AND RELATEDTRANSACTIONS**

This information isincorporated by reference from our Proxy Statement for the 2006 Annual Meetingof Stockholders under the heading “Certain Relationships and RelatedTransactions” or in a subsequent amendment to this Report.

**ITEM 14. PRINCIPAL ACCOUNTING FEES AND SERVICES**

This information is incorporated by reference from ourProxy Statement for the 2006 Annual Meeting of Stockholders under the heading “IndependentAccountant Matters” or in a subsequent amendment to this Report.

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**PART IV**

**ITEM15. EXHIBITS, FINANCIAL STATEMENT SCHEDULES**

(a)(1)                    Financial Statements filed as part of thisReport:

|                                                                                                                                   | ** ** | **Pages** | ** ** |
|-----------------------------------------------------------------------------------------------------------------------------------|------------|-----------|------------|
| Reports of Independent Registered Public Accounting  Firms                                                                        |       |      | F-1        |   |   |
| Consolidated Balance Sheets as of December 31, 2005  and 2004                                                                     |       |      | F-3        |   |   |
| Consolidated Statements of Operations for the fiscal  years ended December 31, 2005, 2004 and 2003                                |       |      | F-4        |   |   |
| Consolidated Statements of Stockholders Equity for the  fiscal years ended 2005, 2004 and 2003                                    |       |      | F-5        |   |   |
| Consolidated Statements of Cash Flows for the fiscal  years ended 2005, 2004 and 2003                                             |       |      | F-6        |   |   |
| Notes to Consolidated Financial Statements                                                                                        |       |      | F-7        |   |   |
| Financial  Statement Schedule—Valuation and Qualifying Accounts for the fiscal years  ended December 31, 2005, 2004 and 2003 |       |      | F-31       |   |   |

 

(a)(2)                    Documentsfiled as a part of this report:
| Exhibit   Number | ** ** | ** ** | ** ** | **Description**                                                                                                                     |
|------------------|------------|------------|------------|-------------------------------------------------------------------------------------------------------------------------------------|
| 3.1(1)           |       | —     |       | Restated  Certificate of Incorporation of the Registrant, as amended                                                                |
| 3.2(2)           |       | —     |       | Amended  and Restated Bylaws of the Registrant                                                                                      |
| 3.3(10)          |       | —     |       | Amendment  to the Amended and Restated Bylaws of the Registrant                                                                     |
| 4.1(3)           |       | —     |       | Form of  Stock Certificate                                                                                                     |
| 4.2(5)           |       | —     |       | Shareholder  Protection Rights Agreement                                                                                            |
| 4.3(11)          |       | —     |       | Indenture  with Deutsche Bank Trust Company Americas dated as of March 8, 2004                                                 |
| 10.1(4)          |       | —     |       | 1997  Non-Qualified Stock Option Plan                                                                                               |
| 10.2(3)          |       | —     |       | 2000  Stock Plan                                                                                                                    |
| 10.3(6)          |       | —     |       | Amended  and Restated 2002 Stock Plan                                                                                               |
| 10.4(3)          |       | —     |       | Form of  Nonqualified Stock Option Agreement                                                                                   |
| 10.5(7)          |       | —     |       | Lease  Agreement dated December 31, 2001 between the Registrant and Castle  Investment Company, Inc.                      |
| 10.6(3)          |       | —     |       | Form of  Indemnity Agreement between the Registrant and its Directors and Executive  Officers                                  |
| 10.7(8)          |       | —     |       | Asset  Purchase Agreement dated February 12, 2002 between the Registrant and  AstraZeneca UK Limited                           |
| 10.8(8)          |       | —     |       | Distributorship  Agreement dated December 12, 2001 between the Registrant and Bayer AG                                         |
| 10.9(7)          |       | —     |       | Trademark  Purchase and Assignment Agreement dated December 13, 2001 by and between  the Registrant and Bayer Aktiengellschaft |
| 10.10(7)         |       | —     |       | First  Amendment to Asset Purchase Agreement dated January 17, 2002 between the  Registrant and Sanofi-Synthelabo Inc.         |
| 10.11(2)         |       | —     |       | 2003  Nonqualified Stock Option Plan                                                                                                |
| 10.12*           |       | —     |       | Amended  and Restated Employment Agreement dated January 24, 2006 between the  Registrant and Patrick Fourteau                 |
| 10.13*           |       | —     |       | Amended  and Restated Employment Agreement dated January 24, 2006 between the  Registrant and Darrell Borne                    |
| 10.14(11)        |       | —     |       | Employment  Agreement dated December 30, 2004 between the Registrant and Leslie  Zacks                                         |
| 10.15(11)        |       | —     |       | Employment  Agreement between the Registrant and Michael Mavrogordato dated  October 27, 2004                                  |
| 10.16(11)        |       | —     |       | Employment  Agreement between the Registrant and Sam Gibbons dated October 16, 2004                                            |

55

----

 
| 10.17(9)+  |   | — |   | Inventory  Management Agreement dated June 10, 2003 by and between the Registrant  and McKesson Corporation                                                                                                           |
|------------|--------|--------|--------|----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| 10.18(9)+  |   | — |   | Inventory  Management Agreement dated February 5, 2003 by and between the  Registrant and Cardinal Health                                                                                                             |
| 10.19(9)+  |   | — |   | Inventory  Management Agreement dated June 16, 2003 by and between the Registrant  and AmerisourceBergen Drug Corporation                                                                                             |
| 10.20(9)   |   | — |   | Credit  Agreement dated February 11, 2003 among the Registrant, the Lenders  party thereto from time to time, LaSalle Bank National Association, as  Administrative Agent                                             |
| 10.21(9)   |   | — |   | First  Amendment dated March 3, 2003 to Credit Agreement dated  February 11, 2003 among the Registrant, LaSalle Bank National  Association, as Administrative Agent, and Lenders signatory thereto               |
| 10.22(9)   |   | — |   | Second  Amendment and Waiver dated August 11, 2003 to Credit Agreement dated  February 11, 2003 among the Registrant, LaSalle Bank National  Association, as Administrative Agent, and Lenders signatory thereto |
| 10.23(10)  |   | — |   | Registration  Rights Agreement with Deutsche Bank Securities Inc. and UBS Securities LLC  dated as of March 8, 2004                                                                                                   |
| 10.24(11)+ |   | — |   | Distribution  and Inventory Management Services Agreement between the Registrant and Cardinal  Health dated as of January 1, 2005                                                                                     |
| 10.25(11)+ |   | — |   | Amendment  of Distribution and Inventory Management Services Agreement between the  Registrant and McKesson Corporation dated as of June 10, 2004                                                                     |
| 10.26*     |   | — |   | Executive  Compensation Table                                                                                                                                                                                              |
| 10.27*     |   | — |   | Director  Compensation Table                                                                                                                                                                                               |
| 10.28(12)+ |   | — |   | Agreement  to License and Purchase, dated March 2, 2005, by and between the  Registrant, Andrx Labs, LLC, and the other seller entities listed therein                                                                |
| 10.29(12)+ |   | — |   | Manufacturing  and Supply Agreement, dated March 28, 2005, by and between the  Registrant and Andrx Pharmaceuticals, Inc.                                                                                        |
| 10.30(12)+ |   | — |   | License  Agreement, dated March 28, 2005, by and between the Registrant and Andrx  Pharmaceuticals, Inc., Andrx Labs, LLC, Andrx Laboratories  (NJ), Inc., and Andrx EU, Ltd                                |
| 10.31*+    |   | — |   | Amendment  to Distribution and Inventory Management Services Agreement between the  Registrant and Cardinal Health dated December 16, 2005                                                                            |
| 10.32*+    |   | — |   | Second  Amendment to Inventory Management Agreement between the Registrant and  McKesson Corporation dated November 21, 2005                                                                                          |
| 10.33*+    |   | — |   | Amendment  to New Distribution Agreement between the Registrant and Bayer Healthcare  Aktiengesellschaft dated December 7, 2005                                                                                       |
| 10.34*     |   | — |   | Lease  Agreement between the Registrant and 485 Properties, LLC dated  February 7, 2006                                                                                                                               |
| 10.35*     |   | — |   | Accelerated  Vesting Plan dated January 24, 2006                                                                                                                                                                      |
| 10.36*+    |   | — |   | Amended  and Restated Manufacturing and Supply Agreement between the Registrant and Patheon  Inc. dated January 1, 2004                                                                                               |
| 14.1*      |   | — |   | Code  of Business Conduct and Ethics                                                                                                                                                                                       |
| 21.1*      |   | — |   | Subsidiaries  of the Registrant                                                                                                                                                                                            |
| 23.1*      |   | — |   | Consent  of Deloitte & Touche LLP                                                                                                                                                                                 |
| 23.2*      |   | — |   | Consent  of BDO Seidman, LLP                                                                                                                                                                                               |
| 31.1*      |   | — |   | Certification  of Chief Executive Officer and President                                                                                                                                                                    |
| 31.2*      |   | — |   | Certification  of Chief Financial Officer                                                                                                                                                                                  |
| 32.1*      |   | — |   | Certification  pursuant to Section 906 of the Sarbanes-Oxley Act of 2002                                                                                                                                              |
| 32.2*      |   | — |   | Certification  pursuant to Section 906 of the Sarbanes-Oxley Act of 2002                                                                                                                                              |

----

*                    Filedherewith.

56

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+                The Registrant hasrequested confidential treatment of portions of this exhibit pursuant to Rule 24(b)-2of the Securities Exchange Act of 1934.

(1)          Incorporated byreference from the Registrant’s Form 10-Q for the quarter ended September 30,2002 (Commission File No. 000-30123).

(2)          Incorporated byreference from the Registrant’s Form 10-Q for the quarter ended June 30,2003 (Commission File No. 000-30123).

(3)          Incorporated byreference from the Registrant’s Form S-1 filed on February 18,2000 (Commission File No. 333-30764).

(4)          Incorporated byreference from the Registrant’s Form S-8 (Commission File No. 333-40856).

(5)          Incorporated byreference from the Registrant’s Form 8 filed on July 16, 2002(Commission File No. 000-30123).

(6)          Incorporated byreference from the Registrant’s Proxy Statement for its May 7, 2004 AnnualMeeting.

(7)          Incorporated byreference from the Registrant’s Form S-1 filed on March 5, 2002(Commission File No. 333-83698).

(8)          Incorporated byreference from the Registrant’s Form S-1 filed on March 5, 2002(Commission File No. 333-83698). The Registrant has requestedconfidential treatment for certain portions of this exhibit pursuant to Rule 406of the Securities Act of 1933, as amended.

(9)          Incorporated byreference from the Registrant’s Form 10-K for the year ended December 31,2003 (Commission File No. 000-30123).

(10)   Incorporated by reference fromthe Registrant’s Form 8-K filed on March 9, 2004 (CommissionFile No. 000-30123).

(11)   Incorporated by reference fromthe Registrant’s Form 10-K for the year ended December 31, 2004(Commission File No. 000-30123).

(12)   Incorporated by reference fromthe Registrant’s Form 10-Q for the quarter ended March 31, 2005(Commission File No. 000-30123).

57

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**SIGNATURES**

Pursuant to the requirements Section 13 or 15(d) ofthe Securities Exchange Act of 1934, the registrant has duly caused this reportto be signed on its behalf by the undersigned, thereunto duly authorized.

 

|                        |   | **FIRST HORIZON PHARMACEUTICAL CORPORATION** |
|------------------------|--------|----------------------------------------------|
| February 27, 2006 |   | By:                                          |   | /s/ PATRICK  P. FOURTEAU |
|                   |   |                                         |   | Patrick P.  Fourteau*Chief Executive Officer and  President* |

 

Pursuantto the requirements of the Securities Exchange Act of 1934, this report hasbeen signed below by the following persons on behalf of the registrant and inthe capacities and the dates indicated:

| /s/  PATRICK P. FOURTEAU |   | Director, Chief Executive Officer and   |   | February 27, 2006 |
|------------------------------------|--------|-----------------------------------------|--------|------------------------|
| Patrick P.  Fourteau               |   | President (principal executive officer) |   |                   |

 

| /s/  DARRELL BORNE |   | Chief Financial Officer,  Treasurer and                 |   | February 27,  2006 |
|------------------------------|--------|---------------------------------------------------------|--------|-------------------------|
| Darrell Borne                |   | Secretary (principal financial and accounting  officer) |   |                    |

 

| /s/  DR. JOHN N. KAPOOR |   | Chairman of the Board |   | February 27,  2006 |
|-----------------------------------|--------|-----------------------|--------|-------------------------|
| Dr. John N.  Kapoor          |   |                  |   |                    |

 

| /s/  JON S. SAXE |   | Director |   | February 27,  2006 |
|----------------------------|--------|----------|--------|-------------------------|
| Jon S. Saxe                |   |     |   |                    |

 

| /s/  PIERRE LAPALME |   | Director |   | February 27,  2006 |
|-------------------------------|--------|----------|--------|-------------------------|
| Pierre Lapalme                |   |     |   |                    |

 

| /s/  JERRY N. ELLIS |   | Director |   | February 27,  2006 |
|-------------------------------|--------|----------|--------|-------------------------|
| Jerry N. Ellis                |   |     |   |                    |

 

| /s/  PATRICK J. ZENNER |   | Director |   | February 27,  2006 |
|----------------------------------|--------|----------|--------|-------------------------|
| Patrick J. Zenner                |   |     |   |                    |

 

| /s/  WILLIAM J. ROBINSON |   | Director |   | February 27,  2006 |
|------------------------------------|--------|----------|--------|-------------------------|
| William J.  Robinson               |   |     |   |                    |

 

58

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**Report of Independent Registered Public AccountingFirm**

To the Board of Directors and Stockholders ofFirst Horizon Pharmaceutical CorporationAtlanta, Georgia

We have audited the accompanying consolidated balancesheet of First Horizon Pharmaceutical Corporation (a Delaware corporation) andsubsidiaries (the “Company”) as of December 31, 2005 and the relatedconsolidated statements of operations, stockholders’ equity, and cash flows forthe year then ended. Our audit also included the financial statement schedulelisted in the Index at Item 15. These consolidated financial statements andfinancial statement schedule are the responsibility of the Company’smanagement. Our responsibility is to express an opinion on the consolidatedfinancial statements and financial statement schedule based on our audit.

We conducted our audit in accordance with thestandards of the Public Company Accounting Oversight Board (United States).Those standards require that we plan and perform the audit to obtain reasonableassurance about whether the financial statements and schedule are free ofmaterial misstatement. An audit includes examining, on a test basis, evidencesupporting the amounts and disclosures in the financial statements and schedule.An audit also includes assessing the accounting principles used and significantestimates made by management, as well as evaluating the overall presentation ofthe financial statements and schedule. We believe that our audit provides areasonable basis for our opinion.

In our opinion, such consolidated financial statementsreferred to above present fairly, in all material respects, the financialposition of the Company as of December 31, 2005, and the results of itsoperations and its cash flows for the year then ended, in conformity withaccounting principles generally accepted in the United States of America. Also,in our opinion, such financial statement schedule as it relates to the yearended December 31, 2005, presents fairly, in all material respects, theinformation set forth therein.

We have also audited, in accordance with the standardsof the Public Company Accounting Oversight Board (United States), theeffectiveness of the Company’s internal control over financial reporting as of December 31,2005, based on the criteria established in *InternalControl—Integrated Framework* issued by the Committee of SponsoringOrganizations of the Treadway Commission and our report dated February 22,2006, expressed an unqualified opinion on management’s assessment of theeffectiveness of the Company’s internal control over financial reporting and anunqualified opinion on the effectiveness of the Company’s internal control overfinancial reporting.

/s/ BDO Seidman, LLPAtlanta, GeorgiaFebruary 22, 2006

F-1

----

**Report ofIndependent Registered Public Accounting Firm**

To the Board of Directors and Stockholders ofFirst Horizon Pharmaceutical CorporationAtlanta, Georgia

We have audited the accompanying consolidated balancesheet of First Horizon Pharmaceutical Corporation (a Delaware corporation) andsubsidiaries (the “Company”) as of December 31, 2004 and the relatedconsolidated statements of operations, stockholders’ equity, and cash flows foreach of the two years in the period ended December 31, 2004. Our auditsalso included the financial statement schedule listed in the Index at Item 15as it relates to the information as of December 2004 and 2003 and for the yearsthen ended. These consolidated financial statements and financial statementschedule are the responsibility of the Company’s management. Our responsibilityis to express an opinion on the consolidated financial statements and financialstatement schedule based on our audits.

We conducted our audits in accordance with thestandards of the Public Company Accounting Oversight Board (United States).Those standards require that we plan and perform the audit to obtain reasonableassurance about whether the financial statements are free of materialmisstatement. An audit includes examining, on a test basis, evidence supportingthe amounts and disclosures in the financial statements. An audit also includesassessing the accounting principles used and significant estimates made bymanagement, as well as evaluating the overall financial statement presentation.We believe that our audits provide a reasonable basis for our opinion.

In our opinion, such consolidated financial statementspresent fairly, in all material respects, the financial position of the Companyas of December 31, 2004, and the results of its operations and its cashflows for each of the two years in the period ended December 31, 2004, inconformity with accounting principles generally accepted in the United Statesof America. Also, in our opinion, such financial statement schedule as itrelates to the information as of December 2004 and 2003 and for the years thenended, when considered in relation to the basic consolidated financialstatements taken as a whole, presents fairly, in all material respects, theinformation set forth therein.

/s/ DELOITTE & TOUCHE LLPAtlanta, GeorgiaMarch 11, 2005

 

F-2

----

**FIRST HORIZON PHARMACEUTICAL CORPORATIONCONSOLIDATED BALANCE SHEETS(IN THOUSANDS, EXCEPT SHARE DATA)**

| ** **                                                                                                                                                                 | ** ** | **December 31,** | ** ** |
|----------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|-----------------------|------------|
| ** **                                                                                                                                                                 | ** ** | **2005**              | ** ** | **2004** | ** ** |
| **ASSETS**                                                                                                                                                                 |       |                  |       |   |   |
| Current assets:                                                                                                                                                            |       |                  |       |   |   |
| Cash and cash equivalents                                                                                                                                                  |       | $                     | 17,043     |   | $ | 36,586 |   |
| Marketable securities                                                                                                                                                      |       | 82,757                |       | 160,636 |   |
| Accounts receivable, net of allowances of $2,427 and  $749 December 31, 2005 and December 31, 2004, respectively                                                 |       | 48,353                |       | 23,833 |   |
| Inventories                                                                                                                                                                |       | 28,924                |       | 15,824 |   |
| Income taxes receivable                                                                                                                                                    |       | 547                   |       | 5,438 |   |
| Current deferred tax assets                                                                                                                                                |       | 3,705                 |       | 3,419 |   |
| Other current assets                                                                                                                                                       |       | 23,059                |       | 7,581 |   |
| Total current assets                                                                                                                                                       |       | 204,388               |       | 253,317 |   |
| Property and  equipment, net                                                                                                                                               |       | 5,148                 |       | 5,110 |   |
| Other assets:                                                                                                                                                              |       |                  |       |   |   |
| Intangibles, net                                                                                                                                                           |       | 315,798               |       | 229,953 |   |
| Other                                                                                                                                                                      |       | 4,371                 |       | 10,104 |   |
| Total other assets                                                                                                                                                         |       | 320,169               |       | 240,057 |   |
| Total assets                                                                                                                                                               |       | $                     | 529,705    |   | $ | 498,484 |   |
| **LIABILITIES AND STOCKHOLDERS’  EQUITY**                                                                                                                             |       |                  |       |   |   |
| Current liabilities:                                                                                                                                                       |       |                  |       |   |   |
| Account payable                                                                                                                                                            |       | $                     | 12,093     |   | $ | 14,569 |   |
| Accrued expenses                                                                                                                                                           |       | 18,482                |       | 20,508 |   |
| Total current liabilities                                                                                                                                                  |       | 30,575                |       | 35,077 |   |
| Long-term  liabilities:                                                                                                                                                    |       |                  |       |   |   |
| Convertible debt                                                                                                                                                           |       | 150,000               |       | 150,000 |   |
| Deferred tax liabilities                                                                                                                                                   |       | 8,803                 |       | 4,404 |   |
| Other long-term liabilities                                                                                                                                                |       | 191                   |       | 594 |   |
| Total liabilities                                                                                                                                                          |       | 189,569               |       | 190,075 |   |
| COMMITMENTS AND  CONTINGENCIES (NOTE 11 and 12)                                                                                                                            |       |                  |       |   |   |
| Stockholders’ equity:                                                                                                                                                 |       |                  |       |   |   |
| Preferred stock, 1,000,000 shares authorized and  none outstanding                                                                                                         |       | —                |       | — |   |
| Common stock, $0.001 par value; 100,000,000 shares  authorized; 35,907,376 and 36,087,044 issued at December 31, 2005 and  December 31, 2004, respectively  |       | 36                    |       | 36 |   |
| Additional paid-in capital                                                                                                                                                 |       | 292,639               |       | 288,335 |   |
| Retained earnings                                                                                                                                                          |       | 82,524                |       | 43,315 |   |
| Deferred compensation                                                                                                                                                      |       | (7,489                | )          | — |   |
| Accumulated other comprehensive loss                                                                                                                                       |       | (4,384                | )          | (87 | ) |
| Stockholders’s  equity before treasury stock                                                                                                                          |       | 363,326               |       | 331,599 |   |
| Less: Treasury stock at  cost,                                                                                                                                             |       |                  |       |   |   |
| Common stock,  1,000,000 shares at December 31, 2005 and 2004                                                                                                         |       | (23,190               | )          | (23,190 | ) |
| Total stockholders’ equity                                                                                                                                            |       | 340,136               |       | 308,409 |   |
| Total liabilities  and stockholders’ equity                                                                                                                           |       | $                     | 529,705    |   | $ | 498,484 |   |

** **

The accompanying notes are an integral part of these consolidated financial statements.

F-3

----

**FIRST HORIZONPHARMACEUTICAL CORPORATIONCONSOLIDATED STATEMENTS OF OPERATIONS(IN THOUSANDS, EXCEPT PER SHARE DATA)**

| ** **                                                    | ** ** | **Year Ended December 31,** | ** ** |
|---------------------------------------------------------------|------------|--------------------------------------------|------------|
| ** **                                                    | ** ** | **2005**                                   | ** ** | **2004** | ** ** | **2003** | ** ** |
| Net revenues                                                  |       | $                                          | 216,358    |   | $ | 151,967 |   | $ | 95,305 |   |
| Operating costs and  expenses:                                |       |                                       |       |   |   |   |   |
| Cost of revenues (exclusive of items shown  separately below) |       | 33,331                                     |       | 29,082 |   | 17,734 |   |
| Selling, general and administrative expense                   |       | 97,386                                     |       | 66,773 |   | 57,822 |   |
| Depreciation and amortization                                 |       | 22,666                                     |       | 16,907 |   | 16,489 |   |
| Impairment charge                                             |       | —                                     |       | — |   | 4,152 |   |
| Research and development expense                              |       | 4,075                                      |       | 1,546 |   | 2,085 |   |
| Total operating costs and expenses                            |       | 157,458                                    |       | 114,308 |   | 98,282 |   |
| Operating income  (loss)                                      |       | 58,900                                     |       | 37,659 |   | (2,977 | ) |
| Other income (expense):                                       |       |                                       |       |   |   |   |   |
| Interest expense                                              |       | (3,013                                     | )          | (2,480 | ) | (194 | ) |
| Interest income                                               |       | 3,209                                      |       | 3,802 |   | 393 |   |
| Other                                                         |       | (710                                       | )          | (12 | ) | (3 | ) |
| Total other income (expense)                                  |       | (514                                       | )          | 1,310 |   | 196 |   |
| Income (loss)  before provision for income taxes              |       | 58,386                                     |       | 38,969 |   | (2,781 | ) |
| (Provision)  benefit for income taxes                         |       | (19,177                                    | )          | (12,415 | ) | 1,043 |   |
| Net income (loss)                                             |       | $                                          | 39,209     |   | $ | 26,554 |   | $ | (1,738 | ) |
| Other  comprehensive income (loss), net of taxes              |       | (4,297                                     | )          | (401 | ) | 264 |   |
| Comprehensive  income (loss)                                  |       | $                                          | 34,912     |   | $ | 26,153 |   | $ | (1,474 | ) |
| Net income (loss) per  common share:                          |       |                                       |       |   |   |   |   |
| Basic earnings (loss) per common share                        |       | $                                          | 1.12       |   | $ | 0.74 |   | $ | (0.05 | ) |
| Diluted earnings (loss) per common share                      |       | $                                          | 0.97       |   | $ | 0.66 |   | $ | (0.05 | ) |
| Weighted average common  shares outstanding:                  |       |                                       |       |   |   |   |   |
| Basic                                                         |       | 35,102                                     |       | 35,761 |   | 35,092 |   |
| Diluted                                                       |       | 42,514                                     |       | 42,429 |   | 35,092 |   |

 

The accompanying notes are an integral part of these consolidated financial statements.

F-4

----

**FIRSTHORIZON PHARMACEUTICAL CORPORATIONCONSOLIDATED STATEMENTS OF STOCKHOLDERS’ EQUITY(IN THOUSANDS, EXCEPT SHARE DATA)**

| ** **                                           | ** ** | ** **              | ** ** | ** **                                  | ** ** | ** **     | ** ** | ** **   | ** ** | ** **   | ** ** | **Accumulated**   | ** **     | ** **   | ** ** |
|------------------------------------------------------|------------|-------------------------|------------|---------------------------------------------|------------|----------------|------------|--------------|------------|--------------|------------|-------------------|----------------|--------------|------------|
| ** **                                           | ** ** | ** **              | ** ** | ** **                                  | ** ** | **Additional** | ** ** | ** **   | ** ** | ** **   | ** ** | **Other**         | ** **     | ** **   | ** ** |
| ** **                                           | ** ** | **Treasury Stock** | ** ** | **Common Stock**                       | ** ** | **Paid-in**    | ** ** | **Deferred** | ** ** | **Retained** | ** ** | **Comprehensive** | ** **     | ** **   | ** ** |
| ** **                                           | ** ** | **Shares**              | ** ** | **Amount**                                  | ** ** | **Shares**     | ** ** | **Amount**   | ** ** | **Capital**  | ** ** | **Compensation**  | ** **     | **Earnings** | ** ** | **Income (Loss)** | ** ** | **Total** | ** ** |
| BALANCE, December 31, 2002                      |       | —                  |       | $      — |       | 35,436,629     |       |         | $ 35  |         |       |              | $ 287,306 |         |       |   | $ (207 | ) |   |   | $ 18,499 |   |   |   | $    50 |   |   | $ 305,683 |   |
| Stock options exercised                              |       | —                  |       | —                                      |       | 1,093,007      |       |         | 1          |         |       |              | 2,552          |         |       |   | — |   |   |   | — |   |   |   | — |   |   | 2,553 |   |
| Employee stock purchase plan                         |       | —                  |       | —                                      |       | 35,031         |       |         | —     |         |       |              | 115            |         |       |   | — |   |   |   | — |   |   |   | — |   |   | 115 |   |
| Shares repurchased and retired                       |       | —                  |       | —                                      |       | (969,225       | )          |         | —     |         |       |              | (3,004         | )            |       |   | — |   |   |   | — |   |   |   | — |   |   | (3,004 | ) |
| Tax benefit from nonqualified stock option exercises |       | —                  |       | —                                      |       | —         |       |         | —     |         |       |              | 1,697          |         |       |   | — |   |   |   | — |   |   |   | — |   |   | 1,697 |   |
| Deferred compensation                                |       | —                  |       | —                                      |       | —         |       |         | —     |         |       |              | —         |         |       |   | 207 |   |   |   | — |   |   |   | — |   |   | 207 |   |
| Net loss                                             |       | —                  |       | —                                      |       | —         |       |         | —     |         |       |              | —         |         |       |   | — |   |   |   | (1,738 | ) |   |   | — |   |   | (1,738 | ) |
| Other comprehensive income                           |       | —                  |       | —                                      |       | —         |       |         | —     |         |       |              | —         |         |       |   | — |   |   |   | — |   |   |   | 264 |   |   | 264 |   |
| BALANCE, December 31, 2003                      |       | —                  |       | $      — |       | 35,595,442     |       |         | $ 36  |         |       |              | $ 288,666 |         |       |   | $     — |   |   |   | $ 16,761 |   |   |   | $  314 |   |   | $ 305,777 |   |
| Stock options exercised                              |       | —                  |       | —                                      |       | 1,537,688      |       |         | 1          |         |       |              | 11,331         |         |       |   | — |   |   |   | — |   |   |   | — |   |   | 11,332 |   |
| Employee stock purchase plan                         |       | —                  |       | —                                      |       | 10,921         |       |         | —     |         |       |              | 129            |         |       |   | — |   |   |   | — |   |   |   | — |   |   | 129 |   |
| Shares repurchased and retired                       |       | —                  |       | —                                      |       | (1,057,007     | )          |         | (1         | )            |       |              | (19,232        | )            |       |   | — |   |   |   | — |   |   |   | — |   |   | (19,233 | ) |
| Tax benefit from nonqualified stock option exercises |       | —                  |       | —                                      |       | —         |       |         | —     |         |       |              | 7,441          |         |       |   | — |   |   |   | — |   |   |   | — |   |   | 7,441 |   |
| Shares repurchased for treasury                      |       | (1,000,000              | )          | (23,190                                     | )          | —         |       |         | —     |         |       |              | —         |         |       |   | — |   |   |   | — |   |   |   | — |   |   | (23,190 | ) |
| Net income                                           |       | —                  |       | —                                      |       | —         |       |         | —     |         |       |              | —         |         |       |   | — |   |   |   | 26,554 |   |   |   | — |   |   | 26,554 |   |
| Other comprehensive loss                             |       | —                  |       | —                                      |       | —         |       |         |       |         |       |              |           |         |       |   |   |   |   |   |   |   |   |   | (401 | ) |   | (401 | ) |
| BALANCE, December 31, 2004                      |       | (1,000,000              | )          | $ (23,190                              | )          | 36,087,044     |       |         | $ 36  |         |       |              | $ 288,335 |         |       |   | $     — |   |   |   | $ 43,315 |   |   |   | $   (87 | ) |   | $ 308,409 |   |
| Stock options exercised                              |       | —                  |       | —                                      |       | 244,077        |       |         | —     |         |       |              | 1,945          |         |       |   | — |   |   |   | — |   |   |   | — |   |   | 1,945 |   |
| Employee stock purchase plan                         |       | —                  |       | —                                      |       | 3,424          |       |         | —     |         |       |              | 56             |         |       |   | — |   |   |   | — |   |   |   | — |   |   | 56 |   |
| Shares repurchased and retired                       |       | —                  |       | —                                      |       | (427,169       | )          |         | —     |         |       |              | (6,534         | )            |       |   | — |   |   |   | — |   |   |   | — |   |   | (6,534 | ) |
| Tax benefit from nonqualified stock option exercises |       | —                  |       | —                                      |       | —         |       |         | —     |         |       |              | 997            |         |       |   | — |   |   |   | — |   |   |   | — |   |   | 997 |   |
| Deferred Compensation                                |       | —                  |       | —                                      |       | —         |       |         | —     |         |       |              | 7,840          |         |       |   | (7,489 | ) |   |   | — |   |   |   | — |   |   | 351 |   |
| Net income                                           |       | —                  |       | —                                      |       | —         |       |         | —     |         |       |              | —         |         |       |   | — |   |   |   | 39,209 |   |   |   | — |   |   | 39,209 |   |
| Other comprehensive loss                             |       | —                  |       | —                                      |       | —         |       |         | —     |         |       |              | —         |         |       |   | — |   |   |   | — |   |   |   | (4,297 | ) |   | (4,297 | ) |
| BALANCE,  December 31, 2005                     |       | (1,000,000              | )          | $ (23,190                              | )          | 35,907,376     |       |         | $36        |         |       |              | $292,639       |         |       |   | $(7,489 | ) |   |   | $82,524 |   |   |   | $(4,384 | ) |   | $340,136 |   |

 

The change inaccumulated other comprehensive income (loss), net of tax, for the year endedDecember 31 is as follows (in thousands): 

| ** **                                                     | ** ** | **2005**      | ** ** | **2004**      | ** ** | **2003**       | ** ** |
|----------------------------------------------------------------|------------|---------------|------------|---------------|------------|----------------|------------|
| Market value adjustments for investments                       |       | $ (163   | )          | $ (1,087 | )          | $  7 |       |
| Foreign currency translation                                   |       | (4,134        | )          | 686           |       | 257            |       |
| Total change in  other comprehensive income (loss), net of tax |       | $ (4,297 | )          | $ (401   | )          | $ 264     |       |

 

Accumulated othercomprehensive income (loss), net of tax, for the year ended December 31 isas follows (in thousands): 

| ** **                                           | ** ** | **2005**      | ** ** | **2004**               | ** ** | ** ** |
|------------------------------------------------------|------------|---------------|------------|------------------------|------------|------------|
| Market value adjustments for investments             |       | $ (1,243 | )          | $ (1,080          | )          |       |
| Foreign currency translation                         |       | (3,141        | )          | 993                    |       |       |
| Total other  comprehensive income (loss), net of tax |       | $ (4,384 | )          | $   (87 | )          |       |

 

The accompanying notes are an integral part of these consolidatedfinancial statements.

F-5

 

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**FIRSTHORIZON PHARMACEUTICAL CORPORATIONCONSOLIDATED STATEMENTS OF CASH FLOWS(IN THOUSANDS)**

| ** **                                                                                          | ** ** | **Year Ended December 31,** | ** ** |
|-----------------------------------------------------------------------------------------------------|------------|--------------------------------------------|------------|
| ** **                                                                                          | ** ** | **2005**                                   | ** ** | **2004** | ** ** | **2003** | ** ** |
| Cash flows from  operating activities:                                                              |       |                                       |       |   |   |   |   |
| Net income (loss)                                                                                   |       | $                                          | 39,209     |   | $ | 26,554 |   | $ | (1,738 | ) |
| Adjustments to reconcile  net income (loss) to net cash provided by (used in) operating activities: |       |                                       |       |   |   |   |   |
| Depreciation and amortization                                                                       |       | 22,666                                     |       | 16,907 |   | 16,489 |   |
| Impairment charge                                                                                   |       | —                                     |       | — |   | 4,152 |   |
| Non-cash interest expense                                                                           |       | 336                                        |       | 293 |   | 77 |   |
| Realized loss on marketable securities                                                              |       | 684                                        |       | — |   | — |   |
| Deferred income tax benefit                                                                         |       | 4,195                                      |       | 5,018 |   | 2,084 |   |
| Non-cash compensation expense                                                                       |       | 351                                        |       | — |   | 207 |   |
| Loss on disposal of property and equipment                                                          |       | —                                     |       | — |   | 12 |   |
| Reduction in taxes payable—stock option exercises                                              |       | 997                                        |       | 7,441 |   | 1,697 |   |
| Changes in assets  and liabilities, net of acquired assets and liabilities:                         |       |                                       |       |   |   |   |   |
| Accounts receivable                                                                                 |       | (24,520                                    | )          | (8,074 | ) | 145 |   |
| Inventories                                                                                         |       | (13,100                                    | )          | (4,636 | ) | 6,256 |   |
| Other current assets and other assets                                                               |       | (15,507                                    | )          | (4,712 | ) | 573 |   |
| Income taxes receivable                                                                             |       | 4,891                                      |       | (599 | ) | (4,839 | ) |
| Accounts payable                                                                                    |       | (2,476                                     | )          | 8,908 |   | (3,942 | ) |
| Accrued expenses and other liabilities                                                              |       | 2,571                                      |       | 2,387 |   | (22,760 | ) |
| Net cash provided by (used in) operating activities                                                 |       | 20,297                                     |       | 49,487 |   | (1,587 | ) |
| Cash flows from  investing activities:                                                              |       |                                       |       |   |   |   |   |
| Purchase of products                                                                                |       | (105,925                                   | )          | — |   | — |   |
| Advance payments for product licenses                                                               |       | —                                     |       | (5,426 | ) | — |   |
| Purchase of property and equipment                                                                  |       | (2,198                                     | )          | (3,484 | ) | (1,791 | ) |
| Proceeds from sales of marketable securities                                                        |       | 97,576                                     |       | — |   | — |   |
| Purchase of marketable securities                                                                   |       | (20,626                                    | )          | (152,422 | ) | (9,985 | ) |
| Net cash used in investing activities                                                               |       | (31,173                                    | )          | (161,332 | ) | (11,776 | ) |
| Cash flows from  financing activities:                                                              |       |                                       |       |   |   |   |   |
| Capitalized financing costs incurred                                                                |       | —                                     |       | (5,015 | ) | (245 | ) |
| Proceeds from long-term debt                                                                        |       | —                                     |       | 150,000 |   | — |   |
| Net proceeds from issuance of common stock                                                          |       | 2,001                                      |       | 11,461 |   | 2,668 |   |
| Acquisition of treasury stock                                                                       |       | —                                     |       | (23,190 | ) | — |   |
| Repurchase of common stock                                                                          |       | (6,534                                     | )          | (19,233 | ) | (3,004 | ) |
| Net cash provided by (used in) financing activities                                                 |       | (4,533                                     | )          | 114,023 |   | (581 | ) |
| Effects of  foreign currency exchange rates on cash                                                 |       | (4,134                                     | )          | 686 |   | 257 |   |
| Net change in  cash and cash equivalents                                                            |       | (19,543                                    | )          | 2,864 |   | (13,687 | ) |
| Cash and cash  equivalents, beginning of period                                                     |       | 36,586                                     |       | 33,722 |   | 47,409 |   |
| Cash and cash  equivalents, end of period                                                           |       | $                                          | 17,043     |   | $ | 36,586 |   | $ | 33,722 |   |

 

The accompanying notes are an integral part of these consolidatedfinancial statements.

F-6

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**FIRSTHORIZON PHARMACEUTICAL CORPORATIONNOTES TO CONSOLIDATED FINANCIAL STATEMENTS**

**1. SUMMARYOF SIGNIFICANT ACCOUNTING POLICIES**

First HorizonPharmaceutical Corporation (the “Company’’), a Delaware Corporation, is aspecialty pharmaceutical company that markets, develops and sells brand nameprescription products. The Company’s key products focus on two therapeuticcategories, Cardiology and Women’s Health.

The Company’s current operating plan focuses first onmaximizing the sales of its existing product portfolio. The Company also plansto accelerate growth by launching line extensions to its current products andby acquiring or licensing approved products or late stage development productsand other businesses. The Company plans to focus on products that complement itsCardiology and Women’s Health categories that will allow the Company toleverage its existing sales force infrastructure.

The Company currently markets and sells 15 products,eight of which are actively promoted and accounted for approximately 89% of totalsales for the year ended December 31, 2005. The Company promotes itsproducts through its nationwide sales and marketing force, targetinghigh-prescribing primary care physicians, endocrinologists, cardiologists,obstetricians and gynecologists.

*Principlesof Consolidation.*The consolidated financial statementsinclude the accounts of the Company and its wholly owned subsidiaries. Allintercompany balances and transactions have been eliminated in consolidation.

*Use ofEstimates.*The preparation of financial statements inconformity with accounting principles generally accepted in the United Statesof America requires management to make estimates and assumptions that affectcertain reported amounts and disclosures. Accordingly, actual results coulddiffer from those estimates.

*Revenue Recognition.*Revenue is recognized when products are delivered and thecustomer takes ownership and assumes risk of loss, collection of the relevantreceivable is probable, persuasive evidence of an arrangement exists and thesales price is fixed or determinable, and are shown net of sales adjustmentsfor discounts, rebates to customers, returns and other adjustments, which areprovided in the same period that the related sales are recorded.

*Revenue Deductions.*Rebate costs, which are recorded as a reduction of sales,include estimated amounts for volume rebate programs, contractual pricereductions with wholesalers and managed care providers, and certain other salesrelated deductions. Provision for these estimated costs are recorded at thetime of sale and are periodically adjusted to reflect actual experiences.

*Product Returns.*The Company’s customers generally may return product from sixmonths prior to the expiration date of the product until twelve months afterexpiration. In accordance with Statement of Financial Accounting Standards (“SFAS”)No. 48, “Revenue Recognition When Right of Return Exists,” a provision forthese estimated returns is recorded at the time of sale based on historicalreturns of the product, product specific information provided by customers andinformation obtained from independent sources regarding the levels of inventorybeing held by customers, as well as overall purchasing patterns by customers.The provision is periodically adjusted to reflect actual experience. Thesecosts are recorded as a reduction of sales.

In connection with theacquisition of product rights, the Company also assumes certain liabilities forreturns of product shipped by the seller prior to the acquisition date. At theacquisition date, the Company estimates the amount of assumed liabilities basedon actual sales return data from the seller. This amount is included in thepurchase price allocation. The Company periodically reviews this estimatedliability.

F-7

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In connection with lineextensions of current products, the Company accrues for returns at thehistorical rate of returns of the previous product line as the line extensionsprovide the same effective relief and treat the same conditions and patientpopulations as the original version.

*Cost               of Revenues.*Costof revenues is comprised of purchased product costs and freight out. Costsrelated to freight-out totaled $0.3 million, $0.5 million and $0.5millions for the years ended December 31, 2003, 2004 and 2005,respectively. The Company does not bill customers for freight costs.

*Royalties.*The Company pays royalties on the sale of certain products.These costs are included in selling, general and administrative expenses in theaccompanying statements of operations. Total royalties were $3.6 million,$5.4 million and $14.9 million for the years ending December 31, 2003,2004 and 2005, respectively.

*Researchand Development.*Research and development expenses consistprimarily of costs incurred to develop formulations, engage contract researchorganizations to conduct clinical studies, test products under development andengage medical and regulatory consultants. The Company expenses all researchand development costs as incurred. Research and development costs were$2.1 million, $1.5 million and $4.1 million for the years ended December 31,2003, 2004 and 2005, respectively.

*Cash andCash Equivalents.*The Company considers only thoseinvestments that are highly liquid, and readily convertible to cash with anoriginal maturity of three months or less to be cash equivalents.

*FinancialInstruments.*The Company classifies its existing marketablesecurities as available-for-sale. These securities are carried at fair marketvalue based on current market quotes, with unrealized gains and losses reportedin stockholders equity as a component of accumulated other comprehensive income(loss). Gains or losses on securities sold are based on the specificidentification method. The Company’s policy is to only invest in high-gradecorporate bonds, government agencies and municipalities. The Company reviewsits investment portfolio as deemed necessary and, where appropriate, adjustsindividual securities for other-than-temporary impairments. The Company doesnot hold securities for speculative or trading purposes.

The Company’s$150.0 million senior subordinated contingent convertible debt had a fairvalue of $180.6 million at December 31, 2004 and $138.1 million at December 31,2005 based on quoted market rates.

TheCompany’s carrying value of other financial instruments approximates fair valuedue to the short maturity of those instruments.

*Concentrationof Credit Risk.*The Company extends credit on anuncollateralized basis primarily to wholesale drug distributors and retailpharmacy chains throughout the U.S. The Company is required to estimate thelevel of accounts receivable which ultimately will not be paid. The Companycalculates this estimate based on prior experience supplemented by a periodiccustomer specific review when needed. Historically, the Company has notexperienced significant credit losses on its accounts. The Company’s threelargest customers accounted for approximately 69% and 66% of accountsreceivable at December 31, 2004 and 2005, respectively.

The mix of sales of theCompany’s products changes as products are added. On a combined basis, productswith sales greater than 10% of the Company’s sales comprised approximately 86%,75% and 73%****of total sales for the yearsended December 31, 2003, 2004 and 2005, respectively.

F-8

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Thefollowing table presents a summary of sales to significant customers as apercentage of the Company’s total revenues:

| **Customer**                   | ** ** | ** ** | ** ** | **2005** | ** ** | **2004** | ** ** | **2003** | ** ** |
|--------------------------------|------------|------------|------------|----------|------------|----------|------------|----------|------------|
| McKesson  Corporation          |       |       | 30         | %        |       |     | 31         | %        |       |   | 29 | % |   |
| Cardinal  Health, Inc.    |       |       | 23         |     |       |     | 25         |     |       |   | 22 |   |   |
| AmerisourceBergen  Corporation |       |       | 10         |     |       |     | 22         |     |       |   | 18 |   |   |

 

The Company’sinternational sales represent less than 1% of sales for the periods presented.

*Segment Reporting.*TheCompany is engaged solely in the business of marketing and selling prescriptionpharmaceutical products. Accordingly, the Company’s business is classified in asingle reportable segment, the sale and marketing of prescription products.Prescription products include a variety of branded pharmaceuticals for thetreatment of cardiovascular, obstetrical and gynecological, pediatric andgastroenterological conditions and disorders.

Thefollowing presents revenues for prescription products by area of treatment forthe years ended December 31, 2003, 2004 and 2005, respectively (inthousands):

| ** **             | ** ** | **2005** | ** ** | **2004** | ** ** | **2003** | ** ** |
|------------------------|------------|----------|------------|----------|------------|----------|------------|
| Cardiovascular         |       | $        | 144,547    |     | $          | 75,252   |       | $ | 43,627 |   |
| Women’s Health(1) |       | 46,614   |       | 22,155   |       | 17,070   |       |
| Non Promoted(1)        |       | 25,197   |       | 54,560   |       | 34,608   |       |
| Net Revenues           |       | $        | 216,358    |     | $          | 151,967  |       | $ | 95,305 |   |

----

(1)          2004 and 2003 amountshave been adjusted to conform to the 2005 promoted products.

*Inventories.*Inventories consist ofpurchased pharmaceutical products and are stated at the lower of cost ormarket. Cost is determined using the first-in, first-out method, and market isconsidered to be net realizable value. Inventories consist of finished productand bulk product awaiting processing and packaging into finished product.Inventories, net of reserves of $0.9 million and $0.5 million at December 31,2004 and 2005, respectively, at December 31, 2004 and 2005 consisted of(in thousands):

| ** **        | ** ** | **2005** | ** ** | **2004** | ** ** |
|-------------------|------------|----------|------------|----------|------------|
| Bulk product      |       | $        | 2,406      |     | $          | 6,882 |   |
| Finished product  |       | 26,518   |       | 8,942    |       |
| Total inventories |       | $        | 28,924     |     | $          | 15,824 |   |

 

*Samples.*Samplesprimarily consist of product samples used in the sales and marketing efforts ofthe Company’s products and are included in other current assets in the Company’sconsolidated balance sheet. Samples are expensed upon distribution as a sellingexpense. Sample inventories, net of reserves of $0.5 million and$0.1 million at December 31, 2004 and 2005, respectively, at December 31,2004 and 2005 were $1.9 million and $9.7 million, respectively.

*Property and Equipment.*Propertyand equipment are recorded at cost, less accumulated depreciation. Majorimprovements, which extend the lives of existing property and equipment, arecapitalized. Expenditures for maintenance and repairs are charged to expense asincurred. Upon retirement or disposal of assets, the cost and relatedaccumulated depreciation are removed from the accounts and any resulting gainor loss is recognized in the statement of operations.

F-9

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Depreciationis provided for on the straight-line basis over the estimated useful lives ofthe assets as follows:

| Office equipment, furniture and fixtures |   | 5 to  7 years                          |   |
|--------------------------------------------------------------|--------|----------------------------------------|--------|
| Computer hardware  and software                              |   | 3 to  5 years                          |   |
| Leasehold improvements                                       |   | useful life of asset or  term of lease |   |

 

Thecomponents of property and equipment at December 31, 2004 and 2005 are asfollows (in thousands):

| ** **                                | ** ** | **2005** | ** ** | **2004** | ** ** |
|-------------------------------------------|------------|----------|------------|----------|------------|
| Office equipment,  furniture and fixtures |       | $        | 572        |     | $          | 607 |   |
| Computer hardware  and software           |       | 7,175    |       | 5,551    |       |
| Leasehold  improvements                   |       | 716      |       | 715      |       |
| Property and  equipment, gross            |       | 8,463    |       | 6,873    |       |
| Less accumulated  depreciation            |       | (3,315   | )          | (1,763   | )          |
| Property and equipment,  net              |       | $        | 5,148      |     | $          | 5,110 |   |

 

Depreciation expenserelated to property and equipment for the years ended December 31, 2003,2004 and 2005 was $0.6 million, $1.2 million and $2.1 million,respectively.

In theevent that facts and circumstances indicate that the carrying amounts ofproperty and equipment may be impaired, an evaluation of recoverability isperformed using the estimated future undiscounted cash flows associated withthe asset compared to the asset’s carrying amount to determine if a write-downis required, pursuant to the provisions of SFAS No. 144 “Accounting forthe Impairment or Disposal of Long-Lived Assets” and its relatedinterpretations. Any impairment loss is measured as the difference between thecarrying amount and the fair value of the impaired asset. The Company believesthere are no impaired assets as of December 31, 2005.

*IntangibleAssets.*Intangible assets, which include license rights,tradenames, managed care contracts and distribution, manufacturing and supplyagreements, are stated at cost, net of accumulated amortization. These costsare capitalized and amortized on a straight-line basis over the estimatedperiods benefited by the asset (1 to 20 years). Amortization of suchassets, excluding distribution, manufacturing and supply agreements, isincluded in depreciation and amortization expense in the accompanyingstatements of operations. Amortization expense for the years ended December 31,2003, 2004 and 2005 totaled $15.9 million, $15.7 million and$20.6 million, respectively. These distribution, manufacturing and supplyagreements are discussed in more detail in Notes 9 and 11.

In accordance with SFAS No. 144,the Company continually reevaluates the propriety of the carrying amount of thedefinite lived intangibles as well as the related amortization period todetermine whether current events and circumstances warrant adjustments to thecarrying values and/or estimates of useful lives. This evaluation is performedusing the estimated projected future undiscounted cash flows associated withthe asset compared to the asset’s carrying amount to determine if a write-downis required. To the extent such projections indicate that the undiscounted cashflows are not expected to be adequate to recover the carrying amounts, theassets are written down to fair value as determined by discounting future cashflows.

In the second quarter of2003, the Company formulated a new sales and marketing strategy upon theCompany hiring Mr. Patrick Fourteau as its then President and ChiefOperating Officer. This new strategy resulted in the discontinuation of thepursuit of a line extension for Cognex as well as the subsequent plans topromote the product. As part of this new strategy, using market research, theCompany updated its forecasts of Cognex sales projections to reflect a lifecycle through June 2013, the period of time that the 

F-10

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Companyexpects it will continue to sell the product in the future. As a result, theestimated useful life of Cognex was decreased from a remaining life of17 years to 10 years, and using the estimated future undiscountedcash flows over the useful life of the product, the intangible asset related toCognex was not projected to be recoverable.

To determine a fair valueof the intangible asset related to Cognex, the Company performed an internalanalysis utilizing a number of factors, including information from anindependent valuation. The Company’s analysis resulted in an impairment chargeof $4.2 million being recorded as of June 30, 2003. The methodologiesused to determine a fair value for Cognex included a combination of a marketapproach, which used a marketable multiple methodology and a comparabletransaction methodology, as well as an income approach, using a discounted cashflow methodology.

TheCompany believes there are no other intangible asset impairments and there wereno other asset write-downs as of December 31, 2005.

*Income Taxes.*Income taxes are provided for under the liability method.This approach requires the recognition of deferred tax assets and liabilitiesfor the expected future tax consequences of differences between the tax basisof assets or liabilities and their carrying amounts in the consolidatedfinancial statements. A valuation allowance is provided for deferred tax assetsif it is more likely than not that these items will either expire before we areable to realize their benefit or if future deductibility is uncertain.

Developingthe provision for income taxes requires significant judgment and expertise infederal, state, and international income tax laws, regulations and strategies,including the determination of deferred tax assets and liabilities and, ifnecessary, any valuation allowances that may be required for deferred taxassets. Our judgments and tax strategies are subject to audit by various taxingauthorities. While we believe we have provided adequately for our income taxliabilities in our consolidated financial statements, adverse determinations bythese taxing authorities could have a material adverse effect on ourconsolidated financial condition and results of operations.

*AdvertisingCosts.*The Company charges the costs of advertising toexpense as incurred. Advertising expenses were $7.3 million,$5.1 million and $11.2 million for the years ended December 31,2003, 2004 and 2005, respectively.

*Foreign CurrencyExposure.*Certain of the Company’s product purchases andsales are denominated in foreign currencies. Gains or losses on foreigncurrency transactions are included in income as incurred. The Company at itsdiscretion enters into short term forward foreign exchange contracts inrelation to certain purchases of three of its products. Historically, theseforward contracts are not designated as hedging instruments and as such, anychange in fair value while open is recognized currently in income. This gain orloss offsets the transaction gain or loss on the underlying foreign denominatedpayables. Foreign denominated payables, receivables and open exchange contractsas of December 31, 2004 and 2005 were not material.

*Stock BasedCompensation.*At December 31, 2005, the Company had fourstock-based employee compensation plans, which are described more fullyin Note 7.

The Company appliesAccounting Principles Board Opinion No. 25, “Accounting for Stock Issuedto Employees,” and related interpretations in accounting for all stock optionsissued to employees. Accordingly, the Company records compensation expense forany stock option grants with exercise prices lower than fair value, recognizedratably over the vesting period. The Company has recognized compensationexpense related to stock option and restricted share grants of$0.2 million, $0.0 million and $0.4 million in the years ended December 31,2003, 2004 and 2005, respectively.

All options granted in theyears ended December 31, 2003, 2004 and 2005 have been granted at exerciseprices equal to fair market value at the date of grant.

F-11

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Theweighted average fair value of options granted during 2003, 2004 and 2005 isestimated at $5.37, $15.70 and $18.14 per share, respectively. The value ofoptions is estimated on the date of the grant using the following weightedaverage assumptions:

| ** **               | ** ** | **2005** | ** ** | **2004** | ** ** | **2003** | ** ** |
|--------------------------|------------|----------|------------|----------|------------|----------|------------|
| Risk-free  interest rate |       | 3.89     | %          | 3.40     | %          | 2.96     | %          |
| Expected dividend  yield |       | —   |       | —   |       | —   |       |
| Expected lives           |       | 5 years  |       | 5 years  |       | 5 years  |       |
| Expected volatility      |       | 115.2    | %          | 125.1    | %          | 134.2    | %          |

 

In2005, the Company issued Restricted Stock to the Board of Directors, executivesand other employees. Issuances in 2005 were as follows:

| **Date of Issuance** | ** ** | ** ** | ** ** | **Shares Issued** | ** ** | **Price of Shares** | ** ** |
|--------------------------------|------------|------------|------------|------------------------|------------|-------------------------------|------------|
| May 31, 2005              |       |       | 12,500     |                   |       |                          | $          | 18.76 |   |   |
| October 31, 2005          |       |       | 530,000    |                   |       |                          | $          | 14.35 |   |   |

 

These shares will vest 25% annually over four years. Forthe years ended December 31, 2003, 2004 and 2005 the Company recorded $0.0million, $0.0 million and $0.4 million in deferred compensation expense relatedto the restricted shares, respectively.

Hadcompensation costs for the Company’s options been determined using the BlackScholes option-pricing models prescribed by SFAS No. 123, “Accountingfor Stock Based Compensation,” the Company’s pro forma net income (loss) percommon share would have been reported as follows (in thousands, except pershare amounts):

| ** **                                                                                                                             | ** ** | **2005** | ** ** | **2004** | ** ** | **2003** | ** ** |
|----------------------------------------------------------------------------------------------------------------------------------------|------------|----------|------------|----------|------------|----------|------------|
| Net income (loss):                                                                                                                     |       |     |       |     |       |     |       |
| As reported                                                                                                                            |       | $        | 39,209     |     | $          | 26,554   |       | $ | (1,738 | ) |
| Add: Stock based  compensation expense recorded                                                                                        |       | 351      |       | —   |       | 207      |       |
| Deduct: Total  stock-based employee compensation expense determined under fair value  based for all awards, net of related tax effects |       | (2,339   | )          | (2,054   | )          | (1,784   | )          |
| Pro forma                                                                                                                              |       | 37,221   |       | $        | 24,500     |     | $          | (3,315 | ) |
| Net income (loss) per  common share—basic:                                                                                        |       |     |       |     |       |     |       |
| As reported                                                                                                                            |       | $        | 1.12       |     | $          | 0.74     |       | $ | (0.05 | ) |
| Pro forma                                                                                                                              |       | $        | 1.06       |     | $          | 0.69     |       | $ | (0.09 | ) |
| Net income (loss) per  common share—diluted:                                                                                      |       |     |       |     |       |     |       |
| As reported                                                                                                                            |       | $        | 0.97       |     | $          | 0.66     |       | $ | (0.05 | ) |
| Pro forma                                                                                                                              |       | $        | 0.92       |     | $          | 0.61     |       | $ | (0.09 | ) |

 

*Earnings Per Share.*Asrequired by SFAS No. 128, “Earnings Per Share,” the Company has presentedbasic and diluted earnings per common share amounts in the accompanyingfinancial statements. Basic earnings per common share are calculated based onthe weighted average common shares outstanding during the year. Dilutedearnings per common share are calculated similarly to basic earnings per commonshare except that the weighted average shares outstanding are increased toinclude additional shares from the assumed exercise of stock options, ifdilutive. The number of additional shares is calculated by assuming thatoutstanding stock options and contingent convertible notes that are dilutivewere exercised or converted and that the proceeds from such exercises, if any,were used to acquire shares of common stock at the average market price duringthe period.

F-12

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Belowis the calculation of basic and diluted net income per common share (inthousands, except per share data):

| ** **                                                         | ** ** | **Year Ended December 31,** | ** ** |
|--------------------------------------------------------------------|------------|--------------------------------------------|------------|
| ** **                                                         | ** ** | **2005**                                   | ** ** | **2004** | ** ** | **2003** | ** ** |
| Net income (loss)                                                  |       | $                                          | 39,209     |   | $ | 26,554 |   | $ | (1,738 | ) |
| Add: Interest  expense on contingent convertible debt (net of tax) |       | 1,929                                      |       | 1,590 |   | — |   |
| Adjusted net  income (loss)                                        |       | $41,138                                    |       | $ | 28,144 |   | $ | (1,738 | ) |
| Weighted average  common shares outstanding—basic             |       | 35,102                                     |       | 35,761 |   | 35,092 |   |
| Dilutive effect  of stock options and restricted stock             |       | 640                                        |       | 1,121 |   | — |   |
| Dilutive effect  of contingent convertible debt                    |       | 6,772                                      |       | 5,547 |   | — |   |
| Weighted average  common shares outstanding—diluted           |       | 42,514                                     |       | 42,429 |   | 35,092 |   |
| Basic net income  (loss) per share                                 |       | $                                          | 1.12       |   | $ | 0.74 |   | $ | (0.05 | ) |
| Diluted net income  (loss) per share                               |       | $                                          | 0.97       |   | $ | 0.66 |   | $ | (0.05 | ) |

 

The number ofoutstanding options (in thousands), which are excluded from the abovecalculation as their impact would be anti-dilutive, are 3.8 million,0.7 million and 0.7 million for the years ended December 31,2003, 2004 and 2005, respectively.

*Foreign Currency Translation.*Assetsand liabilities for non-U.S. subsidiaries are translated from local currenciesto U.S. dollars using exchange rates at the end of the period. Results ofoperations for non-U.S. subsidiaries are translated using average exchangerates for the period. Adjustments resulting from the translation process arereported in a separate component of stockholders’ equity and are not includedin the determination of the results of operations.

*Supplemental Cash Flow Disclosures.*Supplementalcash flow information for the years ended December 31, 2003, 2004 and 2005was as follows (in thousands):

| ** **             | ** ** | **2005** | ** ** | **2004** | ** ** | **2003** | ** ** |
|------------------------|------------|----------|------------|----------|------------|----------|------------|
| Cash paid for  taxes   |       | $        | 8,276      |     | $          | 5,682    |       | $ | 4,856 |   |
| Cash paid for interest |       | $        | 2,957      |     | $          | 1,362    |       | $ | 114 |   |

 

*New AccountingPronouncements*

In July 2005, the Financial Accounting Standards Board (“FASB”) issuedan exposure draft of a proposed interpretation, *Accountingfor Uncertain Tax Positions-an Interpretation of FASB Statement No. 109*(“SFAS No. 109”). This interpretation would apply to all open taxpositions accounted for in accordance with SFAS No. 109, including thoseacquired in business combinations. It is a proposed asset recognition approachto apply a dual threshold for uncertain tax positions. The interpretation wouldallow the recognition of a tax benefit when it is probable that it could besustained upon audit. The interpretation defines “probable” as it is defined inSFAS No. 5, “*Accounting for Contingencies*.”While they have not addressed the effective date, it will not be effective foryear-ended 2005 under their current plans. The Company is currently reviewingthe effect, if any, the proposed guidance will have on its financialstatements.

In May 2005, the FASB issued Statement 154, *“Accounting Changes and Error Corrections, a replacement of APB OpinionNo. 20 and FASB Statement No. 3.” *The standard requires retrospective application to priorperiods’ financial statements of a voluntary change in accounting principleunless it is deemed impracticable, unless the change in accounting  relates to the principle method ofdepreciation, amortization or depletion for long-lived, non-financial assets inwhich case the change is accounted for as a change in accounting estimate thatis affected by a change in accounting principle. The standard is effective foraccounting changes and corrections of errors made occurring in fiscal yearsbeginning after 

F-13

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December 15, 2005. Theadoption of Statement of Financial Accounting Standards (“SFAS”) No. 154is not expected to have a material impact on the Company’s financial positionor results of operations.

In December 2004, the Financial AccountingStandards Board (“FASB”) issued Statement 153, *“Exchangesof Nonmonetary Assets, an amendment of APB Opinion No. 29.”* Thestandard is based on the principle that exchanges of nonmonetary assets shouldbe measured based on the fair value of the assets exchanged and eliminates theexception under ABP Opinion No. 29 for an exchange of similar productiveassets and replaces it with an exception for exchanges of nonmonetary assetsthat do not have commercial substance. The standard is effective fornonmonetary exchanges occurring in fiscal periods beginning after June 15,2005. The adoption of SFAS no. 153 did not have a material impact on theCompany’s financial position or results of operations.

In December 2004, theFASB issued Statement 123 (revised 2004), *“Share-BasedPayment.”* The standard eliminates the disclosure-only election underFAS 123 and requires the recognition of compensation expense for stockoptions and other forms of equity compensation based on the fair value of theinstruments on the date of grant. SFAS 123R is effective for equitycompensation expense in fiscal years beginning after December 15, 2005 andwe will adopt it prospectively on January 1, 2006. See above for thedisclosures of the pro forma dilutive impact on net income and earnings pershare of expensing stock options based on the Black-Scholes Model.

**2. CREDIT FACILITY**

On February 11, 2003,the Company entered into a $20.0 million senior secured revolving creditfacility with various lenders and LaSalle Bank National Association, asadministrative agent. Borrowings may be used for working capital requirementsand general corporate purposes. Borrowings are secured by substantially all ofthe Company’s assets. Borrowings bear interest at the Company’s option at thebase rate in effect from time to time plus an applicable margin or theEurodollar rate, plus an applicable margin. The applicable margin will varydependent upon the Company’s leverage ratio in effect from time to time. Therevolving facility matures on August 11, 2006. The revolving loan containsvarious covenants, including covenants relative to maintaining financial ratiosand earnings levels, limitations on acquisitions, dispositions, mergers andcapital expenditures, limitations on incurring additional indebtedness and aprohibition on payment of dividends and certain issuances of capital stock. Inthe year ended December 31, 2005, the Company utilized the senior securedrevolving credit facility, however as of December 31, 2005 the Company hadrepaid all borrowings on this senior secured revolving credit facility.

**3. MARKETABLE SECURITIES**

The Company classifies its existing marketablesecurities as available-for-sale. All available-for-sale securities areclassified as current as the Company has the ability to use them for currentoperating and investing purposes. There was $0.7 million in realized losses inthe year ended December 31, 2005. At December 31, 2005, the Companyhad total net unrealized losses from marketable securities of$2.0 million.

Thecarrying amount of available-for-sale securities and their approximate fairvalues at December 31, 2005 were as follows (in thousands):

| ** **                                      | ** ** | **Amortized  Cost** | ** ** | **Gross  Unrealized  Gains** | ** ** | **Gross  Unrealized  Losses** | ** ** | **Fair  Value** | ** ** |
|-------------------------------------------------|------------|---------------------|------------|------------------------------|------------|-------------------------------|------------|-----------------|------------|
| U.S. Government  and Federal agency obligations |       |                | $          | 58,227                       |       |                          |       | $               | —     |   |   |   | $ | (1,349 | ) |   | $ | 56,878 |   |
| Corporate bonds                                 |       |                | 26,520     |                         |       |                          | —     |            |       |   | (641 | ) |   | 25,879 |   |
| Total                                           |       |                | $          | 84,747                       |       |                          |       | $               | —     |   |   |   | $ | (1,990 | ) |   | $ | 82,757 |   |

 

F-14

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Thefollowing table presents the age of gross unrealized losses and fair value byinvestment category for all securities in a loss position as of December 31,2005 (in thousands):

| ** **                                      | ** ** | **Less than 12 Months** | ** ** | **12 Months or More** | ** ** | **Total**       | ** ** |
|-------------------------------------------------|------------|----------------------------------------|------------|--------------------------------------|------------|-----------------|------------|
| ** **                                      | ** ** | **Fair  Value**                        | ** ** | **Unrealized  Losses**               | ** ** | **Fair  Value** | ** ** | **Unrealized  Losses** | ** ** | **Fair  Value** | ** ** | **Unrealized  Losses** | ** ** |
| U.S. Government  and Federal agency obligations |       | $                                      | 1,758      |                                 |       | $               | (43        | ) |   | $ | 55,120 |   |   | $ | (1,306 | ) |   | $ | 56,878 |   |   | $ | (1,349 | ) |   |
| Corporate bonds                                 |       | 2,053                                  |       |                                 | (39        | )               |       | 23,826 |   |   | (602 | ) |   | 25,879 |   |   | (641 | ) |   |
| Total                                           |       | $                                      | 3,811      |                                 |       | $               | (82        | ) |   | $ | 78,946 |   |   | $ | (1,908 | ) |   | $ | 82,757 |   |   | $ | (1,990 | ) |   |

 

The Company has determined that its unrealized losseswhich resulted primarily from rising interest rates are temporary based on theminor amount of the losses compared to amortized cost and the ability of the Companyto hold the securities until maturity, as well as the credit worthiness of theinvestee. The Company expects that all losses will be recovered, and intends tohold securities to recovery. If market, industry and/or investee conditionsdeteriorate, we may incur future impairments.

Theamortized cost and estimated fair value of marketable securities at December 31,2005 by contractual maturity are shown below (in thousands):

| ** **                                | ** ** | **Cost** | ** ** | **Estimated  Fair Value** | ** ** |
|-------------------------------------------|------------|----------|------------|--------------------------------|------------|
| Due in one year  or less                  |       | $        | 21,637     |                           |       | $ | 21,353 |   |   |
| Due after one  year through three years   |       | 49,113   |       |                           | 47,809     |   |   |
| Due after three  years through five years |       | 9,467    |       |                           | 9,184      |   |   |
| Due after five years                      |       | 4,530    |       |                           | 4,411      |   |   |
|                                           |            |          |            |                                |            |  |  |  |  |

 

Thecarrying amount of available-for-sale securities and their approximate fairvalues at December 31, 2004 were as follows (in thousands):

| ** **                                      | ** ** | **Amortized  Cost** | ** ** | **Gross  Unrealized  Gains** | ** ** | **Gross  Unrealized  Losses** | ** ** | **Fair  Value** | ** ** |
|-------------------------------------------------|------------|---------------------|------------|------------------------------|------------|-------------------------------|------------|-----------------|------------|
| U.S. Government  and Federal agency obligations |       | $                   | 93,964     |                         |       | $                             | 14         |            |       |   | $ | (1,082 | ) |   | $ | 92,896 |   |
| Corporate bonds                                 |       | 68,443              |       |                         | —     |                          |       |            | (703       | ) |   | 67,740 |   |
| Total                                           |       | $                   | 162,407    |                         |       | $                             | 14         |            |       |   | $ | (1,785 | ) |   | $ | 160,636 |   |

 

 

F-15

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**4. LONG-TERM DEBT**

In March 2004, the Company issued a total of$150.0 million of its 1.75% senior subordinated contingent convertiblenotes due in 2024 in transactions that were exempt from registration inreliance upon Rule 144A and other available exemptions under theSecurities Act. The notes are due March 8, 2024 and accrued interest ispayable semi-annually in arrears on March 8 and September 8 of eachyear. In addition to the interest on the notes, after March 8, 2007, theCompany will also pay contingent interest during specified six-month periods ifthe average trading price of the notes per $1,000 principal amount for the fiveday trading period ending on the third trading day immediately preceding thefirst day of the applicable six-month period equals $1,200 or more. During anyperiod when contingent interest is payable, it will be payable at a rate equalto 0.5% per annum. As this contingent interest feature is based on theunderlying trading price of the notes, the contingent interest qualifies as anembedded derivative. As of December 31, 2005, management determined thatthe fair value of this contingent interest embedded derivative was notmaterial. The net proceeds from this issuance, after deducting offeringexpenses, were approximately $145.4 million. Financing costs of$4.6 million were incurred with the issuance which are being amortized ona straight line basis over the life of the notes and are included in otherassets in the consolidated balance sheet.

Holders of the notes may initially convert the notesinto shares of the Company’s common stock at a conversion rate of 45.1467shares per $1,000 principal amount of the notes, which is equivalent to aconversion price of $22.15 per share, subject to anti-dilution adjustments,before the close of business on March 8, 2024. Holders may convert thenotes only under the following circumstances: (1) during any calendarquarter commencing after June 30, 2004, if the closing sales price of theCompany’s common stock exceeds 120% of the conversion price for at least 20trading days in the 30 consecutive trading days ending on the last trading dayof the preceding calendar quarter; (2) if the notes have been called forredemption; (3) during the five trading day period immediately followingany nine consecutive trading day period in which the trading price of the notesper $1,000 principal amount for each day of that period was less than 95% ofthe product of the closing price of the Company’s common stock and the numberof shares of common stock issuable upon conversion of $1,000 principal amountof the notes; or (4) the occurrence of specified corporate transactions.

The Company has the option to redeem the notesbeginning March 13, 2007 at a price equal to 100% of their aggregateprincipal amount, plus accrued and unpaid interest, including contingentinterest, if any.

The holders of the notes have the option to requirethe Company to repurchase the notes on March 8 of 2009, 2014 and 2019, andupon a change in control, at a price equal to 100% of their aggregate principalamount, plus accrued and unpaid interest, including contingent interest, ifany.

In connection with the issuance of the notes, on March 30,2004 the Company filed a registration statement on Form S-3 with theSecurities and Exchange Commission to register for resale of 6.8 millionshares of the Company’s common stock issuable, subject to anti-dilutionadjustments, upon conversion of the notes. The registration statement becameeffective during the second quarter of 2004.

The Company had no debtother than the aforementioned notes outstanding at December 31, 2005 or December 31,2004.

F-16

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**5. ACCRUED EXPENSES**

Accruedexpenses consist of the following (in thousands):

| ** **                          | ** ** | **2005** | ** ** | **2004** | ** ** |
|-------------------------------------|------------|----------|------------|----------|------------|
| Employee  compensation and benefits |       | $        | 4,111      |     | $          | 1,951 |   |
| Product returns                     |       | 1,090    |       | 1,563    |       |
| Product rebates                     |       | 2,441    |       | 2,031    |       |
| Sales deductions                    |       | 2,802    |       | 2,549    |       |
| Accrued royalties                   |       | 5,082    |       | 1,202    |       |
| Product license  fee                |       | —   |       | 5,000    |       |
| Other                               |       | 2,956    |       | 6,212    |       |
| Total accrued expenses              |       | $        | 18,482     |     | $          | 20,508 |   |

 

**6. STOCKHOLDERS’ EQUITY**

In May 2002, the Company and shareholders amendedthe Certificate of Incorporation to increase the number of authorized shares ofcommon stock to 100,000,000.

In July 2002, the Company announced the adoptionof a shareholder rights plan. The terms of the plan provide for a dividend ofone right to purchase a fraction of a share of a newly created class ofpreferred stock for each share of common stock outstanding as of the close ofbusiness on July 26, 2002, payable on August 9, 2002. The rightsexpire on July 26, 2012 and may only be exercised if certain conditionsare met. Under the Company’s Restated Certificate of Incorporation the Board ofDirectors has the authority, without further action by the stockholders, toissue up to 1,000,000 shares of preferred stock in one or more series and tofix the rights, preferences, privileges and restrictions thereof, includingdividend rights, conversion rights, voting rights, terms of redemption,liquidation preferences, sinking fund terms and the number of shares constitutingany series or the designation of such series, without any further vote oraction by the stockholders. The issuance of preferred stock could adverselyaffect the voting power of holders of common stock and the likelihood that suchholders will receive dividend payments and payments upon liquidation. Theissuance of preferred stock may have the effect of delaying, deferring orpreventing a change in control of the Company, which could have a depressiveeffect on the market price of the common stock. The Company has no present planto issue any shares of preferred stock. As of December 31, 2004 and December 31,2005 there were no shares of preferred stock outstanding.

The Company issued 35,031, 10,921 and 3,424 shares ofcommon stock under its employee stock purchase plan during 2003, 2004 and 2005,respectively. This plan was discontinued June 30, 2005.

In July 2002, the Company announced a sharerepurchase program. This program authorized the repurchase of up to$8 million in common stock until July 2003. Through July 2003,the Company repurchased 823,400 shares of its common stock at an aggregate costof approximately $2.1 million. In August 2003, the Company’s Board ofDirectors authorized the repurchase of up to an additional $7.9 million ofcommon stock and extended the repurchase program to August 2004. In September 2003,the Company repurchased 162,225 shares of common stock at an aggregate cost ofapproximately $1.0 million. Through December 2003, the Company hadrepurchased a total of 985,625 shares of common stock at an aggregate cost ofapproximately $3.1 million. During the six months ended June 2004,the Company repurchased a total of 260,000 shares of common stock at anaggregate cost of approximately $4.6 million. All of these shares wereretired.

In July 2004, the Company’s Board of Directorsauthorized a $20.0 million share repurchase program. The new program,which authorizes the repurchase of up to $5 million of common stock perquarter, became effective in August 2004, terminating and replacing the$10.0 million share repurchase program 

F-17

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authorized by the Company’sBoard of Directors in fiscal 2002. This share repurchase program expired in August 2005.

In the third quarter of 2004, as part of thethen-effective share repurchase program, the Company’s Board of Directorsincreased the per quarter repurchase cap and authorized the Company torepurchase a total of 731,580 shares of common stock, inclusive of the 500,000shares of common stock repurchased from one of Dr. Kapoor’s family partnerships,at an aggregate cost of approximately $13.4 million. These shares havebeen retired. In the fourth quarter of 2004, as part of the plan that becameeffective in August 2004, the Company repurchased 65,427 shares of commonstock. These shares have been retired.

In December 2004, the Company, with Board ofDirectors approval, purchased 1 million shares of common stock at anaggregate cost of approximately $23.2 million which was at a fair marketvalue equal to the December 10, 2004 closing price of the Company’s commonstock as reported by Nasdaq from certain executives and board members and asignificant shareholder of the Company. The Company acquired those shares inpart, to establish a pool of authorized shares that will be available forcontribution to the Company’s Employee Stock Ownership Plan over time as theCompany in its discretion deems appropriate.

The Company adopted a new share repurchase programeffective August 3, 2005, that authorizes the repurchase of up to $20.0million of its outstanding shares of common stock over the next twelve monthswith no periodic sub-limits on the amount of repurchases. This plan replacesall prior share repurchase plans and will expire on August 2, 2006.

In the first quarter of2005, the Company repurchased 127,169 shares of common stock at an average costof $16.44 per share, or $2.1 million. In the  fourth quarter of 2005, the Companyrepurchased 300,000 shares of common stock at an average cost of $14.79 pershare, or $4.4 million. These shares have been retired.

**7. STOCK BASED COMPENSATION**

Pursuant to the Company’s 1997 Non-Qualified StockOption Plan (the “1997 Plan”), the Board of Directors approved the issuance ofoptions to purchase shares of common stock of the Company to various employees.Under the plan, 6,000,000 shares of common stock were reserved for issuance.Vesting periods range from immediate to four years, and options grantedgenerally expire seven years from the date of grant. All options also includeaccelerated vesting provisions in the event of a change in control, as definedin the plan. In 2000, the Company terminated the 1997 Plan and no additionalgrants of stock options will be made under the 1997 Plan. At December 31,2005, 18,000 options remained issued and outstanding under the 1997 Plan.

On February 14, 2000, the Board of Directors andstockholders approved the 2000 Stock Plan (the “2000 Plan”). This plan providesfor the granting of incentive stock options, nonqualified stock options, stockawards or stock bonuses, and sales of stock. The 2000 Plan provides for thegrants of these options and other awards to officers, directors, full- andpart-time employees, advisors and consultants. Only employees may receiveincentive stock options. The Company has reserved 3,000,000 shares of commonstock for issuance under the 2000 Plan. The Company’s compensation committeeadministers the 2000. Plan and has the sole authority to determine the meaningand application of the terms of the plan and all grant agreements, the personsto whom option or stock grants are made, the nature and amount of option orstock grants, the price to be paid upon exercise of each option, the periodwithin which options may be exercised, the restrictions on stock awards, andthe other terms and conditions of awards. All options granted under the 2000Plan include accelerated vesting provisions in the event of a change incontrol, as defined in the plan. The 2000 Plan will terminate in February 2010.In May 2002, the Company determined that no additional options will begranted or awarded under this plan. At December 31, 2005, 280,775 optionsremained issued and outstanding under the 2000 plan.

F-18

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On May 24, 2002, the Board of Directors andstockholders approved the 2002 Stock Plan (the “2002 Plan”). This plan providesfor the granting of incentive stock options, nonqualified stock options, stockawards or stock bonuses, and sales of stock. The 2002 Plan provides for thegrants of these options and other awards to officers, directors, full andpart-time employees, advisors and consultants. Only full-time employees mayreceive incentive stock options. The aggregate number of shares available underthe 2002 plan shall be seven percent of the outstanding shares of common stockon the last day of the preceding fiscal year less any options already grantedunder the 2002 Plan up to a maximum of 3,000,000 shares. The Company’scompensation committee administers the 2002 Plan and has the sole authority todetermine the meaning and application of the terms of the plan and all grantagreements, the persons to whom option or stock grants are made, the nature andamount of option or stock grants, the price to be paid upon exercise of eachoption, the period within which options may be exercised, the restrictions onstock awards, and the other terms and conditions of awards. All options grantedunder the 2002 Plan include accelerated vesting provisions in the event of achange in control, as defined in the plan. On May 7, 2004, the Board ofDirectors and stockholders approved the amendment and restatement of the 2002Plan to reserve an additional 1.5 million shares of common stock forissuance under the Plan. The 2002 Plan will terminate in May 2012. At December 31,2005, 1,726,024 shares were subject to outstanding stock stock-based awards underthe 2002 Plan, and there are 1,024,193 shares available for issue pursuant tostock-based awards under the 2002 Plan.

On June 12, 2003, the Board of Directors approvedthe 2003 Nonqualified Stock Option Plan (the “2003 Plan”). This plan providesfor the granting of nonqualified stock options and stock awards or stockbonuses. The 2003 Plan provides for the grants of these options and otherawards to full and part-time non-executive employees. The aggregate number ofshares available under the 2003 plan is 1,200,000 shares. The Company’scompensation committee administers the 2003 Plan and has the sole authority todetermine the meaning and application of the terms of the plan and all grantagreements, the persons to whom option or stock grants are made, the nature andamount of option or stock grants, the price to be paid upon exercise of eachoption, the period within which options may be exercised, the restrictions onstock awards, and the other terms and conditions of awards. All options grantedunder the 2003 Plan include accelerated vesting provisions in the event of achange in control, as defined in the plan. The 2003 Plan will terminate in June 2013.At December 31, 2005, 554,637 options were issued and outstanding underthe 2003 Plan, and there are 166,968 options available for issue under the 2003Plan.

TheCompany has granted stock options and restricted shares to officers, directors,and employees as follows:

| ** **                             | ** ** | **Number of Shares  Subject to Issuance** | ** ** | **Weighted Average  Exercise Price** | ** ** |
|----------------------------------------|------------|---------------------------------------------------------------|------------|------------------------------------------------|------------|
| Outstanding at  December 31, 2002 |       |                                                          | 3,216,042  |                                           |       |   | 12.34 |   |   |
| Granted                                |       |                                                          | 2,977,725  |                                           |       |   | 6.09 |   |   |
| Canceled                               |       |                                                          | (1,268,780 | )                                              |       |   | 14.19 |   |   |
| Exercised                              |       |                                                          | (1,093,007 | )                                              |       |   | 2.29 |   |   |
| Outstanding at  December 31, 2003 |       |                                                          | 3,831,980  |                                           |       |   | 9.65 |   |   |
| Granted                                |       |                                                          | 1,112,525  |                                           |       |   | 16.64 |   |   |
| Canceled                               |       |                                                          | (588,111   | )                                              |       |   | 17.86 |   |   |
| Exercised                              |       |                                                          | (1,537,688 | )                                              |       |   | 7.37 |   |   |
| Outstanding at  December 31, 2004 |       |                                                          | 2,818,706  |                                           |       |   | 11.97 |   |   |
| Granted                                |       |                                                          | 917,750    |                                           |       |   | 18.10 |   |   |
| Canceled                               |       |                                                          | (370,443   | )                                              |       |   | 12.13 |   |   |
| Exercised                              |       |                                                          | (244,077   | )                                              |       |   | 7.97 |   |   |
| Outstanding at  December 31, 2005 |       |                                                          | 3,121,936  |                                           |       |   | 13.19 |   |   |

 

F-19

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Thefollowing table sets forth the range of exercise prices, number of shares,weighted average exercise price, and remaining contractual lives by similarprice and grant date at December 31, 2005.

| ** **                                             | ** ** | **Outstanding** | ** ** | **Exercisable**                                  | ** ** |
|--------------------------------------------------------|------------|-----------------|------------|--------------------------------------------------|------------|
| **Range of Exercise Price**             | ** ** | ** **      | ** ** | **Outstanding  at  December 31, 2005** | ** ** | **Weighted  Average  Remaining Life** | ** ** | **Weighted  Average  Price** | ** ** | **Exercisable  at  December 31, 2005** | ** ** | **Weighted  Average  Price** | ** ** |
| $ 1.67 -  $ 3.04                        |       |            | 217,773    |                                             |       |   | 4.3 years |   |   |   | $ | 2.48 |   |   |   | 76,240 |   |   |   | $ | 2.46 |   |   |
|    3.15  -     4.89 |       |            | 343,180    |                                             |       |   | 4.5 years |   |   |   | 3.61 |   |   |   | 117,043 |   |   |   | 3.78 |   |   |
|    5.08  -     8.08 |       |            | 129,452    |                                             |       |   | 3.6 years |   |   |   | 6.17 |   |   |   | 71,427 |   |   |   | 5.96 |   |   |
|  10.47 -   12.00                        |       |            | 563,107    |                                             |       |   | 4.9 years |   |   |   | 11.16 |   |   |   | 370,982 |   |   |   | 11.31 |   |   |
|  13.38 -   19.86                        |       |            | 710,306    |                                             |       |   | 5.4 years |   |   |   | 15.83 |   |   |   | 137,229 |   |   |   | 15.63 |   |   |
|  20.28 -   29.20                        |       |            | 615,618    |                                             |       |   | 5.1 years |   |   |   | 22.19 |   |   |   | 469,527 |   |   |   | 22.05 |   |   |
| Restricted shares                                      |       |            | 542,500    |                                             |       |   | 6.8 years |   |   |   | N/A |   |   |   | — |   |   |   | N/A |   |   |
| Total                                                  |       |            | 3,121,936  |                                             |       |   |   |   |   |   |   |   |   |   | 1,242,448 |   |   |   |   |   |   |
|                                                        |            |                 |            |                                                  |            |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

 

Upon the exercise of outstanding options, the Companybecame entitled to a tax effected benefit of $1.7 million,$7.4 million and $1.0** **millionin fiscal 2003, 2004 and 2005, respectively, which represents the tax benefitto the Company for tax deductions for options exercised in each year. Theimpact of the benefit has been credited to additional paid-in capital.

The Company applies Accounting Principles BoardOpinion No. 25, “Accounting for Stock Issued to Employees,” and relatedinterpretations in accounting for all stock options issued to employees.Accordingly, the Company records compensation expense for any stock optiongrants with exercise prices lower than fair value, recognized ratably over thevesting period. The Company has recognized compensation expense related tostock option and restricted share grants of $0.2 million, $0.0 million and$0.4 million in the years ended December 31, 2003, 2004 and 2005, respectively.

The Company adopted an employee stock purchase plan onFebruary 14, 2000 which was terminated on June 30, 2005. The purchaseplan was intended to qualify as an employee stock purchase plan within themeaning of Section 423 of the Internal Revenue Code. The Company hadreserved 750,000 shares of common stock for the stock purchase plan. In orderto participate in the stock purchase plan, employees were required to meeteligibility requirements, including length of employment. Participatingemployees were able to direct the Company to make payroll deductions of up to7.0% of their compensation during an offering period for the purchase of sharesof the Company’s common stock. Each offering period was six months. The stockpurchase plan provided participating employees with the right, subject tospecific limitations, to purchase the Company’s common stock at a price equalto 85.0% of the lesser of the fair market value of the Company’s common stockon the first or last day of the offering period. The Board of Directors had theauthority to amend, suspend or discontinue the stock purchase plan as long asthe change would not adversely affect participants without their consent and aslong as the Company received the stockholder approval required by law.

F-20

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**8. INCOME TAXES**

Theincome tax (provision) benefit for the years ended December 31, 2003, 2004and 2005, respectively, consisted of the following (in thousands):

| ** ** | ** ** | **2005** | ** ** | **2004** | ** ** | **2003** | ** ** |
|------------|------------|----------|------------|----------|------------|----------|------------|
| Current    |       | $        | (14,982    | )        | $          | (7,397   | )          | $ | 3,127 |   |
| Deferred   |       | (4,195   | )          | (5,018   | )          | (2,084   | )          |
|       |       | $        | (19,177    | )        | $          | (12,415  | )          | $ | 1,043 |   |

 

Areconciliation of the statutory rate to the effective rate as recognized in thestatements of operations is as follows:

| ** **                                | ** ** | **2005** | ** ** | **2004** | ** ** | **2003** | ** ** |
|-------------------------------------------|------------|----------|------------|----------|------------|----------|------------|
| Federal statutory rate                    |       | 35.0     | %          | 35.0     | %          | 34.5     | %          |
| State income tax, net of  federal benefit |       | 1.9      |       | 2.7      |       | 3.3      |       |
| International income tax                  |       | (3.2     | )          | (5.7     | )          | —   |       |
| Change in valuation  reserve              |       | (1.6     | )          | 0.1      |       | 32.9     |       |
| Non-deductible  expenses and other        |       | 0.7      |       | (0.2     | )          | (33.2    | )          |
|                                      |       | 32.8     | %          | 31.9     | %          | 37.5     | %          |

 

Deferredtax assets and liabilities reflect the impact of temporary differences betweenthe carrying amounts of assets and liabilities for financial reporting purposesand the amounts recognized for income tax purposes. Significant components ofthe Company’s deferred tax assets and liabilities as of December 31, 2004and 2005 are as follows (in thousands):

| ** **                             | ** ** | **2005** | ** ** | **2004** | ** ** |
|----------------------------------------|------------|----------|------------|----------|------------|
| Deferred tax assets:                   |       |     |       |     |       |
| Accrued returns                        |       | $        | 559        |     | $          | 610 |   |
| Accrued liabilities and  reserves      |       | 2,168    |       | 1,299    |       |
| Net operating loss  carryforward       |       | 53       |       | 887      |       |
| Charitable contributions  carryforward |       | 2,483    |       | 3,191    |       |
| Other assets                           |       | 1,180    |       | 1,163    |       |
| Total deferred tax  assets.            |       | $        | 6,443      |     | $          | 7,150 |   |
| Deferred tax liabilities:              |       |     |       |     |       |
| Intangibles                            |       | $        | 3,027      |     | $          | 2,600 |   |
| Interest accrual                       |       | 7,539    |       | 3,511    |       |
| Other liabilities                      |       | 932      |       | 970      |       |
| Total deferred tax  liabilities        |       | $        | 11,498     |     | $          | 7,081 |   |
| Valuation allowance                    |       | 43       |       | 1,054    |       |
| Net deferred tax liabilities           |       | $        | (5,098     | )        | $          | (985 | ) |

 

At December 31, 2005,the Company had net operating loss carryforwards for state income tax purposesof approximately $0.1** **million,tax effected, expiring at various dates through 2024. At December 31,2005, the Company had charitable contribution carryforwards of $2.5** **million, tax effected, expiring at various datesthrough 2009.

For any deferred taxassets where the Company determines that it is more likely than not that adeferred tax asset would not be recovered, the Company records a valuationallowance. The valuation allowance for deferred tax assets decreased by$1.0 million in 2005 primarily as a result of the Company forecasting fullutilization of its charitable contribution carryforwards. Before the provisionfor income taxes, domestic income was $50.5 million and foreign income was$7.9 million for the year ended December 31, 2005.

F-21

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At December 31, 2005,the Company had an aggregate of $14.9 million of unremitted earnings of foreignsubsidiaries that have been or are intended to be permanently reinvested forcontinued use in foreign operations and that, if distributed, would result intaxes at approximately that U.S. statutory rate.

**9.ACQUISITIONS AND INTANGIBLE ASSETS**

On January 29, 1999,the Company acquired exclusive rights in the U.S. to Robinul and Robinul Fortetablets from American Home Products Corporation (“AHP”) for $4.0 millionin cash with an additional $1.8 million financed by the seller. Pursuantto the acquisition, the Company also assumed liabilities of $0.2 millionfor returns of products shipped by the seller prior to the acquisition date.The Company has recorded the total purchase price for this acquisitionincluding the liabilities assumed to the licensing rights within intangibleassets in its financial statements. The licensing rights are being amortizedover an estimated economic life of 20 years. The Company agreed to payroyalties on net sales as long as the Company sells the product.

On April 14, 2000,the Company acquired exclusive rights from Warner-Lambert Company, asubsidiary of Pfizer, to distribute, market, and sell the drug Ponstel in theU.S. for $9.5 million in cash and a $3.5 million promissory note tothe seller. The Company also assumed liabilities of $1.1 million forcertain returns of products shipped by the seller prior to the acquisitiondate, and returned after October 20, 2000. The Company financed$9.5 million of the transaction under a bridge loan agreement. Both thebridge loan and promissory note were paid in full in June 2000 upon thereceipt of proceeds from the Company’s initial public offering. The acquisitionagreement includes the purchase of the license rights and certain trademarks.The value allocated to tradename and license rights is being amortized overtheir estimated useful lives of 20 years. In addition, the Company agreedto purchase the entire outstanding inventory of Ponstel for approximately$0.1 million.

On June 22, 2000, theCompany acquired exclusive rights from Warner-Lambert Company, asubsidiary of Pfizer, to market, distribute and sell the drug Cognex and a newunapproved version of Cognex called Cognex CR, in the U.S. and other countriesfor $3.5 million in cash. The Company must also pay up to$1.5 million in additional purchase price if the Company obtains FDAapproval to market Cognex CR. The Company also assumed liabilities of$0.8 million for returns of products shipped by Warner-Lambert priorto the acquisition date, and returned after June 22, 2001.  The purchase price was allocated among thefair values of intangible assets (primarily tradename and licensing rights) andliabilities assumed and was being amortized over 20 years.

In 2003, the Company updatedits forecasts of Cognex sales projections to reflect a life cycle through June 2013,the period of time that the Company expects it will continue to sell theproduct in the future. As a result, the estimated useful life of Cognex wasdecreased from a remaining life of 17 years to 10 years, and usingthe estimated future undiscounted cash flows over the useful life of theproduct, the intangible asset related to Cognex was not projected to berecoverable.

To determine a fair valueof the intangible asset related to Cognex, the Company performed an internalanalysis utilizing a number of factors, including information from anindependent valuation. The Company’s analysis resulted in an impairment chargeof $4.2 million being recorded as of June 30, 2003. The methodologiesused to determine a fair value for Cognex included a combination of a marketapproach, which used a marketable multiple methodology and a comparabletransaction methodology, as well as an income approach, using a discounted cashflow methodology.

In June 2003, theCompany reviewed the estimated assumed liability for sales returns for theCognex products. This review is performed by the Company on a periodic basisand is done for all acquisitions. From this review, the Company determined thatthe established reserves for Cognex were in excess of the currently expectedreturns. As a result of the revised estimate, the Company reduced the liabilityand increased net revenues by $0.6 million in June 2003.

F-22

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In December 2003, theCompany reviewed the estimated assumed liability for sales returns for Ponstel.This review is performed by the Company on a periodic basis and is done for allacquisitions. From this review, the Company determined that the establishedreserves for Ponstel were in excess of the currently expected returns. As aresult of the revised estimate, the Company reduced the liability and increasednet revenues by $0.1 million in December 2003.

On August 20, 2001,the Company acquired from Sanofi-Synthelabo Inc. (“Sanofi”) thePrenate line of prescription prenatal vitamins (the “Prenate Acquisition”). Thepurchase price was $51.9 million in cash and the assumption of liabilitiesof $0.9 million for returns of product shipped by Sanofi prior to theacquisition date, and returned after February 20, 2002 and for estimatedcontractual price reductions with wholesalers and insurance providers. Theagreement includes the purchase of the Prenate license rights, certaintradenames and managed care contracts and a supply agreement. The purchaseprice was allocated among the fair values of the intangible assets acquired andthe liabilities assumed and is being amortized over a period of 3 to20 years. The managed care contracts are being amortized over a period of5 years and the supply agreement is being amortized over a period of3 years. All other intangibles are being amortized over 20 years. Theweighted average amortization period is 17 years. In addition, the Companypurchased the outstanding inventory of Prenate for approximately $0.1 million.

In June 2003, theCompany reviewed the estimated assumed liability for sales returns for thePrenate products. This review is performed by the Company on a periodic basisand is done for all acquisitions. From this review, the Company determined thatthe established reserves for the Prenate products were in excess of thecurrently expected returns. As a result of the revised estimate, the Companyreduced the liability and increased net revenues by $0.4 million in June 2003.

On December 21, 2001,the Company acquired from Dura Pharmaceuticals Inc., an affiliate of ElanPharmaceuticals PLC (“Elan”), the U.S. rights to Furadantin, a prescriptiondrug used for the treatment of urinary tract infections in children, for$15.8 million in cash plus acquisition costs of approximately$0.2 million and the assumption of liabilities of $0.3 million forthe return of product shipped by Elan prior to the acquisition date returnedafter December 31, 2002. The purchase price was allocated among the fairvalue of the intangible assets acquired and liabilities assumed and is beingamortized over a weighted average amortization period of 17 years. Thepurchase included all assets related to Furadantin, including the NDA and thetrademark. The license rights and tradename are being amortized over20 years. Additionally, the Company purchased the outstanding inventory ofFuradantin for $0.3 million.

In December 2003, theCompany reviewed the estimated assumed liability for sales returns forFuradantin. This review is performed by the Company on a periodic basis and isdone for all acquisitions. From this review, the Company determined that theestablished reserves for Furadantin were in excess of the currently expectedreturns. As a result of the revised estimate, the Company reduced the liabilityand increased net revenues by $0.1 million in December 2003.

On March 6, 2002, theCompany acquired from AstraZeneca UK Limited certain U.S. rights relating tothe antihypertensive prescription medication Sular. The Company also enteredinto a long-term manufacturing, supply, and distribution agreement with Sular’scurrent manufacturer, Bayer AG. The aggregate purchase price paid was$184.3 million in cash, including $0.6 million in acquisition costs,plus the assumption of liabilities of $1.9 million related to the returnof product shipped prior to the acquisition date. In addition, the Company mustpay up to $30.0 million in additional purchase price after closing, basedon the achievement of certain performance milestones during a specified periodof time. The agreements include the purchase of the Sular license rights,certain tradenames and managed care contracts and a distribution agreement. Thepurchase price also included $5.7 million of product inventory. The purchaseprice was allocated among the fair values of the intangible and tangible assetsacquired and the liabilities assumed and is being amortized over a period of 5to 20 years. The weighted average amortization period is 19 years.The results of Sular are included in the consolidated statements of operationsfrom March 6, 2002.

F-23

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In December 2004, theCompany recorded an additional $5.0 million in purchase price forlicensing rights of Sular as a result of the Company reaching a performancemilestone in the original agreement. This milestone is being amortized over theremaining useful life of the asset.

In May 2004, the Companyentered into an agreement with SkyePharma PLC granting us the exclusive licensefor a term of at least 15 years to market and distribute a fenofibrate productin the U.S. that was approved by the FDA in May 2005. We have sincecommenced marketing and distribution of this product, labeled Triglide. We havealso obtained the right of first refusal to negotiate a license to develop andcommercialize a future cardiovascular product utilizing the SkyePharma deliverytechnology. We paid $20.0 million to SkyePharma for these rights. We utilizeour sales force to market the product and pay SkyePharma 25% of the product’snet sales which includes cost of goods sold. Further, SkyePharma hascontributed $2.5 million toward our sales and marketing efforts, includingproduct samples for the year ended December 31, 2005, and will provide upto an additional $2.5 million in 2006. Over the term of the agreement, upon ourachievement of certain sales levels, SkyePharma can receive up to$30.0 million in additional milestone payments.

In February 2005, weamended the agreement with SkyePharma. This amendment provided for SkyePharmato deliver the fenofibrate product so that we could launch the product in thethird****quarter of 2005. To provide additionalassistance with our launch of the product, SkyePharma agreed to provideadditional marketing support. In January 2006, we further amended ouragreement with SkyePharma. In this amended agreement, SkyePharma increased itscontribution toward our sales and marketing efforts from $5.0 million to $11.3million and the parties further defined their obligations with respect to thepayment for samples.

In May 2005, the USFood and Drug Administration granted approval for Triglide, a novel fenofibrateformulation that employs one of SkyePharma’s proprietary solubilizationtechnologies. The Company obtained exclusive US marketing rights in 2004 toTriglide. Under its Agreement with SkyePharma, the Company made a payment of$15 million to SkyePharma as a result of the approval during the quarter ended June 30,2005.  SkyePharma is also entitled toroyalties on net sales, as defined. The intangible asset recorded in connectionwith the acquisition of Triglide is being amortized over a period of 15 years.

In March 2005, theCompany acquired the worldwide rights to Fortamet and Altoprev from AndrxCorporation. As of December 31, 2005, the Company has paid Andrx$85.0 million. Andrx is also entitled to royalties on net sales of theseproducts.

With the assistance ofvaluation experts, the Company allocated the purchase price to the fair valueof the various intangible assets acquired from Andrx Corporation, which are notdeemed to have an indefinite life. Intangible assets are amortized on astraight-line basis over their respective useful lives. The intangible assetsrecorded in connection with the acquisition of Fortamet and Altoprev is beingamortized over a period of 15 years.

The followingtable reflects the components of all intangible assets as of December 31,2005 (in thousands):

| ** **                      | ** ** | **Gross Amount** | ** ** | **Accumulated  Amortization** | ** ** | **Net Amount** | ** ** | **Average Life** | ** ** |
|---------------------------------|------------|-----------------------|------------|-------------------------------|------------|---------------------|------------|-----------------------|------------|
| Licensing rights                |       |                  | $          | 356,040                       |       |                |       | $                     | (59,642    | ) |   |   | $ | 296,398 |   |   | 10 to 20 years |   |
| Trade names                     |       |                  | 11,060     |                          |       |                | (2,293     | )                     |       |   | 8,767 |   |   | 15 to 20 years |   |
| Contracts                       |       |                  | 8,300      |                          |       |                | (6,492     | )                     |       |   | 1,808 |   |   | 5 years |   |
| Supply/Distribution  agreements |       |                  | 10,350     |                          |       |                | (3,951     | )                     |       |   | 6,399 |   |   | 1 to 10 years |   |
| Other intangibles               |       |                  | 3,108      |                          |       |                | (682       | )                     |       |   | 2,426 |   |   | 20 years |   |
| Total                           |       |                  | $          | 388,858                       |       |                |       | $                     | (73,060    | ) |   |   | $ | 315,798 |   |   |   |   |

 

F-24

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Thefollowing table reflects the components of all intangible assets as ofDecember 31, 2004 (in thousands):

| ** **                      | ** ** | **Gross Amount** | ** ** | **Accumulated  Amortization** | ** ** | **Net Amount** | ** ** | **Average Life** | ** ** |
|---------------------------------|------------|-----------------------|------------|-------------------------------|------------|---------------------|------------|-----------------------|------------|
| Licensing rights                |       |                  | $          | 249,715                       |       |                |       | $                     | (41,285    | ) |   |   | $ | 208,430 |   |   | 20 years |   |
| Tradenames                      |       |                  | 11,060     |                          |       |                | (1,739     | )                     |       |   | 9,321 |   |   | 20 years |   |
| Contracts                       |       |                  | 8,300      |                          |       |                | (4,832     | )                     |       |   | 3,468 |   |   | 5 years |   |
| Supply/Distribution  agreements |       |                  | 11,490     |                          |       |                | (4,056     | )                     |       |   | 7,434 |   |   | 1 to 10 years |   |
| Other intangibles               |       |                  | 3,082      |                          |       |                | (1,782     | )                     |       |   | 1,300 |   |   | 20 years |   |
| Total                           |       |                  | $          | 283,647                       |       |                |       | $                     | (53,694    | ) |   |   | $ | 229,953 |   |   |   |   |

 

Amortizationis calculated on a straight-line basis over the estimated useful life of theintangible asset. Estimated annual amortization expense for each of the 5succeeding fiscal years is as follows (in thousands):

| **Year ending December 31,** | ** ** | ** ** | ** ** | ** ** | ** ** |
|---------------------------------------------|------------|------------|------------|------------|------------|
| 2006                                        |       | $          | 23,134     |       |
| 2007                                        |       | 21,828     |       |
| 2008                                        |       | 21,577     |       |
| 2009                                        |       | 21,509     |       |
| 2010                                        |       | 21,476     |       |
|                                             |            |            |            |            |            |  |

 

**10. LICENSE AGREEMENTS AND PRODUCT RIGHTS**

In January 1999, theCompany acquired exclusive rights in the U.S. to Robinul and Robinul Fortetablets from American Home Products Corporation. The Company must pay royaltieson net sales under its license agreement with American Home Products. TheCompany entered agreements with Mikart, dated April 23, 1999 andJanuary 21, 2001, for Mikart to become qualified under applicableregulations to manufacture and supply the Company’s requirements for Robinul.Mikart became qualified by the FDA to manufacture Robinul on December 3,2001 and began supplying the Robinul products to the Company in December 2001.Under these agreements, Mikart will manufacture the products for 5 yearsfrom the time Mikart became a qualified manufacturer plus renewal terms of oneyear until either party elects not to renew. The agreement with Mikart requiresthat the Company purchase certain designated minimum quantities.

In January 2002, theCompany entered into a license agreement with Wyeth-AyerstCanada Inc. and Whitehall-Robins Inc. under which the Companyacquired rights to have the product manufactured, and to market and sellRobinul and Robinul Forte in Canada. The Company will pay Wyeth-AyerstCanada a royalty on net sales of Robinul in Canada. We do not currently haveplans to market or sell Robinul or Robinul Forte in Canada.

In July 1999, theCompany acquired exclusive U.S. rights to distribute, market and sellNitrolingual from Pohl-Boskamp beginning on February 1, 2000 for fiveyears plus an additional five-year renewal period. In October 2004, thedistribution agreement was renewed for an additional five years with anadditional renewal period of two years. In 2005, we amended our agreement withPohl-Boskamp. The amended agreement terminates in 2010 with additional two-yearrenewal periods. Under the agreement, we must pay a royalty on net sales of theproduct. Also, Pohl-Boskamp can terminate our distribution agreement forNitrolingual if a company with a product competitive with Nitrolingual acquiresdirect or indirect influence or control over us. Our agreement withPohl-Boskamp prohibits us from selling other products which are indicated forthe relief of angina pectoris. Aventis had exclusive rights throughJanuary 2000 to a version of the product containing CFC named Nitrolingualspray. To promote earlier 

F-25

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adoptionof Nitrolingual Pumpspray, the Company obtained exclusive rights from Aventisto market this CFC product in the U.S. as of November 22, 1999.

In March 2002, theCompany acquired exclusive U.S. rights to distribute and sell Sular fromAstraZeneca PLC and Bayer Health. We paid $184.3 million in cash,including $0.6 million in acquisition costs, plus the assumption ofliabilities of $1.9 million related to the return of product shipped priorto the acquisition date. In December 2002, we increased our estimates forassumed liabilities by $0.7 million. Under the asset purchase agreement,we acquired the regulatory approval to sell Sular in the U.S., currentinventory, licensing rights to certain intellectual property, marketingmaterials for the promotion, advertising and marketing of Sular in the U.S.,study materials relating to clinical studies of Sular, and certain ofAstraZeneca’s contracts relating to the marketing, sale and distribution ofSular. We were required to pay AstraZeneca up to an additional$20.0 million upon achievement of certain sales milestones throughFebruary 2005. As of December 31, 2004, we calculated that we owedAstraZeneca $5.0 million for reaching these milestones which we paid inMarch 2005. We did not owe nor make any other milestone payments in 2005.

In March 2002, wealso entered into a ten-year agreement with Bayer, which appoints us as theexclusive party to sell and distribute Sular in the U.S., provides us with therights to sell Sular under certain patents and other technical informationowned by Bayer, assigns us the Sular trademark, and provides for themanufacture and supply of Sular to us. We pay Bayer for the manufacture andsupply of Sular on a unit basis. The unit price to us for Sular may adjustbased upon changes in the net revenue per unit that we recognize in the sale ofSular. We must also pay Bayer an additional $10.0 million upon theachievement of a certain sales milestone for Sular if a sales threshold isachieved during the ten year term of the agreement. In December 2005, weamended our agreement with Bayer. The amended agreement modified the applicablemilestones and increased protection from foreign exchange rate fluctuations. InJanuary 2006, we owed $5.0 million to Bayer under the amended agreement.This payment was made in January 2006. Under the amended agreement, we mustpurchase minimum quantities of Sular from Bayer through March 2007 and wemust obtain the consent of Bayer prior to selling another product containingthe active ingredient in Sular.

Subject to obtaining theconsent of Bayer prior to conducting clinical trials for new cardiovascularindications for Sular and in the event that we receive an NDA approval forthese new uses, we may deduct a percentage of the costs incurred to obtain suchapproval, up to a certain amount, from our payments to Bayer under the amendedagreement for five years following such approval. Bayer will have access to anydata that we obtain pursuant to such trials and we will grant Bayer aroyalty-free license to use such data outside of the U.S.

In March 2005, theCompany licensed and purchased certain rights to the type 2 diabetesprescription medication Fortamet and the cholesterol medication Altoprev fromAndrx Laboratories. We paid $50.0 million for the Fortamet rights at closingand have paid $35.0 million for the Altoprev rights, a portion of which issubject to Andrx’s continuing ability to satisfy certain manufacturing servicelevels. We (i) purchased the Fortamet and Altoprev trademarks, worldwidemarketing rights to Fortamet and Altoprev, certain Fortamet inventory, andmarketing materials for the promotion, advertising and marketing of Fortametand Altoprev, (ii) assumed certain of Andrx’s contracts relating to thesale of Fortamet and Altoprev and (iii) will pay Andrx a percentage of thenet revenues associated with Fortamet and Altoprev on an ongoing basis. We alsoentered into an exclusive license agreement for the regulatory approvals tosell Fortamet and Altoprev in the United States.

We also entered into along-term manufacturing and supply agreement appointing Andrx as manufacturerof Fortamet and Altoprev. The terms of the agreement require us to pay Andrxfor the manufacture of Fortamet and Altoprev on a per unit basis for a ten yearterm, subject to Andrx’s ability to terminate as of the conclusion of theseventh year. The unit price may adjust based on changes in the cost of theactive pharmaceutical ingredients as well as changes in an annual inflationaryindex.

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In May 2004, the Companyentered into an agreement with SkyePharma PLC granting us the exclusive licensefor a term of at least 15 years to market and distribute a fenofibrate productin the U.S. that was approved by the FDA in May 2005. We have sincecommenced marketing and distribution of this product, labeled Triglide. We havealso obtained the right of first refusal to negotiate a license to develop andcommercialize a future cardiovascular product utilizing the SkyePharma deliverytechnology. We paid $20.0 million to SkyePharma for these rights. We utilizeour sales force to market the product and pay SkyePharma 25% of the product’snet sales which includes cost of goods sold. Further, SkyePharma hascontributed $2.5 million toward our sales and marketing efforts and provided uswith free product samples for the year ended December 31, 2005, and willprovide up to an additional $2.5 million in 2006. Over the term of theagreement, upon our achievement of certain sales levels, SkyePharma can receiveup to $30.0 million in additional milestone payments.

In February 2005, weamended the agreement with SkyePharma. This amendment provided for SkyePharmato deliver the fenofibrate product so that we could launch the product in thethird****quarter of 2005. To provide additionalassistance with our launch of the product, SkyePharma agreed to provideadditional marketing support. In January 2006, we further amended ouragreement with SkyePharma. In this amended agreement, SkyePharma increased itscontribution toward our sales and marketing efforts from $5.0 million to $11.3million and the parties further defined their obligations with respect to thepayment for samples.

In December 2000, theCompany signed an agreement with Westward Pharmaceuticals to manufacturePonstel. This agreement expires in April 2006 subject to automatic annualrenewals. The Company must purchase all of its requirements for Ponstel from Westwardand is subject to minimum purchase requirements. The Company must pay Westwarda price for Ponstel based on a multiple of Westward’s direct cost of goods soldin the manufacture and supply of the product. In addition, the Company must payWestward milestone payments, as long as no generics have been introduced, uponcertain anniversary dates of FDA approval of the manufacture of Ponstel by Westward.During 2004, the Company paid $0.3 million in milestone payments to Westward.The Company filed a site transfer application with the FDA and receivedapproval in February 2004. Westward supplies Cognex to us pursuant to anagreement that expires March 4, 2008 and is renewable for two years. Forthe Cognex product, the Company negotiated a supply agreement with a Warner-Lambertaffiliate to continue to manufacture and supply Cognex and the activeingredient in Cognex for 2 years subject to a one-year renewal. TheCompany will pay Warner-Lambert’s affiliate a production fee for itsmanufacture of Cognex and the active ingredient. The supply agreement containsdesignated quantities of Cognex and its active ingredient that Warner-Lambert’saffiliate will supply and that the Company must purchase.

For the Prenate productline, under the terms of the asset purchase agreement, the Company was assigneda contract between Sanofi and Patheon Inc. to manufacture the productline. The Company finalized a new manufacturing agreement with Potheon in 2005to manufacture Prenate Elite. This agreement expires in January 2009. TheCompany also assumed a supply and packaging agreement with BannerPharmacaps Inc. (“Banner”) and Sanofi for the supply and packaging of theproducts. Under the terms of the supply agreement with Banner, as amended, theCompany will pay Banner a royalty on net sales. The agreement with Banner wasterminated in December 2004 as the Company discontinued Prenate GT andPrenate Advance.

Each of the Company’sthird-party manufacturing agreements requires that the Company purchaseall of their product requirements from the manufacturers that are a party tothose agreements.

The Company uses third-partymanufacturers for the production of its products for development and commercialpurposes. Given the general under-utilization of resources, theavailability of excess capacity for manufacturing in the marketplace, and thelower cost of outsourcing, the Company intends to continue to outsourcemanufacturing for the near-term.

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**11.**          RETIREMENTPLAN

In 1996, the Company begana qualified defined contribution 401(k) plan, which provides benefits tosubstantially all employees. The annual contribution, if any, to the trust isat the discretion of the Board of Directors of the Company. Employercontributions to the plan for the years ended December 31, 2003, 2004 and2005 were $0.5 million, $0.6 million and $0.7 million, respectively.

In 2005, the Company beganan Employee Stock Ownership Plan, which provides benefits to substantially allemployees. As of December 31, 2005, there were no shares of the Companyheld by the plan. The annual contribution, if any, to the trust is at thediscretion of the Board of Directors of the Company. Company expenses relatedto the plan for the year ended December 31, 2005 were $0.8 million.  In February 2006, the Company contributed200,000 shares of common stock to the plan from its Treasury shares.

**12.**          COMMITMENTSAND CONTINGENCIES

In December 2001, theCompany entered into a lease agreement for a its current facility. In April 2002,the Company moved into this facility. This lease expires in 2009. The lease forthe previous facility was terminated in June 2002 and the Company has nofurther obligations related to this lease. The total rent expense for theCompany was $0.6 million, $0.6 million and $0.6 million for theyears ended December 31, 2003, 2004, and 2005 respectively.

In September 2004,the Company entered into a lease agreement for office space in Dublin, Ireland.In December 2005, the Company entered into a new lease agreement for newoffice space in Dublin, Ireland. This space is leased under a cancelableoperating lease that expires in September 2010. The total rent expense forthe Company was $25,000 for the year ended December 31, 2005.

The Company leasesvehicles for certain employees under non-cancelable lease agreements expiringin 2006. The total vehicle lease expense under the lease agreements for theyears ended December 31, 2003, 2004 and 2005 was $1.8 million,$2.4 million and $4.3 million, respectively.

On February 7,2006, the Company entered into a lease agreement with 485 Properties, LLCto lease 50,994 square feet of office space at Corporate Center V, an officetower located in Atlanta, Georgia. The eight year lease term, cancelable afterfive years, will commence on or before July 15, 2006 pending thesatisfactory completion of certain tenant improvements. Lease rates begin at$1.0 million per year and escalate during the term to $1.2 million for theeighth year.

The Company will relocateits corporate and administrative functions to the new premises from its currentfacilities but will continue to maintain its warehouse function at its currentfacilities pending the identification of new warehouse facilities. The Companywill seek to sublet its current facilities to third parties.

Thetotal minimum future commitments under leases for years succeeding December 31,2005 is as follows (in thousands):

| **Period ending December 31,** | ** ** | ** ** | ** ** | ** ** | ** ** |
|-----------------------------------------------|------------|------------|------------|------------|------------|
| 2006                                          |       | $          | 4,903      |       |
| 2007                                          |       | 4,708      |       |
| 2008                                          |       | 4,096      |       |
| 2009                                          |       | 1,304      |       |
| 2010                                          |       | 1,000      |       |
| Total                                         |       | $          | 16,011     |       |

 

The Company has employmentcontracts with certain executives, which provide for certain levels ofseverance in the event of termination without cause or for certain change ofcontrol events, as defined.

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First Horizon, certainformer and current officers and directors are defendants in a consolidatedsecurities lawsuit initiated on August 22, 2002 in the United StatesDistrict Court for the Northern District of Georgia. Plaintiffs in the classaction alleged in general terms that we violated Sections 11 and 12(a)(a) ofthe Securities Act of 1933 and that we violated Sections 10(b) and 20(a) ofthe Securities Exchange Act of 1934 and Rule 10b-5 promulgatedthereunder. In an amended complaint, Plaintiffs claim that we issued a seriesof materially false and misleading statements to the market in connection withour public offering on April 24, 2002 and thereafter relating to alleged “channelstuffing” activities. The amended compliant also alleged controlling personliability on behalf of certain of our officers under Section 15 of theSecurities Act of 1933 and Section 20 of the Securities Exchange Act of1934. Plaintiffs sought an unspecified amount of compensatory damages to beproven at trial.

On September 29,2004, the U.S. District Court for the Northern District of Georgia dismissed,without prejudice, the class action lawsuit. Although the class action lawsuitwas dismissed, the court granted the plaintiffs the right to refile their classaction lawsuit provided that the plaintiffs pay all of the defendant’s fees andcosts associated with filing the motions to dismiss the class action lawsuit.Plaintiffs did not file a second amended complaint as permitted, but insteadfiled a motion asking the District Court to reconsider its September 29,2004 order and lift the condition that they must pay defendants’ fees and costsbefore further amendment. On June 22, 2005, the District Court deniedplaintiffs’ motion and gave them another opportunity to amend if they paydefendants’ fees and costs. Once again, plaintiffs chose not to file a second amendedcomplaint. Instead, plaintiffs filed an appeal to the United States Court ofAppeals for the Eleventh Circuit. This appeal currently is pending.

The Company is alsoinvolved with other various routine legal proceedings incident to the ordinarycourse of business. None of these proceedings are expected to have a materialadverse effect on the consolidated financial statements.

**13.**          RELATED-PARTYTRANSACTIONS

In the third quarter of2004, the Company purchased 500,000 shares of common stock from one of Dr. Kapoor’sfamily partnerships, at an aggregate cost of approximately $13.4 million.

On December 10, 2004,the Company, with Board of Directors approval, purchased 1 million sharesof common stock at fair market value equal to the December 10, 2004closing price of the Company’s common stock as reported by Nasdaq from certainexecutives and a board member who is a significant shareholder of the Company.The Company acquired those shares in part, to establish a pool of authorizedshares that will be available for contribution to the Company’s Employee StockOwnership Plan over time as the Company in its discretion deems appropriate.

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**14.**          QUARTERLYFINANCIAL INFORMATION (UNAUDITED)

The following table setsforth summary quarterly financial information for the years ended December 31,2004 and 2005 (in thousands):

| **2005 by Quarter** | ** ** | ** ** | ** ** | **First Quarter** | ** ** | **Second Quarter** | ** ** | **Third Quarter** | ** ** | **Fourth Quarter** | ** ** |
|-------------------------------|------------|------------|------------|------------------------|------------|-------------------------|------------|------------------------|------------|-------------------------|------------|
| Net revenues                  |       |       | $          | 40,957                 |       |                    |       | $                      | 49,816     |                    |       |   | $ | 58,718 |   |   |   | $ | 66,867 |   |   |
| Gross profit                  |       |       | 33,788     |                   |       |                    | 42,463     |                   |       |                    | 49,950     |   |   |   | 56,826 |   |   |
| Operating income              |       |       | 11,475     |                   |       |                    | 12,025     |                   |       |                    | 15,854     |   |   |   | 19,546 |   |   |
| Net income                    |       |       | 7,588      |                   |       |                    | 8,004      |                   |       |                    | 10,634     |   |   |   | 12,983 |   |   |
| Earnings per share:           |       |       |       |                   |       |                    |       |                   |       |                    |       |   |   |   |   |   |   |
| Basic                         |       |       | $          | 0.22                   |       |                    |       | $                      | 0.23       |                    |       |   | $ | 0.30 |   |   |   | $ | 0.37 |   |   |
| Diluted                       |       |       | $          | 0.19                   |       |                    |       | $                      | 0.20       |                    |       |   | $ | 0.26 |   |   |   | $ | 0.32 |   |   |

 

| **2004 by Quarter** | ** ** | ** ** | ** ** | **First Quarter** | ** ** | **Second Quarter** | ** ** | **Third Quarter** | ** ** | **Fourth Quarter** | ** ** |
|-------------------------------|------------|------------|------------|------------------------|------------|-------------------------|------------|------------------------|------------|-------------------------|------------|
| Net revenues                  |       |       | $          | 32,018                 |       |                    |       | $                      | 35,990     |                    |       |   | $ | 41,559 |   |   |   | $ | 42,400 |   |   |
| Gross profit                  |       |       | 26,443     |                   |       |                    | 29,165     |                   |       |                    | 32,664     |   |   |   | 34,613 |   |   |
| Operating income              |       |       | 8,280      |                   |       |                    | 8,926      |                   |       |                    | 11,156     |   |   |   | 9,297 |   |   |
| Net income                    |       |       | 5,047      |                   |       |                    | 5,509      |                   |       |                    | 7,435      |   |   |   | 8,563 |   |   |
| Earnings per share:           |       |       |       |                   |       |                    |       |                   |       |                    |       |   |   |   |   |   |   |
| Basic                         |       |       | $          | 0.14                   |       |                    |       | $                      | 0.15       |                    |       |   | $ | 0.21 |   |   |   | $ | 0.24 |   |   |
| Diluted                       |       |       | $          | 0.13                   |       |                    |       | $                      | 0.14       |                    |       |   | $ | 0.18 |   |   |   | $ | 0.21 |   |   |

 

Quarterly 2004 resultshave been restated to reflect the companies adoption of EITF 04-8, *“The Effect of Contingently Convertible Instrumentson Diluted Earnings Per Share.”*

**15.**          SUBSEQUENTEVENT

On February 7,2006, the Company entered into a lease agreement with 485 Properties, LLCto lease 50,994 square feet of office space at Corporate Center V, an officetower located in Atlanta, Georgia. The eight year lease term, cancelable afterfive years, will commence on or before July 15, 2006 pending thesatisfactory completion of certain tenant improvements. Lease rates begin at$1.0 million per year and escalate during the term to $1.2 million for theeighth year.

The Company will relocateits corporate and administrative functions to the new premises from its currentfacilities but will continue to maintain its warehouse function at its currentfacilities pending the identification of new warehouse facilities. The Companywill seek to sublet its current facilities to third parties.

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**SCHEDULE II**

**FIRST HORIZONPHARMACEUTICAL CORPORATION**

**VALUATIONAND QUALIFYING ACCOUNTSYEARS ENDED DECEMBER 31, 2003, 2004 AND 2005(IN THOUSANDS)**

| **Classification** | ** ** | ** **                      | ** ** | **Balance of  Beginning of  Year** | ** ** | **Charged to Costs  and Expenses** | ** ** | **Deductions** | ** ** | **Balance End  of Year** | ** ** |
|--------------------|------------|---------------------------------|------------|----------------------------------------------|------------|---------------------------------------------------|------------|----------------|------------|------------------------------------|------------|
| 2003               |       | Accounts  receivable allowances |       |                                         | 767        |                                              |       |           | 3,034      |                               |       |   | (3,255 | ) |   |   | 546 |   |   |
|               |       | Allowance for  product returns  |       |                                         | 12,216     |                                              |       |           | 5,694      |                               |       |   | (14,097 | ) |   |   | 3,813 |   |   |
|               |       | Allowance for  product rebates  |       |                                         | 8,370      |                                              |       |           | 9,280      |                               |       |   | (14,477 | ) |   |   | 3,173 |   |   |
|               |       | Allowance for  sales deductions |       |                                         | 2,301      |                                              |       |           | 6,425      |                               |       |   | (7,612 | ) |   |   | 1,114 |   |   |
| 2004               |       | Accounts  receivable allowances |       |                                         | 546        |                                              |       |           | 4,229      |                               |       |   | (4,026 | ) |   |   | 749 |   |   |
|               |       | Allowance for  product returns  |       |                                         | 3,813      |                                              |       |           | 6,410      |                               |       |   | (8,660 | ) |   |   | 1,563 |   |   |
|               |       | Allowance for  product rebates  |       |                                         | 3,173      |                                              |       |           | 9,553      |                               |       |   | (10,695 | ) |   |   | 2,031 |   |   |
|               |       | Allowance for  sales deductions |       |                                         | 1,114      |                                              |       |           | 25,781     |                               |       |   | (24,346 | ) |   |   | 2,549 |   |   |
| 2005               |       | Accounts  receivable allowances |       |                                         | 749        |                                              |       |           | 34,832     |                               |       |   | (33,154 | ) |   |   | 2,427 |   |   |
|               |       | Allowance for  product returns  |       |                                         | 1,563      |                                              |       |           | 8,228      |                               |       |   | (8,701 | ) |   |   | 1,090 |   |   |
|               |       | Allowance for product  rebates  |       |                                         | 2,031      |                                              |       |           | 14,079     |                               |       |   | (13,669 | ) |   |   | 2,441 |   |   |
|               |       | Allowance for sales  deductions |       |                                         | 2,549      |                                              |       |           | 12,550     |                               |       |   | (12,297 | ) |   |   | 2,802 |   |   |
|                    |            |                                 |            |                                              |            |                                                   |            |                |            |                                    |            |  |  |  |  |  |  |  |  |  |  |

 

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