**UNITED STATESSECURITIES AND EXCHANGE COMMISSION**

**Washington,D.C. 20549**

**FORM 10-K**

**(MARK ONE)**

**x**                               ANNUAL REPORT PURSUANT TO SECTION 13OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

**Forthe fiscal year ended December 31, 2006**

**or**

**o**                                  TRANSITION REPORT PURSUANT TOSECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

**Forthe transition periodfrom            to            **

**CommissionFile No. 000-30123**

**SCIELE PHARMA, INC.**

(Exact name of registrantas specified in its charter)

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

 

**5 Concourse Parkway, Suite 1800,Atlanta, Georgia 30328**

(Address of principalexecutive offices) (Zip code)

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

Securities registeredpursuant to Section 12(b) of the Act:

| Title of each class                 |   | Name of each  exchange            |
|-------------------------------------|--------|-----------------------------------|
|                                |   | on which  registered              |
| **Common  Stock, $0.001 par value** |   | **The  NASDAQ Stock Market, LLC** |

 

Securities registeredpursuant to Section 12(g) of the Act: **None**

Indicate by check markwhether the registrant is a well-known seasoned issuer, as defined in Rule 405of the Securities Act. Yes x No o

Indicate by check markwhether the registrant is not required to file reports pursuant to Section 13or Section 15(d) of the Act. Yes o  No x

Indicate by check markwhether the registrant (1) has filed all reports required to be filed by Section 13or 15(d) of the Securities Exchange Act of 1934 during the preceding12 months (or for such shorter period that the registrant was required tofile such reports), and (2) has been subject to such filing requirementsfor the past 90 days. Yes x  No o

Indicate by check mark ifdisclosure of delinquent filers pursuant to Item 405 of Regulation S-K isnot contained herein and will not be contained, to the best of the registrant’sknowledge, in definitive proxy or information statements incorporated byreference in Part III of this Form 10-K or any amendment tothis Form 10-K. o

Indicate by check markwhether the registrant is a large accelerated filer, an accelerated filer, or anon-accelerated filer. See definition of “accelerated filer and largeaccelerated filer” in Rule 12b-2 of the Exchange Act.
| Large accelerated filer  x | Accelerated filer  o | Non-accelerated filer  o |
|--------------------------------------|--------------------------------|------------------------------------|

 

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

Common shares of the registrantoutstanding as of February 20, 2007 were 35,169,815**.**Theaggregate market value, as of June 30, 2006, of such common shares held bynon-affiliates of the registrant was approximately $710,589,000 based upon thelast sales price reported that date on the Nasdaq Stock Market’s Global SelectMarket of $23.19 per share. (Aggregate market value estimated solely for thepurposes of this report. For purposes of this calculation, all executiveofficers, directors and 10% stockholders are classified as affiliates.)

**DOCUMENTS INCORPORATED BYREFERENCE**

Part III:Portions of Registrant’s Proxy Statement to be filed with the Securities andExchange Commission on or about March 7, 2007 relating to the 2007 AnnualMeeting of Stockholders expected to be held on April 25, 2007 areincorporated into Part III of this Form 10-K.

 

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**ANNUAL REPORT OF FORM 10-KFOR THE FISCAL YEAR ENDED DECEMBER 31, 2006**

**TABLEOF CONTENTS**
| **PART I**   | ** ** | ** **                                                                                                         | ** ** |
|-------------------|------------|--------------------------------------------------------------------------------------------------------------------|------------|
| ITEM 1.           |       | BUSINESS                                                                                                           |       | 1 |   |
| ITEM  1A.         |       | RISK  FACTORS                                                                                                      |       | 17 |   |
| ITEM 1B.          |       | UNRESOLVED STAFF COMMENTS                                                                                          |       | 27 |   |
| ITEM 2.           |       | PROPERTIES                                                                                                         |       | 27 |   |
| ITEM  3.          |       | LEGAL  PROCEEDINGS                                                                                                 |       | 27 |   |
| ITEM 4.           |       | SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS                                                                |       | 28 |   |
| **PART II**  | ** ** | ** **                                                                                                         | ** ** |
| ITEM 5.           |       | MARKET FOR REGISTRANT’S COMMON EQUITY, RELATED  STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES |       | 29 |   |
| ITEM  6.          |       | SELECTED  FINANCIAL DATA                                                                                           |       | 33 |   |
| ITEM 7.           |       | MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL  CONDITION AND RESULTS OF OPERATIONS                        |       | 33 |   |
| ITEM 7A.          |       | QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET  RISK                          |       | 49 |   |
| ITEM 8.           |       | FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA                                                                        |       | 49 |   |
| ITEM 9.           |       | CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON  ACCOUNTING AND FINANCIAL DISCLOSURE                              |       | 50 |   |
| ITEM 9A.          |       | CONTROLS AND PROCEDURES                                                                                            |       | 50 |   |
| ITEM  9B.         |       | OTHER  INFORMATION                                                                                                 |       | 52 |   |
| **PART III** | ** ** | ** **                                                                                                         | ** ** |
| ITEM 10.          |       | DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT                                                                 |       | 53 |   |
| ITEM 11.          |       | EXECUTIVE COMPENSATION                                                                                             |       | 53 |   |
| ITEM 12.          |       | SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND  MANAGEMENT AND RELATED STOCKHOLDER MATTERS                    |       | 53 |   |
| ITEM 13.          |       | CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS                                                                     |       | 53 |   |
| ITEM 14.          |       | PRINCIPAL ACCOUNTANT FEES AND SERVICES                                                                             |       | 53 |   |
| **PART IV**  | ** ** | ** **                                                                                                         | ** ** |
| ITEM 15.          |       | EXHIBITS, FINANCIAL STATEMENT SCHEDULES                                                                            |       | 54 |   |

 

** **

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**PART I**

**ITEM 1.**   BUSINESS

**Our Business**

ScielePharma, Inc. (the “Company”) is a pharmaceutical company specializing insales, marketing and development of branded prescription products focused onCardiovascular/Diabetes and Women’s Health. The Company’s Cardiovascular/Diabetesproducts treat patients with high cholesterol, hypertension, hightryglycerides, angina, and type 2 diabetes. Its Women’s Health products aredesigned to improve the health and well-being of women of all ages, includingexpectant and nursing mothers and their babies. Headquartered in Atlanta,Georgia, and founded in 1992, Sciele Pharma employs approximately 800 people. TheCompany’s success is based on placing the needs of patients first, improvinghealth and quality of life, and implementing its business platform—anEntrepreneurial Spirit, Innovation, Speed of Execution, Simplicity and Teamwork.Our key marketed products include:

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

 

Our current operating plan focuses on maximizing thesales of our existing product portfolio. We also plan to accelerate growth bylaunching line extensions to our current products and by acquiring or licensingapproved products or late stage development products and other businesses. Weplan to focus on products that complement our Cardiovascular, Diabetes andWomen’s Health categories that will allow us to leverage our existing salesforce infrastructure as well as additional therapeutic areas which complementour existing sales structure.

We currently market and sell 16 products, 10 of whichare actively promoted and accounted for approximately 95% of our total salesfor the year ended December 31, 2006. We promote our products through ournationwide sales and marketing force of approximately 600 salesrepresentatives, targeting high-prescribing primary care physicians,endocrinologists, cardiologists, obstetricians and gynecologists.

We were incorporated in Delaware in July 1992 asthe surviving corporation of a merger between Century PharmaceuticalCorporation and Horizon Pharmaceutical Corporation. In June of 2006, thestockholders of First Horizon Pharmaceutical Corporation approved changing thename from First Horizon Pharmaceutical Corporation to Sciele Pharma, Inc.The name change became effective on June 15, 2006. Our principal office islocated at 5 Concourse Parkway, Suite 1800, Atlanta, Georgia 30328, andour telephone number is (770) 442-9707. Our corporate internetaddress is www.sciele.com. We make available free of charge through our websiteour annual 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) ofthe Exchange 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.

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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** | ** ** |
|----------------------------------------------------------|------------|------------|------------|---------------------------------------------------------------------------------------------|------------|----------------------|------------|
| Nitrolingual Pumpspray  (nitroglycerin sublingual spray) |       | 2000       |       | Acute relief of an attack or prophylaxis of angina pectoris due to coronary  artery disease |       |
| Ponstel Capsules  (mefenamic acid)                       |       | 2000       |       | Primary dysmenorrhea in  patients 3 14 years of age                                    |       |
| Sular (nisoldipine)  Tablets                             |       | 2002       |       | Hypertension                                                                                |       |
| Prenate Elite                                            |       | 2004       |       | Prenatal vitamin                                                                            |       |
| 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                                        |       |
| OptiNate                                                 |       | 2005       |       | Prenatal vitamin with  omega 3                                                              |       |
| Ostiva                                                   |       | 2006       |       | Nutrional support for  healthy bones                                                        |       |
| Zovirax                                                  |       | 2006       |       | Topical herpes medication                                                                   |       |

 

*Sular*

In March 2002, we acquired exclusive U.S. rightsto distribute and sell the antihypertensive prescription medication Sular fromAstraZeneca and Bayer Healthcare. We also entered into a long-termmanufacturing, supply and distribution agreement with Sular’s manufacturer,Bayer. Sular is a once-a-day treatment for hypertension that competes in themarket for antihypertensive prescription medications.

We believe that Sular offers certain advantages overother antihypertensive medications based upon its proven efficacy and safety,and its demonstrated ability to provide twenty-four hour blood pressure controlas compared to other branded antihypertensives.

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, calcium channelblockers 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 andAltoprev*

In March 2005, we licensed and purchased certainrights to the type 2 diabetes prescription medication Fortamet and thecholesterol lowering medication Altoprev from Andrx Laboratories, which wasacquired in 2006 by Watson Laboratories. As part of the transaction, weacquired the worldwide rights to sell Fortamet and Altoprev. We also enteredinto a long-term manufacturing and supply agreement with Andrx Laboratories forthe manufacture and supply of Fortamet and Altoprev.

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Fortamet is a patented, once-a-day extended-releasetablet used in the management of type 2 diabetes. It contains metformin HCl,which is an oral anti-hyperglycemic drug that has the effect of lowering bloodglucose. We believe that Fortamet is advantageous in the market because of its1000mg once-a-day extended release metformin formulation. Like all metformins,Fortamet has a blackbox warning (a warning designed to advise people ofpotential serious risks) associated with lactic acidosis.

Altoprev is a patentedonce-a-day treatment for high cholesterol. It consists of a lovastatinextended-release tablet containing a cholesterol lowering agent. We believethat Altoprev is advantageous in the market because it offers once-a-dayadministration in multiple starting doses (20mg, 40mg or 60mg). Moreover,Altoprev’s extended release delivery system allows lower peak levels oflovastatin acid 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 labeledTriglide. In May 2005, we announced that the U.S. Food and DrugAdministration had approved Triglide as an oral treatment for lipid disorderssuch as elevated triglycerides. Triglide is being manufactured and supplied bySkyePharma. Triglide is a fenofibrate manufactured using SkyePharma’s IDD-Ptechnology.

*Nitrolingual*

In February 2000, we began marketingNitrolingual, a product for which we acquired exclusive distribution rights inthe U.S. from Pohl-Boskamp. Nitrolingual is sold in 200 and 60 dose bottles. InOctober 2004, the distribution agreement was renewed and was then amendedin 2005. The amended agreement expires in January 2010 and may be renewedthereafter for subsequent 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 fromthe date of manufacture. Each metered dose of Nitrolingual provides consistentdelivery of nitroglycerin. Also, Nitrolingual has advantages over nitroglycerintablets pertaining to storage and handling.

*Prenate Elite andOptiNate*

Prescription prenatal vitamins are generallyrecommended before, during and after pregnancy so that the mother and the fetusreceive adequate amounts of essential vitamins and minerals. In April 2004,we launched 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. Folicacid, a water-soluble B vitamin, has been shown to help preventserious birth defects in babies.

We introduced OptiNate in March 2005,as a line extension to our Prenate line. OptiNate is a prescriptionmultivitamin/multimineral nutritional supplement indicated for use in improvingthe nutritional status of women throughout pregnancy and in the postnatalperiod. It contains 16 key vitamins and minerals together with a singlemilligram of folate in a combination of folic acid, metafolin and omega-3fatty acids. Omega-3 fatty acids such as those found in OptiNate can beespecially beneficial to a 

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baby’sbrain and eye development. We believe OptiNate has an advantage in the marketbecause its omega-3 fatty acid capsule is a prescription prenatal vitaminwith an all-natural vegetarian sourced capsule.

*Zovirax*

In December 2006, weentered into a promotional agreement, which has an initial term of five years,with an affiliate of Biovail Corporation to provide promotional support forZovirax in the United States. Zovirax is a topical form of the drug acyclovir,which is used in the treatment of type I (cold sores) and type II (genital)herpes simplex viruses.

*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 knownNSAID for 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 cardiovascular thromboticevents, myocardial infarction, and stroke.

*Ostiva*

In July 2006, we acquired exclusive U.S. rightsto market, distribute and sell Ostiva from PamLab, LLC. Ostiva is an oralprescription nutritional supplement formulation with Metafolin, calcium, magnesium,vitamins B6, B12 and vitamin D that gives women nutritional support to helpmaintain healthy bones. Together with regular exercise, a healthy diet, andenough calcium, Ostiva can help women take action to reduce the risk ofosteporosis. Ostiva may be used in conjuction with other products that mayrequire dietary supplementation such as bisposphonates.

Ostiva offers anutritional foundation for maintaining bone health. It contains Metafolin, anactive form of folate, which can aid in reducing elevated homocysteine levelsand, by doing so, may lead to healthier bones. Ostiva also contains calcium,which can contribute to the development of healthy bones; vitamin D, whichhelps enhance the absorption of calcium within the body; and magnesium andvitamins B6 and B12, which may contribute to maintaining bone health andreducing the risk of osteoporosis.

**Other Products**

In December 2001, we acquired U.S. rights toFuradantin from Dura Pharmaceuticals, an affiliate of Elan Pharmaceuticals.Furadantin is indicated for the treatment of urinary tract infections and isprescribed primarily by pediatricians. Furadantin is a product well-suited forchildren because it is formulated in liquid suspension form and has afruit-flavored taste. Furadantin contains nitrofurantoin, which has littlebacterial resistance.

In June 2000, we acquired worldwide rights tomarket, distribute and sell Cognex from Pfizer, as well as rights to a newunapproved controlled release version of Cognex called Cognex CR. Cognex isindicated for the treatment of mild to moderate dementia associated withAlzheimer’s disease. Alzheimer’s disease is a progressive, degenerative diseasethat 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 a higher-strengthdosage of Robinul, from Wyeth. Both Robinul and Robinul Forte belong to a classof drugs known as anticholinergics that reduce the motion of thegastrointestinal tract and decrease stomach 

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secretions.The FDA has approved both products for use as a therapy in conjunction withother therapeutics in the treatment of peptic ulcers. In the first quarter of2005, in an effort to combat generic competition, we engaged a third party tohandle the authorized generic distribution of Robinul and Robinul Forte, and weceased actively promoting the Robinul line.

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

**Regulatory Classification**

Sular, Furadantin, Cognex,Ponstel, Triglide, Altoprev, Fortamet, Nitrolingual, Zovirax, Robinul andRobinul Forte have FDA approved New Drug Applications (NDAs). The FDA alsoapproved an abbreviated NDA for Zebutal. Prenate Elite, Ostiva and OptiNate,which are prescription vitamins, Tanafed DP, Tanafed DMX and Zoto-HC do nothave approved NDAs.

**Research and Development**

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$1.5 million, $4.1 million and $16.6 million for the years ended December 31,2004, 2005 and 2006, respectively.

Research and developmentexpense increased $12.5 million to $16.6 million for the year ended December 31,2006, compared to $4.1 million for the year ended December 31, 2005.This increase is primarily related to greater activity in lifecycle managementinitiatives for our products, including the new Sular formulation and theglycopyrrolate formulation, which is targeting chronic moderate to severedrooling in pediatric patients, as well as management’s increased emphasis ondevelopment. From 2004 through 2006, research and development expenses alsoincluded the development of branded products. Historically, research anddevelopment expenses for branded product activities included, among otherthings, costs related to personnel, overhead, professional services, filingfees and raw materials, but primarily included the cost of laboratory services,clinical investigators and clinical research organizations that wereresponsible for conducting the clinical trials required to support a productapplication with the FDA and preparing NDAs. Research and development expensesare periodically evaluated to take into consideration, among other things, ourlevel of profitability and cash flows. Additionally, we recognized $1.1 millionin research and development stock-based compensation for the year ended December 31,2006. There were no stock-based compensation expenses recognized in researchand development for the years ended December 31, 2005 or 2004.

**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 professional relationships with these physicians and respond totheir needs as well as their patients’ needs. Since 2004, we have expanded oursales and marketing force from approximately 360 to approximately 600professionals nationwide. In January 2006, we created a separate specialtysales force to call on OBGYN professionals exclusively.

We sell our products to pharmaceutical wholesalers(who in turn distribute to pharmacies), chain drug stores, other retailmerchandisers, hospitals and, on a limited basis, directly to pharmacies. Forthe years ended December 31, 2004, 2005 and 2006, sales to our top threepharmaceutical wholesalers accounted for approximately 78%, 63% and 69%,respectively, of all of our sales. The following wholesalers each accounted for10% or more of all of our sales for the years ended December 31, 2004,2005 and 

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2006: McKessonCorporation (31%, 30% and 34%, respectively), Cardinal Health, Inc. (25%,23% and 24%, respectively), and AmerisourceBergen Corporation (22%, 10% and11%, respectively).

The Company has two main types of arrangements withwholesalers of its products: (a) ordinary course arrangements with healthbenefit providers, such as managed care contractors and pharmacy benefitmanagers (“Standard Arrangements”), and (b) Inventory ManagementAgreements (“IMAs”). Pursuant to those arrangements, the Company providesdiscounts to various health benefit providers nationwide for purchases of theCompany’s products, although such providers have no obligation to order anyproducts at any time and the Company is under no obligation to offer or providethe discounts. The Company has utilized such Standard Arrangements for several yearsand expects to continue to do so in the future. The Company’s three IMAs wereentered 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.

In December 2004, we entered into a newDistribution and IMA with Cardinal Health continuing our existing relationshipwith Cardinal Health. Under the agreement, Cardinal Health, among other things,provides us with certain distribution and inventory management services,including accounts receivable management, customer service support,consolidated deliveries to providers, and contract and chargeback administration.This agreement calls for Cardinal Health to maintain the inventory levelsspecified in the agreement. In order to minimize product shortages and maximizeproduct 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 event 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 IMA with McKesson Corporation. Among other terms and conditions, the amendmentprovides that McKesson maintain specified inventory levels. The amendment alsoprovides that McKesson prepare, and provide to us, inventory reports detailingthe status and movement of our products in McKesson’s inventory. The amendmentacknowledges that the agreement by McKesson to provide the reports and tomaintain certain inventory levels is in consideration for providing McKessonwith economic relief from price increases instituted by the Company. Except asmodified by the amendment, the terms and conditions, including any contractualobligations to provide services, of the agreement underlying and amended by theamendment remain in full force and effect. In December 2005, we furtheramended our IMA with McKesson. The amended agreement enables us to takeadvantage of a centralized purchasing location. Under the amended agreement,certain of McKesson’s purchasing and inventory requirements were revised as wasMcKesson’s rights to make limited purchases of the Company’s products at pricesin effect prior to any announced price increases.

In January 2006, we entered into an IMA withAmerisourceBergen Drug Corporation which replaced our then-current IMA, datedJune 2003. Under the agreement, AmerisourceBergen, among other things, providesus with certain inventory management services. This agreement calls forAmerisourceBergen to maintain the inventory levels specified in the agreement. Inorder to minimize product shortages and maximize product availability,AmerisourceBergen agreed to institute an automated balancing system on ourproducts and optimize ordering during backorder situations or limited productavailability. 

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We have the right to cancel any order exceedingcertain levels of products sold. The agreement also provides thatAmerisourceBergen prepares and provides to the Company, inventory and salesreports detailing the status and movement of our products in AmerisourceBergen’sinventory, monitors customer order patterns, provides event managementservices, and provides support for new product launches. 

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.

The percentage of totalsales contributed by product lines for the prior three years is as set forthbelow.

| ** **              | ** ** | **For the Year Ended  December 31(1)** | ** ** |
|-------------------------|------------|------------------------------------------------------------|------------|
| ** **              | ** ** | **2006**                                                   | ** ** | **2005** | ** ** | **2004** | ** ** |
| Cardiovascular/Diabetes |       |                                                       | 76         | % |   |   | 67 | % |   |   | 50 | % |   |
| Women’s Health     |       |                                                       | 19         | % |   |   | 22 | % |   |   | 15 | % |   |
| Non Promoted            |       |                                                       | 5          | % |   |   | 11 | % |   |   | 35 | % |   |

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(1)          Percentages for theyears ended December 31, 2004 and 2005 are based on sales during thoseyears of the products we promoted in 2006.

We operate in one reportable business segment and inone primary georgraphical area, the U.S., with international sales representingless than one percent of total sales. Additional information on segmentreporting and georgraphical areas is included in Note 1 to our ConsolidatedFinancial Statements under the caption “Summary of Significant AccountingPolicies.”

**Third-PartyAgreements**

*Sular*

In March 2002, we acquired exclusive U.S. rightsto distribute and sell Sular from AstraZeneca PLC and Bayer Healthcare AG(“Bayer”). We paid $184.3 million in cash, including $0.6 million inacquisition costs, plus the assumption of liabilities of $1.9 millionrelated to the return of product shipped prior to the acquisition date. InDecember 2002, we increased our estimates for assumed liabilities by$0.7 million. Under the asset purchase agreement, we acquired theregulatory approval to sell Sular in the U.S., current inventory, licensingrights to certain intellectual property, marketing materials for the promotion,advertising and marketing of Sular in the U.S., study materials relating toclinical studies of Sular, and certain of AstraZeneca’s contracts relating tothe marketing, sale and distribution of Sular. We were required to payAstraZeneca up to an additional $20.0 million upon achievement of certainsales milestones through February 2005. As of December 31, 2004, wecalculated that we owed AstraZeneca $5.0 million for reaching thesemilestones which we paid in March 2005. We do not owe nor did we make anyother milestone payments to AstraZeneca.

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. We were required to 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. InDecember 2005, we amended our agreement with Bayer to modify theapplicable milestones and increase protection from foreign exchange ratefluctuations. In January 2006 we paid $5.0 million to Bayer under theamended agreement. In July 2006, the Company’s attained sales of Sularrequiring a final $5.0 million milestone payment to Bayer, which was made inOctober 2006. We do not owe nor did we make any other milestone paymentsto Bayer.

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*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 (iii) will pay Andrx apercentage of the net revenues associated with Fortamet and Altoprev on anongoing basis. We also entered into an exclusive license agreement for theintellectual property regulatory approvals to sell Fortamet and Altoprev in theUnited States.

In March 2005, we alsoentered into a long-term manufacturing and supply agreement appointing Andrx asthe manufacturer of Fortamet and Altoprev. The terms of the agreement requireus to pay Andrx for the manufacture of Fortamet and Altoprev on a per unitbasis for a ten year term, subject to Andrx’s ability to terminate as of theconclusion of the fifth year. The unit price may adjust based on changes in thecost of the active pharmaceutical ingredients as well as changes in an annualinflationary index.

*Triglide*

In May 2004, we entered into an agreement withSkyePharma granting us the exclusive license for a term of at least 15 years tomarket and distribute a fenofibrate product in the U.S. that was approved bythe FDA in May 2005. We have since commenced marketing and distribution ofthis product, labeled Triglide. We have also obtained the right of firstrefusal to negotiate a license to develop and commercialize a futurecardiovascular product utilizing the SkyePharma delivery technology. We paid$20.0 million to SkyePharma for these rights. We utilize our sales force tomarket the product and pay SkyePharma 25% of the product’s net sales whichincludes cost of goods sold. Further, SkyePharma was obligated to contribute$2.5 million toward our sales and marketing efforts and provided us with freeproduct samples for the year ended December 31, 2005, and was required toprovide 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 January 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 in January 2010, butmay be renewed for additional two year periods. We must also pay a royalty onnet 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.

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*Prenate Elite andOptiNate*

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.

The manufacturingagreement with Patheon, Inc., which manufactures Prenate Elite, wasinitially entered into with Sanofi-Synthelabo, Inc. in October 1999and had a term of five years. We finalized a new manufacturing agreement withPatheon for Prenate Elite in 2005 which expires in January 2009. OptiNateis manufactured by Patheon 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.Westward began supplying the product to us in the second quarter of 2003.****This agreement was renewed for an additional one-year termin 2006 and expires in April 2008.

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 ofWestward’s direct cost of goods sold in the manufacture and supply of theproduct.

*Ostiva*

In July 2006, weacquired exclusive U.S. rights to market, distribute and sell Ostiva fromPamLab. Ostiva is an oral prescription nutritional supplement formulation withMetafolin, calcium, magnesium, vitamins B6, B12 and D that gives womennutritional support to help maintain healthy bones. Together with regularexercise, a healthy diet, and enough calcium, Ostiva can help women take actionto reduce the risk of osteporosis. Ostiva may be used in conjuction with otherproducts that may require dietary supplementation such as bisposphonates. The intangibleasset recorded in connection with the acquisition is expected to be amortizedover a period of eight years.

*Zovirax*

In December 2006, weentered into a promotional agreement, which has an initial term of five years,with an affiliate of Biovail Corporation to provide promotional support forZovirax in the United States. Zovirax is a topical form of the drug acyclovir,which is used in the treatment of type I (cold sores) and type II (genital)herpes simplex viruses. The intangible asset recorded in connection with the contractacquisition cost is expected to be amortized over a period of five years.

*Other Products*

Generally, our other products are manufactured undermanufacturing and supply agreements, which require that we purchase all of ourrequirements for these products from the manufacturers which are a party tothese agreements, including specified minimum purchase quantities of theproduct for each year. Except for agreements regarding our Zoto-HC products,these agreements generally state that the product supplier will provideproducts only to us.

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

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In December 2001, we also entered into a supplyagreement with Elan Pharmaceutical to manufacture and supply Furadantin to usthrough May 2003. In August 2002, we entered into a manufacturingagreement with OSG Norwich Pharmaceuticals to manufacture Furadantin for us.OSG became qualified to manufacture the product in November 2003.Beginning January 2004, we were required to purchase a minimum amount ofinventory annually from OSG Norwich Pharmaceutical. This agreement expires in August 2007and we intend to renew this agreement for an additional two-year term.

In May 2003, we entered into a supply agreementwith Vinchem to supply us the active ingredient in Furadantin. This agreementexpires May 2010 and is renewable for successive one-year terms.

*Cognex.**  *In 2000, we acquired worldwide rights to market,distribute and sell Cognex as well as rights to a new unapproved version ofCognex called Cognex CR from Pfizer. We paid $3.5 million in cash forCognex. We must pay Pfizer up to $1.5 million in additional purchase priceif we obtain FDA approval to market Cognex CR in the U.S. At this time, we arepreliminarily exploring opportunities to develop and seek FDA approval tomarket Cognex CR. In the event that we voluntarily stop selling Cognex for60 days or more, other than for reasons outside our control, the FederalTrade Commission may order that Cognex revert back to Pfizer and be divested toanother purchaser. Westward Pharmaceuticals supplies Cognex. This agreementexpires March 2008, but may be renewed for an additional two-year term. Weare seeking a new supplier for the active ingredient in Cognex. Based on ourcurrent sales projections, we believe that we have adequate supplies of theactive ingredient in Cognex for the foreseeable future. However, if salesexceed our current projections or if we are unable to locate a new supplier ofthe active ingredient in Cognex, our ability to sell Cognex would be limitedand 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, in April1999 and January 2001, for Mikart to become qualified under applicableregulations to manufacture and supply our requirements for Robinul. Mikart wasapproved by the FDA to manufacture Robinul in December 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, weentered into a license agreement with Wyeth-Ayerst Canada Inc. andWhitehall-Robins Inc. under which we acquired rights to manufacture, havemanufactured for us, market and sell Robinul and Robinul Forte in Canada. If webegin to sell Robinul in Canada, we will pay Wyeth-Ayerst Canada a royalty onnet sales of Robinul in Canada.

**Products UnderDevelopment**

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 development projectsinclude line extensions which allow us to extend the life cycles of ourproducts. We expect the strength of extensive literature-based clinical data onthe active ingredients in our products under development, current acceptanceand usage of the active ingredients in these products by healthcareprofessionals and the safety profile of the active ingredients in approvedproducts will reduce development costs and risks associated with FDA approval.Although we have increased our development infrastructure, we typicallycontract with third parties to formulate, develop and manufacture materialsneeded for clinical trials and to perform scale-up work. We select third-partycontractors that we believe have the capability to commercially manufacture theproducts. By selecting qualified third parties capable of both developingformulations and providing full-scale manufacturing 

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services,we believe we will be able to shorten development and scale-up times necessaryfor production. The key advantage to this approach is that the third-partycontractor will have the equipment, operational parameters and validatedtesting procedures already in place for the commercial manufacture of ourproducts.

**Manufacturers andSingle Source Suppliers**

We use third-party manufacturers for the production ofour products for development and commercial purposes. Given the availability ofexcess capacity for manufacturing in the marketplace and the lower cost ofoutsourcing, we intend to continue to outsource our manufacturing for the nearterm. Some of our products are currently available only from sole or limitedsuppliers. These third-party manufactured products include products that havehistorically accounted 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 non-U.S.-based suppliers. Arrangements with internationalraw material suppliers are subject to, among other things, FDA regulation,various import duties, foreign currency risk and other government clearances.Acts of governments 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 applied to haveregistered “Sciele Pharma” 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), Triglide, Fortamet, Altoprev,Prenate, Optinate, DHA 200 (and an associated design), Prenate Elite, Ponstel,Furadantin (and an associated design), Zoto-HC (and an associated design) andZebutal. We own the U.S. rights to the Cognex trademark and its internationalcounterparts. We also have filed U.S. trademark applications for Ostiva.Further, we have been licensed rights to use the trademarks Nitrolingual,Zovirax and Robinul from Pohl-Boskamp, Biovail and Wyeth, respectively.Maintenance of our trademarks requires that we enforce our rights by preventinginfringement by third parties.

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**Patents**

We consider the protectionafforded by patents important to our business. We intend to seek patentprotection in the U.S. and selected foreign countries where deemed appropriatefor products we develop. There can be no assurances that any patents willresult from our patent applications, that any patents that may be issued forany of the products we sell will protect the intellectual property associatedwith the 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 additional licenses to sell ourproducts, defend infringement actions or challenge the validity of theintellectual property in court, all of which could be expensive and timeconsuming.

*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. Pursuant to our May 2006 agreement withSkyePharma, we have an exclusive license to the patent rights associated withSkyePharma’s Geomatrix technology in connection with a potential Sular lineextension.

*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. Thepatents expire in March of 2020.

*Triglide*

Pursuant to our 2004agreement with SkyePharma, we have an exclusive license to the patent rightsassociated with Triglide in the United States. The related patent expires in2021.

*Nitrolingual*

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

*Prenate, OptiNateand Ostiva*

Pursuant to an agreementwith our metafolin supplier, we have licensed certain patent rights associatedwith reduced folates. The patents expire from 2017 through 2020.

*Other Products*

*Cognex.**  *We own certain patent rights relating to the use ofan active ingredient in Cognex to treat conditions associated with Alzheimer’sdisease. The U.S. patents expire from 2008 through 2013.

**Competition**

The market for drugs is highly competitive with manyestablished manufacturers, suppliers and distributors actively engaged in allphases of the business. We believe that competition in the sale of our productsis based primarily on efficacy, reimbursement coverage, brand awareness,availability, product safety, and price. Our brand name pharmaceutical productsmay be subject to competition from alternate therapies during the period ofpatent protection and thereafter from generic or other competitive products.All of our products compete with generic and/or other competitive products inthe marketplace.

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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.******Thesecompetitors, as well as others, have been in business for a longer period oftime, have a greater number of products on the market and have greaterfinancial and other resources than we do. If we directly compete with them forthe same markets and/or products, their financial and market strength couldprevent us from capturing 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, KingPharmaceuticals, Inc., Shire Pharmaceuticals Group plc, Abbott Laboratories,Inc., Barr Pharmaceuticals, Inc., Solvay Pharmaceuticals, Inc.,Reliant Pharmaceutical, LLC, and other companies that acquire branded productsfrom other pharmaceutical companies. These companies may have greater resourcesand abilities than we have.

**GovernmentRegulation**

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.

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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 a basisfor design of the human clinical trials. An applicant submits the results ofthe pre-clinical studies with chemistry, manufacturing and control informationand pharmacology and toxicology data in support of the proposed clinical studydesign to the FDA as a part of an IND and for review by the FDA prior to thecommencement of human clinical trials. Unless the FDA determines otherwise, theIND will become effective 30 days following its receipt by the FDA.However, the FDA may place an IND on “clinical hold” until the applicantgenerates and supplies the FDA with additional data, which prohibits theapplicant from commencing the proposed clinical trials until the “clinical hold”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 consents, sponsor monitoringand auditing of the clinical, laboratory and product manufacturing sites aswell as review and approval of each study by an Institutional Review Board.Clinical trials are typically conducted in three sequential Phases, althoughPhases may overlap. In Phase I, the investigational new drug usually isadministered to 20-50 healthy human subjects and is tested for safety.Phase II usually 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 any time if thereare significant safety issues or lack of efficacy. In some cases, the FDA canrequest Phase IV clinical studies to be conducted as a condition ofapproval of the NDA, although the Phase IV studies will be conducted within adesignated time period following NDA approval. These studies can be designed toobtain additional safety and efficacy data, detect new uses for or abuses of adrug, 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-statedtimeframe can 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 

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same drug. In addition,the FDA recommends a 505(b)(2) NDA for a modification, such as a newdosage form or drug delivery form, of a previously approved drug (but not thatheld by the 505(b)(2) applicant), which requires more than merelybioequivalence data. This 505(b)(2) NDA is similar to a full NDA, exceptthat, under conditions prescribed by the FDA, it may be supported in whole orin part by one or more animal and human study investigations in the originatorNDA or those published in scientific literature in lieu of the applicant’sclinical trials. This type of NDA application is submitted to market potentialproduct line extensions or new uses of already-approved products. Payment ofuser fees may 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 occurs sooner.Furthermore, distinct from patent considerations, approval of a generic type ofANDA could be delayed because of the existence of five or three years ofmarketing non-patent exclusivity afforded by the FDA for the innovator drug or180 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, and 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 approvedoriginator drug regarding active ingredient(s), route of administration, dosageform, strength and conditions of use recommended on the labeling. The ANDArequires only bioequivalence data and other technical and manufacturinginformation, but typically no safety and effectiveness studies.

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,buildings and facilities, equipment, control of components and drug productcontainers and closures, production and process controls, packaging andlabeling controls, holding and distribution, laboratory controls, records andreports, and returned and salvaged products. Ongoing compliance with cGMPprocedures, labeling and other regulatory requirements is monitored throughperiodic inspections and market surveillance by state and federal agencies,including the FDA. It is also our obligation to periodically monitor the FDAcompliance of our third-party manufacturers. Failure by our third-partymanufacturers to comply with these rules could result in sanctions beingimposed, including fines, injunctions, civil penalties, suspension orwithdrawal of FDA approvals, seizures or recalls of products, operatingrestrictions and criminal prosecutions. Moreover, we rely upon our third-partymanufacturers to 

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provide many of the documentsthat we use to comply with our FDA reporting requirements for all products wesell.

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.

Whether or not we obtainFDA approval, we must obtain approval of a pharmaceutical product by comparablegovernmental regulatory authorities in foreign countries prior to thecommencement 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 DrugDesignation**

In June 2006, the FDAgranted the Company orphan drug designation for glycopyrrolate, which is beingdeveloped to treat chronic moderate to severe drooling in pediatric patients.We may request orphan drug status for some of our other products underdevelopment. Orphan drug designation may be granted to those products developedto treat diseases or conditions that affect fewer than 200,000 persons in theU.S. or that affect more than 200,000 persons in the U.S. and for which thereis no reasonable expectation that the cost of developing and making a drug inthe U.S. for such disease or condition will be recovered from sales in the U.S.of such drug. Under the law, the developer of an orphan drug may be entitled toseven years of market exclusivity following the approval of the product by theFDA, exemption from user fee payments to the FDA and a tax credit for theamount of money spent on human clinical trials. However, should there be acompetitor with a similar molecular entity pursuing the same intended clinicaluse, we must be the first to receive FDA marketing approval in order to receivemarket exclusivity under the Orphan Drug Act. Although we may receive marketexclusivity under the Orphan Drug Act, the FDA will allow the sale of amolecularly equivalent drug which is clinically superior to or a molecularentity different from another approved orphan drug, even if it is for the sameindication, during the seven-year exclusive marketing period. It is alsopossible that a competitor may attempt to undermine any exclusivity provided tous by promoting a product for an off-label use that is the otherwise protectedproduct. We cannot be certain that any of our products under development wouldultimately receive orphan drug designation, or that the benefits currentlyprovided by this designation, if we were to receive it, will not subsequentlybe amended or eliminated. Orphan drug designation does not convey any advantagein, or shorten the duration of, the regulatory 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, can affect the pricing or relativeattractiveness of our products by regulating the reimbursement they provide onour products and competing products. Insurance carriers may not reimbursehealthcare providers for use of our products for new indications. Domestic andforeign government and third-party payors are increasingly attempting tocontain healthcare costs by limiting both coverage and the level ofreimbursement for new pharmaceutical products.

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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 ourproduct portfolio. If third-party payors remove any of these products fromtheir lists or choose not to pay for our product prescriptions, patients andpharmacies may not continue to choose our products.

**Insurance**

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

**Employees**

We had 782 full-timeemployees as of December 31, 2006, including 625 sales employees in thefield and 157 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 andother information contained in this Report on Form 10-K. The risks anduncertainties described below are not the only ones we are facing and otherrisks and uncertainties may become important factors that affect us.

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 toOur 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 Next GenerationPrescription Services data, total Sular prescriptions increased 21.7% for theyear ended December 31, 2006 compared to the year ended December 31,2005. Although we have revised our operational plan to focus on maximizingsales of our existing products, particularly Sular, we may not be able to increaseSular 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 the following,all or any of which may have an adverse effect on the sales of Sular:

·       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.

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***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, as the patentprotection for our other products expires, competitors could introducecompetitive products which may reduce our sales of such products, adverselyimpacting our financial performance.

***Pohl-Boskamp can terminate our rights to NitrolingualPumpspray.***

Nitrolingual Pumpspray is one of our key products.Pohl-Boskamp can terminate our distribution agreement for NitrolingualPumpspray if a company with a product competitive with Nitrolingual Pumpsprayacquires direct or indirect influence or control over us. Pohl-Boskamp’stermination of our distribution agreement could have a material adverse impacton our financial results.

***In the future, we may not be able to increase oursales of promoted products sufficiently to compensate for the decrease in salesof our non-promoted products.***

We suffered declining sales of our non-promotedproducts for the year ended December 31, 2006. We plan to compensate forthis decline in revenues by increasing sales of our existing actively promotedproducts and acquiring new products. However, we may not be able to increasesales of actively promoted products or locate attractive acquisition candidatesand successfully complete an acquisition to offset the declining sales ofnon-promoted products.

***If we are unable to introduce line extensions of ourexisting products, we may not achieve our sales plan.***

Part of our operating plan includes theintroduction of line extensions of our existing products to create marketingadvantages and extend the life cycles of our products. If we are unable tointroduce line extensions for any reason, including our, or our third partydevelopers’, inability to obtain necessary FDA approval, we may not achieve oursales plan and/or revenue growth.

***Introductions of line extensions of our existing productsmay require us to make unexpected changes in our estimates for future productreturns and reserves for obsolete inventory which would adversely affect ouroperating results.***

From time-to-time we may seek to introduce lineextensions on an unexpected and expedited basis before we are able to reducethe levels of inventories of product which may be rendered obsolete orotherwise adversely affected by the line extension. This may require us toincrease our estimate for returns of product on hand at wholesalers, which isrecorded as a reduction of our net revenues, and increase our reserve forobsolete inventory in our warehouse which is recorded as a cost of revenues.Accordingly, the introduction of line extensions may adversely affect ouroperating results.

***Our ability to grow will suffer if we do not acquireor license rights to new products and integrate them successfully.***

We depend onacquisitions of rights to products from others as our primary source for newproducts. 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

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

We often face significant competition from otherpharmaceutical companies in acquiring rights to products, which makes it moredifficult to find attractive products on acceptable terms. In addition,integration of new products into our existing structure may requireunanticipated investments of time and resources or an expansion of our salesforce. If we are unable to acquire or license rights to new products or areunsuccessful in integrating such products, our ability to grow will suffer andour operating results may be adversely affected.

***As part of our growth strategy, we may acquirebusinesses, which will subject us to additional risks.***

As an element ofour growth strategy, we may acquire businesses with products that complementour current products, and we have evaluated and discussed such opportunitieswith interested parties in the past. In addition to the risks that we face inlocating and consummating new product acquisitions, we face the followingrisks, the occurrence of any or all of which may adversely affect our business:

·       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 conduct acquisitions usingconvertible debt or equity securities, the increased number of shares may bedilutive to our shareholders, and may result in lower earnings per share.

***We may incur charges for intangible asset impairment.***

When we acquire the rights to manufacture and sell aproduct, we record the aggregate purchase price, along with the value of theproduct related liabilities we assume, as intangible assets. We use theassistance of valuation experts to help us allocate the purchase price to thefair value of the various intangible assets we have acquired. Then, we mustestimate the economic useful life of each of these intangible assets in orderto amortize their cost as an expense in our statement of operations over theestimated economic useful life of the related asset. The factors that drive theactual economic useful life of a pharmaceutical product are inherentlyuncertain, and include patent protection, physician loyalty and prescribingpatterns, competition by products prescribed for similar indications, futureintroductions of competing products not yet FDA approved, the impact ofpromotional efforts and many other issues. We use all of these factors ininitially estimating the economic useful lives of our products, and we alsocontinuously monitor these factors for indications of appropriate revisions.

In assessing the recoverability of our intangibleassets, we must make assumptions regarding estimated undiscounted future cashflows and other factors. If the estimated undiscounted future cash flows do notexceed the carrying value of the intangible assets, we must determine the fairvalue of the intangible assets. If the fair value of the intangible assets isless than its carrying value, an impairment loss will be recognized in anamount equal to the difference. If these estimates or their related assumptionschange in the future, we may be required to record impairment changes for theseassets. We review intangible assets for impairment at least annually andwhenever events or changes in circumstances indicate that the carrying amountof an asset may not be recoverable. If we determine that an intangible asset isimpaired, a non-cash impairment charge would be recognized.

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As circumstances after an acquisition can change, thevalue of intangible assets may not be realized by us. If we determine that animpairment has occurred, we would be required to write-off the impaired portionof the unamortized intangible assets, which could have a material adverseeffect on our results of operations in the period in which the write-offoccurs. In addition, in the event of a sale of any of our assets, we cannot becertain that our recorded value of such intangible assets would be recovered.

***We may encounter problems in the manufacture or supplyof our products that could limit our ability to sell our products.***

We depend entirely on third parties to manufacture andsupply our products. We do not currently have manufacturing facilities,personnel or access to raw materials to independently manufacture our products.Except for any contractual rights and remedies which we may have with our manufacturersand suppliers, we have no control over the availability of our products ortheir quality or cost to us. We do not maintain alternative manufacturingsources for any of our products, and we may not be able to locate alternativemanufacturers on commercially acceptable terms in the event of a manufacturinginterruption or termination of an existing manufacturing agreement.

In addition, third party intellectual property rightslimit our ability to manufacture and supply our products. For example, due tothe patent held on Nitrolingual by our supplier, Pohl-Boskamp, no alternativesource for Nitrolingual exists. Similarly, third parties hold the patents forthe composition of the coat core tablet for Sular, the patent rights forFortamet and Altoprev, the patent rights for the active ingredients,manufacturing processes and other aspects of our products. In the event thatthese suppliers ceased to supply product to us, we may not be able to locateanother manufacturer or supplier who would be able to manufacture or supply theproducts without violating such patents.

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 othermanufacturers for 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, 2006 had a 44.4% 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 

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products, barriers toentry for products competing with our products are low, which makes it easierfor competitors 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, 2006, sales toMcKesson Corporation represented 34%, Cardinal Health Inc. represented 24% andAmerisourceBergen Corporation represented 11% 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.

***If our productsunder development fail in clinical studies, if we fail or encounterdifficulties in obtaining regulatory approval for new products or new uses ofexisting products, or if our development agreements are terminated, we willhave expended significant resources for no return.***

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

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, Zoto, Robinul line, Ponstel and Furadantin products are susceptible togeneric competition and because of products that compete with Sular, Prenate,Nitrolingual Pumpspray, Altoprev, Fortamet, Triglide, Ponstel, Ostiva andZovirax, 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 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 leveland/or grow our business.

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

In March 2004, the Company issued a total of $150.0 millionof its 1.75% senior subordinated contingent convertible notes due in 2024 (the “2004Notes”) in transactions that were exempt from registration in reliance upon Rule 144Aand other available exemptions under the Securities Act. In May 2006 andpursuant to a registered exchange offer, the Company exchanged each outstanding2004 Note with new notes (the “New Notes”) that, among other things, requirethe Company to redeem the $150.0 million 2004 Notes with cash instead of commonstock. As an incentive to the 2004 Note holders to exchange the 2004 Notes forNew Notes, the Company paid each exchanging holder an exchange fee equal to0.75% of the face value of each New Note exchanged. The Company paid anaggregate exchange fee of $1,125,000. The New Notes are due March 8, 2024and accrued interest is payable semi-annually in arrears on March 8 and September 8of each year, which commenced on September 8, 2004. In addition to theinterest on the New Notes, after March 8, 2007, the Company will also pay contingentinterest during specified six-month periods if the average trading price of theNew Notes per $1,000 principal amount for the five day trading period ending onthe third trading day immediately preceding the first day of the applicablesix-month period equals $1,200 or more. During any period when contingentinterest is payable, it will be payable at a rate equal to 0.5% per annum. Asthis contingent interest feature is based on the underlying trading price ofthe New Notes, the contingent interest qualifies as an embedded derivative. Asof December 31, 2006, management determined that the fair value of thiscontingent interest embedded derivative was not material. The net proceeds fromthis issuance, after deducting initial offering expenses, were approximately$145.5 million. Financing costs of $5.0 million were incurred with theoriginal issuance and $1,125,000 with the exchange, which are being amortizedon a straight-line basis over the life of the notes, and are included in otherassets in the consolidated balance sheet.

On September 18, 2006, the Company and certain ofits subsidiaries (together with Sciele, the “Borrower”) entered into a securedcredit agreement (the “Credit Agreement”) with UBS Securities LLC and LaSalleBank National Association as lead arrangers, UBS AG, Stamford Branch, asissuing bank, administrative agent and collateral agent, Regents Bank, FifthThird Bank and Bank of America, N.A. as co-documentation agents and UBS LoanFinance LLC, as swingline lender. The Credit Agreement provides the Company andits Cayman subsidiary, Sciele Pharma Cayman Ltd., with a five-year revolvingcredit facility of up to $100 million with an option to expand the facilitycredit line by up to an additional $75 million. As of December 31, 2006,there was no outstanding balance under the Agreement.

Incurrence of significant indebtedness, including ourexisting debt, could (1) limit our operating flexibility as a result ofrequirements by lenders, (2) require us to use a large portion of our cashflow from 

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operations for debtservice payments that could reduce profits and would reduce the availability ofour cash flow to fund operations, product acquisitions, the expansion of oursales force and facilities and research and development efforts and (3) limitacquisitions of products or companies due to restrictive covenants under oursenior secured credit facility with which we must comply as long as it is ineffect.

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 all ofour product acquisitions, licensing opportunities, marketing programs, productdevelopment programs, potential business acquisitions and manufacturingopportunities.

***The regulatorystatus of some of our products makes these products subject to increased competitionand*** 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, 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 products or submit safety and efficacydata on those products, which could be costly, or we might have to discontinueselling certain products if the FDA does not approve our marketing application.We could lose third-party reimbursement for these products and face increasedcompetition.

In addition, the FDA considers certain products to benew drugs, but has indicated its intent to exercise enforcement discretion and notpursue regulatory action unless certain conditions occur. If these conditionswere to materialize, or the FDA disagreed with our conclusions about theregulatory status of these products, we might be required to submit a 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 a 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 productpackaging companies are subject to inspection by the FDA and, in appropriatecases, the Drug Enforcement Administration and foreign 

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regulators. Some of ourthird-party manufacturers 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 timelymanner until 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.

***An adverse judgmentin the securities class action litigation in which we and certain directors andexecutive officers are defendants could have a material adverse effect on ourresults of operations and liquidity.***

The Company, certain former and current officers anddirectors are defendants in a consolidated securities lawsuit filed on August 22,2002 in the United States District Court for the Northern District of Georgia.Plaintiffs in the class action alleged in general terms that we violatedSections 11 and 12(a)(a) of the Securities Act of 1933 and that weviolated Sections 10(b) and 20(a) of the Securities Exchange Act of1934 and Rule 10b-5 promulgated thereunder. In an amended complaint,Plaintiffs claim that we issued a series of materially false andmisleading statements to the market in connection with our public offering on April 24,2002 and thereafter relating to alleged “channel stuffing” activities. Theamended complaint also alleged controlling person liability on behalf ofcertain of our officers under Section 15 of the Securities Act of 1933 andSection 20 of the Securities Exchange Act of 1934. Plaintiffs seek anunspecified amount of compensatory damages.

On September 29, 2004, the U.S. District Courtfor the Northern District of Georgia dismissed, without prejudice, theclass action lawsuit. Although the lawsuit was dismissed, the courtgranted the plaintiffs the right to refile provided that the plaintiffs pay allof the defendant’s fees and costs associated with filing the motion to dismissthe lawsuit. Plaintiffs did not file a second amended complaint as permitted,but instead filed 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 secondamended complaint. Instead, plaintiffs filed an appeal to the United StatesCourt of Appeals for the Eleventh Circuit.

On September 18, 2006, the Eleventh Circuit Courtof Appeals affirmed the District Court’s determination that the AmendedComplaint was a “shotgun pleading” which did not satisfy the pleadingrequirements under the federal rules. The Court of Appeals,however, disagreed with the remedy ordered by the District Court. Insteadof dismissing the Amended Complaint with a right to further amend if Plaintiffspaid Defendants’ fees and costs, the Court of Appeals held that theDistrict Court should have ordered Plaintiffs to replead under Federal Rule ofCivil Procedure 12(e). The Court of Appeals also held that Plaintiffs’ claimsunder the Securities Act of 1933 must meet the heightened pleadingstandards of Federal Rule of Civil Procedure 9(b) because thoseclaims are based on alleged fraud. Accordingly, the Court of Appeals vacatedthe District Court’s orders and remanded with instructions to order arepleading.

The Company shall continue to vigorously defend thisaction. No accrual is recorded in the Company’s financial statements related tothis case as the Company believes that its risk of loss is remote.

***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 

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transfer funds to andrepatriate funds from our subsidiaries and future changes in laws. An adverseinterpretation or ruling by one of the taxing authorities in a jurisdiction inwhich we operate or a change in law could increase our tax liability or resultin the imposition of penalty payments, which could adversely impact ouroperating 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 and Zovirax products from competition. We obtained exclusivedistribution rights in the U.S. to distribute our Fortamet, Altoprev, Triglide,****and Nitrolingual products, but have no or only limitedrights to enforce the patents relating to these products. We obtained exclusiveU.S. distribution rights to Sular from Bayer. Bayer holds the patent for thecomposition of the coat core tablet for Sular. Any exclusivity afforded by anyof these patents or rights could cease because we have no rights or onlylimited rights to enforce patents or to require enforcement actions by theowners of the patents. Proceedings involving our rights in patents or patent applicationscould result in adverse decisions. In addition, the confidentiality agreementsrequired of our employees and third parties may not provide adequate protectionfor our trade secrets, know-how and other proprietary information which we relyon to develop and sell our products. If any of our employees or third partiesdisclose any of our trade secrets or know-how, we could encounter increasedcompetition.

***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 ofothers. Patent and trademark infringement problems occur frequently inconnection with the sale and marketing of pharmaceutical products. If we do notavoid alleged infringement of the intellectual property rights of others, wemay need to seek a license to sell our products, defend an infringement actionor challenge the validity of the intellectual property in court, all of whichcould be expensive and time consuming. In addition, if we are found liable forinfringing a patent, we may have to stop selling one or more of our productsand pay damages. It could be very costly if we have to defend the patents ortrademarks covering our products or if we were found liable for infringementwhich could increase 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 U.S. dollar—Euroexchange rate. Although wedid not enter into any forward contracts in 2006, we may seek to eliminaterisks from foreign currency fluctuations after the time of shipment of productby entering into forward contracts for these purchases of inventory at the timeof product shipments. The Company’s earnings and cash flows could be adverselyaffected in the future by the relationship of the U.S. dollar with foreigncurrencies, and there can be no assurance that any hedging activity will besuccessful in protecting us from exchange risk.

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***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, 2006 of lessthan $0.1 million. At December 31, 2006, the Company had total netunrealized losses from marketable securities of $0.9 million.

In connection with borrowings incurred under thecredit facility with UBS Securities LLC, we could experience market risk withrespect to changes in the general level of the interest rates and their effectupon our interest expense. Borrowings under this facility bear interest atvariable rates. Because such rates are variable, an increase in interest rateswill result in additional interest expense and a reduction in interest rateswill result 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 New Notes, which are also subjectto market risk. All other things being equal, the fair market value of theCompany’s fixed rate debt will increase as rates decline and will decrease asrates rise. The fixed rate New Notes outstanding, totaling $150.0 millionat December 31, 2006, had a fair value of $171.0 million based on quotedmarket rates as of such date.

**Risks Related toour Common Stock**

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

The market pricefor our securities has been highly volatile. Various factors, including factorsthat are not related to our operating performance, may cause significant volumeand price fluctuations in the market. The following factors, among others, maycause fluctuations in our stock 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;

·       third-partymanufacturer interruptions in the supply of raw materials, delays in shippingor regulatory problems and/or delays;

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

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

***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 

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partyfrom acquiring us or replacing members of our Board of Directors, even if theacquisition or the replacements would be beneficial to our stockholders. Theseprovisions could also reduce the price that certain investors might be willingto pay for shares of our common stock and/or New Notes and result in the marketprice being lower than it would be without these provisions. Our charter andother documents contain 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;

·       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.   UNRESOLVEDSTAFF 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 a approximately101,000 square foot office and warehouse facility in Alpharetta, Georgia. Ourfacility includes space for offices and a warehouse. This lease expires in May 2009.In October 2006, we terminated a portion of this lease. We currentlyoccupy approximately 47,000 square feet of the facility. In December 2005,we entered into a lease with subsequent modifications for a approximately 5,000square foot office in Dublin, Ireland. This lease expires in September 2010.In February 2006, the Company entered into a lease agreement with 485Properties, LLC to lease approximately 51,000 square feet of office space atCorporate Center V, an office tower located in Atlanta, Georgia. The eight yearlease term, cancelable after five years, commenced in June 2006.

The Company relocated itscorporate and administrative functions to the new premises at Corporate CenterV from its then-current facilities, but continues to maintain its warehouse andtraining functions at its facilities in Alpharetta, Georgia.

**ITEM 3.   LEGALPROCEEDINGS**

The Company, certain former and current officers anddirectors are defendants in a consolidated securities lawsuit filed on August 22,2002 in the United States District Court for the Northern District of Georgia.Plaintiffs in the class action alleged in general terms that we violatedSections 11 and 12(a)(a) of the Securities Act of 1933 and that weviolated Sections 10(b) and 20(a) of the Securities Exchange Act of1934 and Rule 10b-5 promulgated thereunder. In an amended complaint,Plaintiffs claim that we issued a series of materially false andmisleading statements to the market in connection with our public offering on April 24,2002 and thereafter relating to alleged “channel stuffing” activities. Theamended compliant also alleged controlling person liability on behalf ofcertain of our officers under Section 15 of the Securities Act of 1933 andSection 20 of the Securities Exchange Act of 1934. Plaintiffs seek anunspecified amount of compensatory damages.

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On September 29, 2004, the U.S. District Courtfor the Northern District of Georgia dismissed, without prejudice, theclass action lawsuit. Although the lawsuit was dismissed, the courtgranted the plaintiffs the right to refile provided that the plaintiffs pay allof the defendant’s fees and costs associated with filing the motion to dismissthe lawsuit. Plaintiffs did not file a second amended complaint as permitted,but instead filed 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 secondamended complaint. Instead, plaintiffs filed an appeal to the United StatesCourt of Appeals for the Eleventh Circuit.

On September 18, 2006, the Eleventh Circuit Courtof Appeals affirmed the District Court’s determination that the AmendedComplaint was a “shotgun pleading” which did not satisfy the pleadingrequirements under the federal rules. The Court of Appeals,however, disagreed with the remedy ordered by the District Court. Insteadof dismissing the Amended Complaint with a right to further amend if Plaintiffspaid Defendants’ fees and costs, the Court of Appeals held that theDistrict Court should have ordered Plaintiffs to replead under Federal Rule ofCivil Procedure 12(e). The Court of Appeals also held that Plaintiffs’ claimsunder the Securities Act of 1933 must meet the heightened pleadingstandards of Federal Rule of Civil Procedure 9(b) because thoseclaims sound in fraud. Accordingly, the Court of Appeals vacated the DistrictCourt’s orders and remanded with instructions to order a repleading.

The Company shall continue to vigorously defend thisaction. No accrual is recorded in the Company’s financial statements related tothis case as the Company believes that its risk of loss is remote.

The Company is alsoinvolved with other various legal proceedings incident to the course ofbusiness. None of these proceedings are expected to have a material adverseeffect on the consolidated financial statements.

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

No matters were submitted to a vote of ourstockholders during the quarter ended December 31, 2006.

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**PART II**

**ITEM 5.   MARKETFOR REGISTRANT’S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUERPURCHASES OF EQUITY SECURITIES**

Ourcommon stock began trading on the Nasdaq National Market (now known as theNasdaq Global Select Market) on May 31, 2000. Our trading symbol is “SCRX.”The following table lists, for the periods indicated, the high and low saleprices per share for our common stock as reported on the Nasdaq Global SelectMarket.

| ** **     | ** ** | **High**   | ** ** | **Low**    | ** ** |
|----------------|------------|------------|------------|------------|------------|
| **2006**       | ** ** | ** ** | ** ** | ** ** | ** ** |
| First Quarter  |       | $          | 25.48      |       | $          | 14.84 |   |
| Second Quarter |       | 25.29      |       | 20.09      |       |
| Third Quarter  |       | 23.16      |       | 17.01      |       |
| Fourth Quarter |       | 24.75      |       | 18.77      |       |
|                |            |            |            |            |            |  |  |

 

| ** **     | ** ** | **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 20, 2007,the last reported sale price for our common stock on the Nasdaq Global SelectMarket was $23.99 per share. Asof February 20, 2007, there were approximately 149****holders of recordof our common stock.

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**Stock Price Performance Graph**

Setforth below is a line-graph presentation comparing the cumulative stockholderreturn on our common stock against cumulative total returns of the NasdaqGlobal Select Market and the Nasdaq Pharmaceutical Index. The performance graphshows total return on investment for the period beginning December 31,2001 and ending December 31, 2006. The stockholder return shown on thegraph below is not necessarily indicative of future performance, and theCompany will not make or endorse any predictions as to future stockholderreturns.

**COMPARE 5-YEARCUMULATIVE TOTAL RETURNAMONG SCIELE PHARMA, INC.,NASDAQ MARKET INDEX AND NASDAQ PHARMACEUTICAL**

****

**Assumes $100 invested on December 31, 2001Assumes dividend reinvestedFiscal Year ending December 31, 2006**

| ** **               | ** ** | **Fiscal Year Ending** | ** ** |
|--------------------------|------------|----------------------------------|------------|
| Company/Index/Market     |       | 12/31/2001                       |       | 12/31/2002 |   | 12/31/2003 |   | 12/31/2004 |   | 12/30/2005 |   | 12/29/2006 |   |
| Sciele Pharma, Inc. |       | 100.00                           |       | 25.44 |   | 38.28 |   | 77.88 |   | 58.69 |   | 81.66 |   |
| NASDAQ US Only           |       | 100.00                           |       | 69.97 |   | 106.36 |   | 115.98 |   | 120.15 |   | 134.80 |   |
| NASDAQ Pharmaceuticals   |       | 100.00                           |       | 61.63 |   | 88.91 |   | 96.09 |   | 105.97 |   | 106.27 |   |

 

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**Equity Compensation Plan Information**

Thefollowing table provides information as of December 31, 2006 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        |       |                                                                                                                                                      | 521,516       |                                                                                                             |       |                                                                                                                                                                                                           | $          | 4.90 |   |   |   | 201,820 |   |   |
| 2002 Stock Plan Approved  by Stockholders(1) |       |                                                                                                                                                      | 2,208,475     |                                                                                                             |       |                                                                                                                                                                                                           | 9.18       |   |   |   | 142,047 |   |   |
| 2000 Stock Plan Approved  by Stockholders    |       |                                                                                                                                                      | 223,898       |                                                                                                             |       |                                                                                                                                                                                                           | 19.48      |   |   |   | — |   |   |
| Employee Stock Ownership  Plan               |       |                                                                                                                                                      | N/A           |                                                                                                             |       |                                                                                                                                                                                                           | N/A        |   |   |   | 800,000 |   |   |
| **Total**                                    | ** ** | ** **                                                                                                                                                | **2,953,889** |                                                                                                             | ** ** | ** **                                                                                                                                                                                                     | ** ** |   |   |   | **1,143,867** |   |   |

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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.

**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 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 expired on August 2,2006.

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On August 3,2006, the Company adopted a new share repurchase program authorizing therepurchase of up to $30.0 million of outstanding common stock. This planreplaces all prior share repurchase plans and will expire on August 2,2007. As of December 31, 2006, $22.1 million was available for repurchasesunder the program. 

| ** **                                     | ** ** | ** **         | ** ** | ** **    | ** ** | ** **                        | ** ** | ** **               | ** ** | **Approximate Dollar**        | ** ** |
|------------------------------------------------|------------|--------------------|------------|---------------|------------|-----------------------------------|------------|--------------------------|------------|------------------------------------|------------|
| ** **                                     | ** ** | **Total**          | ** ** | ** **    | ** ** | **Total Number of**     | ** ** | ** **               | ** ** | **Value of Shares**      | ** ** |
| ** **                                     | ** ** | **Number of** | ** ** | **Average**   | ** ** | **Shares Purchased as** | ** ** | ** **               | ** ** | **that May Yet Be** | ** ** |
| ** **                                     | ** ** | **Shares**         | ** ** | **Price**     | ** ** | **Part of Publicly**    | ** ** | ** **               | ** ** | **Purchased Under**           | ** ** |
| **Fiscal Period**                         | ** ** | ** **         | ** ** | **Purchased** | ** ** | **Per Share**                | ** ** | **Announced Plans** | ** ** | **Plan**                           | ** ** | **the Plans** | ** ** |
| January 1  through March 31, 2006    |       |               | —     |          |       |                              | $          | —                   |       |                               |       | — |   |   |   | 1 |   |   |   | $ | 15,563,420 |   |   |
| April 1  through June 30, 2006       |       |               | 334,100    |          |       |                              | $          | 20.75                    |       |                               |       | 334,100 |   |   |   | 1 |   |   |   | $ | 8,631,399 |   |   |
| July 1  through August 2, 2006       |       |               | —     |          |       |                              | $          | —                   |       |                               |       | — |   |   |   | 1 |   |   |   | $ | 8,631,399 |   |   |
| August 3  through September 30, 2006 |       |               | 409,973    |          |       |                              | $          | 19.22                    |       |                               |       | 409,973 |   |   |   | 2 |   |   |   | $ | 22,118,963 |   |   |
| October 1  through December 31, 2006 |       |               | —     |          |       |                              | $          | —                   |       |                               |       | — |   |   |   | 2 |   |   |   | $ | 22,118,963 |   |   |
| Total                                          |       |               | 744,073    |          |       |                              | $          | 19.91                    |       |                               |       | 744,073 |   |   |   |   |   |   |   |   |   |   |
|                                                |            |                    |            |               |            |                                   |            |                          |            |                                    |            |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

 

*Plan 1 refers to the Share Repurchase Plan effective August 3,2005 through August 2, 2006. Plan 2 refers to the Share Repurchase Planeffective August 3, 2006 through August 2, 2007.*

**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 deemappropriate. In February 2006, the Company distributed 200,000 shares toemployees under the Employee Stock Ownership Plan.

**Employee StockOwnership 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, of which 50,000 shareswere allocated to the 2005 plan year and 150,000 shares were allocated to the2006 plan year. As of December 31, 2006, 800,000 shares are available todistribute under this program.

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**ITEM 6.   SELECTEDFINANCIAL DATA**

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 years ended December 31, 2006, and 2005 andDeloitte & Touche LLP, independent registered public accounting firm,as of and for the years ended December 31, 2004, 2003 and 2002. Theseresults may not be indicative of future results. Our results of operationsinclude contributions from products we acquired only from their respectiveacquisition date. 

| ** **                        | ** ** | **Year Ended December 31,**                          | ** ** |
|-----------------------------------|------------|---------------------------------------------------------------------|------------|
| ** **                        | ** ** | **2006**                                                            | ** ** | **2005** | ** ** | **2004** | ** ** | **2003** | ** ** | **2002** | ** ** |
| ** **                        | ** ** | **(In thousands, except per shares data)** | ** ** |
| **Statement of Operations Data:** | ** ** | ** **                                                          | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| Net revenues                      |       | $                                                                   | 293,181    |   | $ | 216,358 |   | $ | 151,967 |   | $ | 95,305 |   | $ | 115,178 |   |
| Net income (loss)                 |       | $                                                                   | 45,244     |   | $ | 39,209 |   | $ | 26,554 |   | $ | (1,738 | ) | $ | 6,166 |   |
| Net income (loss) per  share:     |       |                                                                |       |   |   |   |   |   |   |   |   |
| Basic                             |       | $                                                                   | 1.29       |   | $ | 1.12 |   | $ | 0.74 |   | $ | (0.05 | ) | $ | 0.19 |   |
| Diluted                           |       | $                                                                   | 1.20       |   | $ | 0.97 |   | $ | 0.66 |   | $ | (0.05 | ) | $ | 0.18 |   |

 

| ** **                       | ** ** | **As of December 31,** | ** ** |
|----------------------------------|------------|---------------------------------------|------------|
| ** **                       | ** ** | **2006**                              | ** ** | **2005** | ** ** | **2004** | ** ** | **2003** | ** ** | **2002** | ** ** |
| ** **                       | ** ** | **(In thousands)**               | ** ** |
| **Balance Sheet Data:**          | ** ** | ** **                            | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| Cash and cash  equivalents       |       | $                                     | 45,261     |   | $ | 17,043 |   | $ | 36,586 |   | $ | 33,722 |   | $ | 47,409 |   |
| Marketable  securities           |       | 121,190                               |       | 82,757 |   | 160,636 |   | 9,996 |   | — |   |
| Total assets                     |       | 590,005                               |       | 529,705 |   | 498,484 |   | 325,153 |   | 352,932 |   |
| Total debt                       |       | 150,000                               |       | 150,000 |   | 150,000 |   | — |   | — |   |
| Total stockholders’  equity |       | 387,823                               |       | 340,136 |   | 308,409 |   | 305,777 |   | 305,683 |   |
|                                  |            |                                       |            |  |  |  |  |  |  |  |  |  |  |  |  |  |

 

**ITEM 7.   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 Report on Form 10-K contains forward-lookingstatements within the meaning of the Private Securities Litigation Reform Actof 1995. These statements involve a number of risks and uncertainties. Althoughour forward-looking statements reflect the good faith judgment of ourmanagement, these statements can only be based on facts and factors currentlyknown by us. Consequently, forward-looking statements are inherentlysubject to risks and uncertainties, and actual results and outcomes may differmaterially from results and outcomes discussed in the forward-lookingstatements.

Forward-looking statements can be identified bythe 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 similarwords (including their use in the negative), or by discussions of futurematters such as the development of new products, technology enhancements,possible changes in legislation and other statements that are not historical. Thesestatements include but are not limited to statements under the captions “Business,”“Risk Factors” and 

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“Management’s Discussionand Analysis of Financial Conditions and Results of Operations” as well as allother sections in this Report on Form 10-K.

Risks anduncertainties that could cause our forward-looking statements to fail to occurinclude, 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 reachanticipated sales 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 slowergrowth for the class of drugs to which our promoted products belong andunfavorable clinical studies about such class of drugs;

·       Wemay encounter problems in the manufacture or supply of our products, forwhich we 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 promotedproducts from patent infringers;

·       Altoprevhas experienced manufacturing issues. If the issues recur and cannot beresolved, our ability to acquire the product for sale and sampling will beadversely affected;

·       Wemay incur unexpected costs in integrating new products into ouroperations;

·       Wemay be unable to develop or market line extensions for our productsincluding Prenate, Sular, Triglide, Altoprev and Fortamet, or, even ifdeveloped, obtain patent protection for our line extensions; further,introductions by us of line extensions of our existing productsmay require that we make unexpected changes in our estimates for futureproduct returns and reserves for obsolete inventory; if these risks occur, ouroperating results would be adversely affected;

·       Ifwe have difficulties acquiring new products or rights to market new products fromthird parties, our financial results could be adversely affected;

·       Ourlicensor/supplier can terminate our rights to commercialize Nitrolingual andthe 60 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 affected our operating results;

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

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

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·       Ourbusiness is subject to increasing government price controls and otherhealthcare cost containment measures;

·       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;

·       Wemay be found noncompliant with applicable federal, state or internationallaws, rules or regulations;

·       Ifgeneric competitors to any of our products are introduced, our revenuesmay 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.

**Results ofOperations**

***Years Ended December 31, 2006 and December 31,2005***

*NetRevenues.**  *Netrevenues increased $76.8 million, to $293.2 million for 2006, compared to$216.4 million for 2005. This increase was primarily the result ofincreased revenues for promotional products of $87.0 million to$278.2 million resulting from a full year of Altoprev and Fortamet saleswhich were launched in April 2005, OptiNate sales which was launched inMarch 2005 the continued growth of Sular scripts which is attributed to thesuccessful leveraging of our improved managed care position by our sales force,the launch of Triglide in July 2005, as well as price increases. Theincrease in revenues was partially offset by a decrease in net revenues fornon-promoted products of $10.2 million in 2006 compared to 2005. This reductionis primarily from our Tanafed line as a result of generic entries into themarket.

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**Product Overview**

| ** **      | ** ** | **Change in total dispensed prescriptions for  the year ended December 31, 2006 compared  to the year ended December 31, 2005(a)** | ** ** | **Change in new dispensed prescriptions for  the year ended December 31, 2006 compared  to the year ended December 31, 2005(a)** | ** ** |
|-----------------|------------|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|
| Sular           |       |                                                                                                                                                                                                                    | 14.8       | %                                                                                                                                                                                                                     |       |   | 21.7 | % |   |
| Fortamet        |       |                                                                                                                                                                                                                    | (10.0      | )%                                                                                                                                                                                                                    |       |   | 23.6 | % |   |
| Altoprev        |       |                                                                                                                                                                                                                    | (28.4      | )%                                                                                                                                                                                                                    |       |   | (25.7 | )% |   |
| Triglide(b)     |       |                                                                                                                                                                                                                    | 696.6      | %                                                                                                                                                                                                                     |       |   | 409.9 | % |   |
| Nitrolingual(c) |       |                                                                                                                                                                                                                    | 27.9       | %                                                                                                                                                                                                                     |       |   | (8.3 | )% |   |
| Prenate  Elite  |       |                                                                                                                                                                                                                    | (19.3      | )%                                                                                                                                                                                                                    |       |   | (19.3 | )% |   |
| OptiNate(d)     |       |                                                                                                                                                                                                                    | 112.0      | %                                                                                                                                                                                                                     |       |   | 66.8 | % |   |
| Ponstel         |       |                                                                                                                                                                                                                    | (14.3      | )%                                                                                                                                                                                                                    |       |   | (15.3 | )% |   |
| Ostiva(e)       |       |                                                                                                                                                                                                                    | N/A        |                                                                                                                                                                                                                  |       |   | N/A |   |   |
| Zovirax(f)      |       |                                                                                                                                                                                                                    | N/A        |                                                                                                                                                                                                                  |       |   | N/A |   |   |

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(a)*          *Source:IMS’s Next Generation Prescription Services data.

(b)*         *Triglide was launched in July 2005.

(c)*          *We believe that IMS data does not capture prescriptions ofNitrolingual from some of the non-retail channels and prescription trends inthe non-retail channel which may have a significant impact on the reportedchange.

(d)*         *OptiNate was launched in March 2005.

(e)*          *Ostiva was launched in September 2006.

(f)*            *We acquired Zovirax marketing rights in December 2006 andlaunched our promotion in January 2007.

Net revenues fromour cardiovascular and diabetes products (namely Sular,Fortamet, Altoprev, Triglide and Nitrolingual) increased $78.5 million, to$223.0 million for the year ended December 31, 2006, compared to $144.5million year ended December 31, 2005. The increase was primarily due to 2006including a full year of Altoprev and Fortamet sales which were launched in April 2005,the continued growth of Sular prescriptions which is attributed to thesuccessful leverageing of our improved managed care position by our salesforce, the launch of Triglide in July 2005, as well as price increases.

Net revenues from our promoted Women’sHealth products (namely Prenate Elite, OptiNate, Ponstel, Ostiva and Zovirax)increased $8.6 million, to $55.2 million for the year ended December 31,2006, compared to $46.6 million for the year ended December 31, 2005respectively. Thisincrease is primarily related to the successful launch of our women’s healthsales force in the first quarter of 2006, continued growth of our market sharefor OptiNate which was launched in April 2005, the launch of Ostiva in September 2006,and price increases.

Net revenues from our non-promoted products(adjusted for our 2006 promoted product mix) decreased $10.2 million, to $15.0million for the year ended December 31, 2006, compared to $25.2 millionfor the year ended December 31, 2005. This reduction is primarily from our Tanafedline as a result of generic entries into the market.

*Cost of Revenues.**  *Cost of revenuesincreased $7.4 million, to $40.7 million for the year ended December 31,2006, compared to $33.3 million for the year ended December 31, 2005.The increase in costof revenues is related to the change in product mix and the increase in salesvolumes and product prices for 2006 as compared to 2005.

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*Gross Margin.**  *Gross margins for2006 were 86.1% compared to 84.6% for 2005. This increase in gross margin forthe year ended December 31, 2006 is the result of a change in product mixand price increases.

*Selling, General and Administrative Expenses.**  *Selling,general and administrative expenses (“SG&A”) increased $47.9 million, to$145.3 million for the year ended December 31, 2006, compared to$97.4 million for the year ended December 31, 2005. This increase in selling, generaland administrative expenses is due primarily to sales force expansion and theincrease in royalty and commission expenses related to higher revenues.Additionally, we recognized $6.8 million in stock based compensation expense inSG&A for the year ended December 31, 2006, compared to the $1.1 millionin share based compensations for the year ended December 31, 2005. Thisincrease is primarily related to the adoption of Statement of FinancialAccounting Standards (“SFAS”) 123(R), *Share Based Payment,*in 2006.

*Depreciation and Amortization.**  *Depreciationand amortization expense increased $3.2 million, to $25.9 million forthe year ended December 31, 2006 compared to $22.7 million for theyear ended December 31, 2005. This increase is primarily related to the increase in amortizableintangible assets as a result of a full year of amortization related to thepurchase of Fortamet and Altoprev and the launch of Triglide and Ostiva, aswell as the $10.0 million in Sular milestones paid during 2006.

The Company believes there are nointangible asset impairments and there were no other asset write-downs asof December 31, 2006.

*Research and Development Expense.**  *Researchand development expense increased $12.5 million, to $16.6 million forthe year ended December 31, 2006, compared to $4.1 million for theyear ended December 31, 2005. These increases were primarily related to greater activity in thedevelopment program for lifecycle management initiatives for our products,which includes the new Sular formulation and the glycopyrrolate formulation forchronic moderate to severe drooling in pediatric patients, as well asmanagement’s increased emphasis on development. Additionally, we recognized$1.1 million in research and development stock-based compensation expense forthe year ended December 31, 2006. There were no comparable expenses in2005.

*Interest Expense.**  *Interest expenseincreased $0.2 million, to $3.2 million for the year ended December 31,2006, compared to $3.0 million for the year ended December 31, 2005. The increase is due entering intothe new $100.0 million secured credit facility in September 2006discussed in note 2 to the consolidated financial statements.

In March 2004, the Company issued atotal of $150.0 million of its 1.75% senior subordinated contingentconvertible notes due in 2024 (the “2004 Notes”) in transactions that wereexempt from registration in reliance upon Rule 144A and other availableexemptions under the Securities Act. In May 2006 and pursuant to aregistered exchange offer, the Company exchanged each outstanding 2004 Notewith new notes (the “New Notes”) that, among other things, require the Companyto redeem the $150.0 million 2004 Notes with cash instead of common stock. Asan incentive to the 2004 Note holders to exchange the 2004 Notes for New Notes,the Company paid each exchanging holder an exchange fee equal to 0.75% of theface value of each New Note exchanged. The Company paid an aggregate exchangefee of $1,125,000. The New Notes are due March 8, 2024 and accruedinterest is payable semi-annually in arrears on March 8 and September 8of each year, which commenced on September 8, 2004. In addition to theinterest on the New Notes, after March 8, 2007, the Company will also paycontingent interest during specified six-month periods if the average tradingprice of the New 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. As this contingent interest feature is based on the underlying tradingprice of the New Notes, the contingent interest qualifies as an embeddedderivative. As of December 31, 2006, management determined that the fairvalue of this contingent interest embedded 

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derivative wasnot material. The net proceeds from this initial issuance, after deductingoffering expenses, were approximately $145.5 million. Financing costs of$5.0 million were incurred with the original issuance and $1,125,000 withthe exchange, which are being amortized on a straight-line basis over the lifeof the notes, and are included in other assets in the consolidated balancesheet.

Upon conversion, the Company will deliver,for each New Note, consideration (the “conversion value”) having a value equalto the product of the conversion rate (initially, approximately 45.1467,subject to adjustment) multiplied by the average of the closing price of ourcommon stock on the Nasdaq Global Select Market on each of the five consecutivetrading days beginning on the third trading day following the conversion dateof New Notes (the “applicable stock price”). This consideration value will bepaid in cash (the “required cash amount”) in an amount equal to the lesser of (a) theaggregate principal amount of New Notes on the conversion date or (b) theconversion value, and the remainder will be paid in shares of our common stock.The number of shares to be delivered will equal (a)(i) the conversionvalue minus (ii) the required cash amount, divided by (b) theapplicable stock price. Holders may convert the New Notes only under thefollowing circumstances: (1) during any calendar quarter, if the closingsales price of the Company’s common stock exceeds 120% of the conversion pricefor at least 20 trading days in the 30 consecutive trading days ending onthe last trading day of the preceding calendar quarter; (2) if the NewNotes have been called for redemption; (3) during the five trading dayperiod immediately following any nine consecutive trading day period in whichthe trading price of the New Notes per $1,000 principal amount for each day ofthat period was less than 95% of the product of the closing price of theCompany’s common stock and the number of shares of common stock issuable uponconversion of $1,000 principal amount of the New Notes; or (4) theoccurrence of specified corporate transactions.

A holderthat surrenders New Notes for conversion in connection with certain fundamentalchanges that occur prior to March 13, 2007 may be entitled to anincrease in the conversion rate. However, in lieu of increasing the conversionrate applicable to those New Notes, the Company may in certaincircumstances elect to change its conversion obligation so that, in lieu ofdelivering cash, and, if applicable, shares of our common stock in respect ofsuch conversion obligation, the Company will deliver shares of the acquiringcompany’s common stock. In addition to the events which would constitute achange of control (as defined in the indenture relating to the New Notes), afundamental change will also include the occurrence of any transaction or eventor any series of transactions or events in connection with which all orsubstantially all of our common stock is exchanged for, converted into,acquired for or constitutes solely the right to receive stock, othersecurities, other property, assets or cash, unless either:

(a)          the persons that “beneficially owned” the shares of our voting stockimmediately prior to such transaction, “beneficially own,” shares of thesurviving or continuing corporation’s voting stock representing at least amajority of the total voting power of all outstanding classes of voting stockof such corporation or

(b)         both of the following conditions are satisfied:

(i)             at least 90% of the consideration (other than cash payments forfractional shares or pursuant to statutory appraisal rights) in suchtransaction consists of common stock, ordinary shares or American DepositoryShares, and any associated rights, traded on a U.S. national securitiesexchange or quoted on the Nasdaq Global Market (or that will be so traded orquoted when issued or exchanged in connection with such transaction) and

(ii)         as a result of such transaction, the consideration due uponconversion of New Notes shall be payable solely in shares of such securities,and any associated rights and cash for fractional shares.

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The Company has the option to redeem theNew Notes beginning March 13, 2007 at a price equal to 100% of theiraggregate principal amount, plus accrued and unpaid interest, includingcontingent interest, if any.

The holders of the New Notes have theoption to require the Company to repurchase the New Notes on March 8 of2009, 2014 and 2019, and upon a change in control, at a price equal to 100% oftheir aggregate principal amount, plus accrued and unpaid interest, includingcontingent interest, if any.

The Company had no debt (including underour credit facility) other than the aforementioned notes outstanding at December 31,2006 or December 31, 2005.

*Interest Income.**  *Interest incomeincreased $1.7 million, to $4.9 million for the year ended December 31,2006, compared to $3.2 million for the year ended December 31, 2005. The increase in interest income forthe year ended December 31, 2006 is primarily due to a higher average cashand marketable securities balance as a result of cash generation from sales andhigher returns on current investments.

*Other.**  *Other loss, which consists primarily of loss on sale of marketablesecurities, decreased $0.7 million, to less than $0.1 million for the yearended December 31, 2006, compared to $0.7 million for the year ended December 31,2005.

*Provision forIncome Taxes.**  *Income taxes were provided for at arate of 31.8% for the year ended December 31, 2006 compared to 32.8% forthe year ended December 31, 2005. This decrease in the effective rate is dueprimarily to the change in the mix of tax jurisdictions, both domestic andinternational, where our income was earned.

**YearsEnded December 31, 2005 and December 31, 2004**

*Net Revenues.**  *Netrevenues increased $64.4 million, to $216.4 million for 2005, compared to$152.0 million for 2004. Unit sales increased 34.5% as compared to theprior year. This increase was primarily the result of price increases on ourproducts and the successful expansion of our product mix to include Altoprev,Fortamet, Triglide and OptiNate. In addition to the expansion in products,during 2005, the Company increased its sales force from approximately 360 salesprofessionals to approximately 470 sales professionals and increased itsemphasis 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’s National Prescription Audit PlusTM data.

(b)          Fortamet was launched in May 2004, by Andrx Corporation. As aresult, comparative data is not available for 2004.

(c)           Triglide was launched in July 2005. As a result, comparativedata is not available for 2004.

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(d)          We believe that IMS data does not capture prescriptions ofNitrolingual from some of the non-retail channels and prescription trends inthe non-retail channel which may have a significant impact on the reportedchange.

(e)           Prenate Elite was launched inMarch 2004. As a result, comparative data is not available for 2004.

(f)             OptiNate was launched in March 2005. As a result, comparativedata is not available for 2004.

Net revenues fromour Cardiovascular and Diabetes products (namely Sular,Fortamet, Altoprev, Triglide and Nitrolingual) increased $69.2 million, to$144.5 million for the year ended December 31, 2005, compared to $75.3million year ended December 31, 2004. This increase was primarily a result of theaddition of our new products, Altoprev and Fortamet, commencing in April 2005,the launch of Triglide in July 2005, price increases on our products andtotal prescription growth of Sular.

Net revenues from our promoted Women’sHealth products (namely Prenate Elite, OptiNate and Ponstel) increased $24.4million, to $46.6 million for the year ended December 31, 2005, comparedto $22.2 million for the year ended December 31, 2004 respectively. Thisincrease was due primarily to price increases on our products, an increase intotal prescriptions for Prenate Elite and Ponstel and the successful launch ofOptiNate in March 2005.

Net revenues from our non-promoted products(adjusted for our 2005 promoted product mix) decreased $29.4 million, to $25.2million for the year ended December 31, 2005, compared to $54.6 millionfor the year 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 launchof Prenate Elite, the next generation of the Prenate line of prenatal vitamins.We began promoting and selling Prenate Elite in April 2004. Prenate Elitehad captured a market share of 12.8% of new prescriptions and 13.4% of totalprescriptions of prenatal vitamins in December 2005 (Source: IMS Health’s NationalPrescription Audit PlusTM data). Additionally, the launch of OptiNate in March 2005had captured 7.2% of new prescriptions of prenatal vitamins and 7.2% of totalprescription in December 2005 (Source: IMS Health’s National PrescriptionAudit PlusTM data).

*Cost of Revenues.**  *Cost of revenuesincreased $4.2 million, to $33.3 million for the year ended December 31,2005, compared to $29.1 million for the year ended December 31, 2004.The increase in cost of revenues was related to the change in product mix andan increase in sales which resulted in an increase in units sold by 34.5% ascompared to the prior year.

*Gross Margin.**  *Gross margins for 2005were 85%, compared to 81% for 2004. This increase in gross margin was theresult of the change in product mix from the prior year primarily as the resultof acquisitions completed in 2005 and the successful launch of Triglide andOptiNate. Also contributing to the increased gross margins were price increasesimplemented during the year.

*Selling, General and Administrative Expenses.**  *Selling,general and administrative expenses 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. This increase wasprimarily related to the increase in our sales force, the associated costs forthe launch of our new products and an increase in royalty expense of$9.5 million and commission expense of $4.5 million related to theincreased net revenues.

*Depreciation and 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 were nointangible asset impairments and there were no other asset write-downs asof December 31, 2005.

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*Research and Development Expense.**  *Researchand development expense increased $2.6 million, to $4.1 million forthe year ended December 31, 2005, compared to $1.5 million for theyear ended December 31, 2004. This increase was primarily related togreater activity in the development program for lifecycle managementinitiatives for our products.

*Interest Expense.**  *Interest expenseincreased $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% per annum. The net proceeds fromthis initial issuance after deducting offering expenses were approximately$145.4 million.

*Interest Income.**  *Interest income 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. Thedecrease in interest income for the year is primarily due to a decrease in theaverage cash and marketable securities balance resulting from the acquisitionsof Fortamet, Altoprev and Triglide.

*Other.**  *Other loss increased $0.7 million, to $0.7 million for the yearended December 31, 2005, compared to $0.0 million for the year ended December 31,2004. The decrease in other loss is the result of the sale of marketablesecurities for the purchase of the licensing rights for Altoprev and Fortamet.

*Provision forIncome Taxes.**  *Income taxes were provided for at a rate of 32.8% for the year endedDecember 31, 2005 compared to 31.9% for the year ended December 31,2004. This increase is related to the changes in jurisdications in which we dobusiness and the effect of the international operations.

**Liquidityand Capital Resources**

Our liquidity requirements arise fromworking capital requirements, product development activities, funding ofacquisitions and debt service. We expect to need additional funds to acquire orobtain licenses for new products, develop and test new products and potentiallyto acquire other businesses, which may increase our cost of capital. We mayseek funding through public and private financing and may seek to incur debt,issue shares of our stock, or both, either to finance a transaction or asconsideration for a transaction. Adequate funds for these purposes, whetherthrough the financial markets or from other sources, may not be available whenwe need them or on terms acceptable to us. Insufficient funds could cause us todelay, scale back or abandon some or all of our product acquisitions, licensingopportunities, marketing programs, product development programs, potentialbusiness acquisitions and manufacturing opportunities. We have historically metthese cash requirements through cash from operations, borrowings and the issuanceof common stock.

Our cash and cash equivalents were $45.3million at December 31, 2006, compared to $17.0 million at December 31,2005. Net cash provided by operating activities for the year ended December 31,2006 was $91.8 million. This provision of cash resulted from the netincome for the year of $45.2 million, resulting primarily from the salesof our promoted products, a decrease in accounts receivable of $0.8 million, asa result of an overall reduction in our days sales outstanding, an increase inaccounts payable of $6.8 million, primarily related to increased businessvolume, a decrease in inventory of $2.3 million, primarily related to 

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improvedinventory management, a decrease in other current assets and other assets of$2.3 million. Additional cash includes adjustment for non-cash expense items ofdepreciation and amortization of $25.9 million, stock based compensationexpenses of $7.9 million, interest expense of $0.5 million, deferred income taxbenefits of $4.3 million, recognized losses on the disposal of property andequipment of $0.1 million and less than $0.1 million for the loss on sale ofsecurities. These providers of cash were partially offset by an increase inincome taxes receivable of $4.3 million, primarily related to estimated taxpayments made during the year, and a decrease of less than $0.1 million inaccrued expenses and other liabilities.

Our cash and cash equivalents were $17.0million at December 31, 2005, compared to $36.6 million at December 31,2004. Net cash provided by operating activities for the year ended December 31,2005 was $20.3 million. This providing of cash resulted from the netincome for the year of $39.2 million, resulting primiarly from the salesof our promoted products, non-cash expenses including depreciation andamortization of $22.7 million, non-cash deferred income tax benefit of $4.2million, increase in income tax receivable of $4.9 million, increase in accruedexpenses and other liabilities of $2.6 million, and other miscellanousnon-cash transactions of $2.4 million. These providers of cash were partiallyoffset by an increase in accounts receivable of $24.5 million whichresulted from our increased sales, other current assets and other assets of$15.5 million related primarily to increased samples for our new products,inventories of $13.1 million related to increased levels for our productsand a decrease in accounts payable of $2.5 million.

We maintain supply agreements with thirdparty suppliers for all of our products. Some of these supply agreementscontain minimum purchase requirements. For most of these supply agreements, webelieve that our inventory requirements and related purchases of inventory willexceed the minimum purchase requirement in 2007. In those cases in which we donot believe 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 forthe year ended December 31, 2006 was $53.5 million, compared to net cashused in investing activities for the year ended December 31, 2005 whichwas $31.2 million. The principal uses of this cash were for the purchase of marketablesecurities of $199.5 million, of which $162.1 million were reinvestmentfrom maturing securities or additional purchases utilizing cash generated fromsales, $4.4 million for the purchase of property and equipment, primarily fornew office furniture and computer systems for the new corporate office, $11.9million for the purchase of product licenses, specifically, $10.0 millionfor milestone payments to Bayer Healthcare AG in 2006, a $0.9 millionpayment for the launch of Ostiva in September 2006, and $1.0 million inpayments related to the addition of Zovirax in December 2006.

Net cash used in investing activities forthe year ended December 31, 2005 was $31.2 million, compared to net cashused in investing activities for the year ended December 31, 2004 whichwas $161.3 million. The primary use of cash for investing activities wasthe purchase 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 by financing activities forthe year ended December 31, 2006 was $9.5 million, compared to cash usedby financing activities of $4.5 million for the year ended December 31,2005. This is primarilyresulting from the repurchase of our common stock for $14.8 million and $3.2million for debt financing costs, consisting of the exchange of the contingentconvertible debt. Partially offsetting this net cash used was $5.3 millionfor the issuances of common stock related to employee stock options and $3.1 millionfor a non-cash reduction in taxes payable relating to stock options.

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Net cash used by financing activities forthe year ended December 31, 2005 was $4.5 million, compared to cashprovided by 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 byproceeds from the issuance of common stock of $2.0 million.

We believe that our cash on hand, cash weexpect to generate from our operations and availability under our revolvingcredit facility will be sufficient to fund our 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 requirements will result in the acquisition of excessiveinventory. We expect we will also experience growth in our accounts receivableas our sales increase.

In March 2004, the Company issued atotal of $150.0 million of its 1.75% senior subordinated contingentconvertible notes due in 2024 (the “2004 Notes”) in transactions that wereexempt from registration in reliance upon Rule 144A and other availableexemptions under the Securities Act. In May 2006 and pursuant to aregistered exchange offer, the Company exchanged each outstanding 2004 Notewith new notes (the “New Notes”) that, among other things, require the Companyto redeem the $150.0 million 2004 Notes with cash instead of common stock. Asan incentive to the 2004 Note holders to exchange the 2004 Notes for New Notes,the Company paid each exchanging holder an exchange fee equal to 0.75% of theface value of each New Note exchanged. The Company paid an aggregate exchangefee of $1,125,000. The New Notes are due March 8, 2024 and accruedinterest is payable semi-annually in arrears on March 8 and September 8of each year, which commenced on September 8, 2004. In addition to theinterest on the New Notes, after March 8, 2007, the Company will also paycontingent interest during specified six-month periods if the average tradingprice of the New 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. As this contingent interest feature is based on the underlying tradingprice of the New Notes, the contingent interest qualifies as an embeddedderivative. As of September 30, 2006, management determined that the fairvalue of this contingent interest embedded derivative was not material. The netproceeds from this issuance, after deducting offering expenses, wereapproximately $145.5 million. Financing costs of $5.0 million wereincurred with the original issuance and $1,125,000 with the exchange, which arebeing amortized on a straight-line basis over the life of the notes, and areincluded in other assets in the consolidated balance sheet.

On September 18, 2006, we entered intoa secured credit agreement (the “Credit Agreement”) with UBS Securities LLC andLaSalle Bank National Association as lead arrangers, UBS AG, Stamford Branch,as issuing bank, administrative agent and collateral agent, Regents Bank, FifthThird Bank and Bank of America, N.A. as co-documentation agents and UBS LoanFinance LLC, as swingline lender. The Credit Agreement provides us and ourCayman subsidiary, Sciele Pharma Cayman Ltd., with a five-year revolving creditfacility of up to $100 million, with an option to expand the facility creditline by up to an additional $75 million.

Amounts outstanding under the new creditfacility generally bear interest at the lenders’ corporate base rate or theLIBOR, plus a specified margin of between 1.75% and 2.5% depending on theBorrower’s ratio of indebtedness to earnings. The Credit Agreement containscustomary negative covenants and financial covenants.

Our obligations under the Credit Agreementare secured by a pledge of substantially all of our assets and are guaranteedby substantially all of our subsidiaries that are not borrowers.

We terminated our existing credit agreementwith LaSalle Bank National Association, dated February 11, 2003, assubsequently amended, once we entered into the new Credit Agreement.

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Pursuant to a previously announced share repurchaseprogram, during the six months ended June 2004, the Company repurchased atotal of 260,000 shares of common stock at an aggregate cost of approximately$4.6 million. All of these shares were retired. In July 2004, theCompany’s Board of Directors authorized a subsequent $20.0 million sharerepurchase program. The new program, which authorizes the repurchase of up to$5 million of common stock per quarter, became effective in August 2004.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 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, the Company, with Board ofDirectors approval, purchased one 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 authorized 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. In the first quarterof 2005, the Company repurchased 127,169 shares of common stock at an averagecost of $16.44 per share, or $2.1 million. In the fourth quarter of 2005,the Company repurchased 300,000 shares of common stock at an average cost of$14.79 per share, or $4.4 million. In the second quarter of 2006, the Companyrepurchased 334,100 shares of common stock at an average cost of $20.71 pershare, or $6.9 million. These shares have been retired. This plan expired on August 2,2006.

The Company adopted a new share repurchase programeffective August 3, 2006, that authorizes the repurchase of up to $30.0million 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, 2007. In thethird quarter of 2006, the Company repurchased 409,973 shares of commonstock at an average cost of $19.19 per share, or $7.9 million. These shareshave 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.

**Contractual Obligations (in thousands)**

| ** **                       | ** ** | **Payment due by period** | ** ** |
|----------------------------------|------------|------------------------------------------|------------|
| **Contractual Obligations** | ** ** | ** **                               | ** ** | **Total** | ** ** | **2007** | ** ** | **2008 - 2009** | ** ** | **2010 - 2011** | ** ** | **Thereafter** | ** ** |
| Operating lease  obligations     |       | $                                        | 20,670     |   | $ | 7,233 |   |   | $ | 10,892 |   |   |   | $ | 2,545 |   |   | $ | — |   |
| Purchase  obligations            |       | 11,103                                   |       | 3,701 |   |   | 7,402 |   |   |   | — |   |   | — |   |
| Long-term  debt obligations      |       | 150,000                                  |       | — |   |   | — |   |   |   | — |   |   | 150,000 |   |
| Total                            |       | $                                        | 181,773    |   | $ | 10,934 |   |   | $ | 18,294 |   |   |   | $ | 2,545 |   |   | $ | 150,000 |   |
|                                  |            |                                          |            |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

 

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Operating lease obligations include $5.6 millionand $7.9 million in 2007 and 2008-2009, respectively for ourcorporate fleet vehicles. Also included is the annual lease payment of$1.6 million per annum through July 2011 for all office space.

On February 7, 2006, the Company enteredinto a lease agreement with 485 Properties, LLC to lease approximately 51,000square feet of office space at Corporate Center V, an office tower located inAtlanta, Georgia. The lease agreement is for an eight year lease term,cancelable after five years, commenced on July 15, 2006. The leasepayments under this lease are included in the above chart under operating leaseobligations.

The Company relocated its corporate and administrativefunctions to the new premises at Corporate Center V from its then-currentfacilities, but continues to maintain its warehouse and training functions atits facilities in Alpharetta, Georgia.

In December 2005, the Company entered into a newlease agreement for approximately 5,000 square feet of office space in Dublin,Ireland. This space is leased under a cancelable operating lease that expiresin September 2010.

Purchase obligations for inventory are based on theunit contractual obligations at the unit cost as of December 31, 2006.Unit prices are subject to increase upon notification by the supplier in theevent of increased costs incurred by the supplier.

Long-term debt obligations do not include interestpayments of $2.6 million per year relating to the $150.0 million seniorsubordinated contingent convertible note.

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

**Off-Balance SheetArrangements**

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.

**Critical AccountingPolicies**

We view ourcritical accounting policies to be those policies which are very important tothe portrayal of our financial condition and results of operations, and requiremanagement’s most difficult, complex or subjective judgments. The circumstancesthat make these judgments difficult or complex relate to the need formanagement to make estimates about the effect of matters that are inherentlyuncertain. We believe our critical accounting policies are as 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, thisassessment requires analysis of the financial strength of our customers, whichcan be highly 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.

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·       *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 seller andinclude that amount in the allocation of the total purchase price. We reviewthe 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 intangible assets. We use the assistance of valuation experts to help usallocate the purchase price to the fair value of the various intangible assetsthat we have acquired. Then, we must estimate the economic useful life of eachof these 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 ofappropriate revisions.

In assessing therecoverability of our intangible assets, we must make assumptions regardingestimated future cash flows and other factors. If the estimated undiscountedfuture cash flows do not exceed the carrying value of the intangible assets, wemust determine the fair value of the intangible assets. If the fair value ofthe intangible assets is less than its carrying value, an impairment loss willbe recognized in an amount equal to the difference. We review intangible assetsfor impairment at least annually and whenever events or changes incircumstances indicate that the carrying amount of an asset may not berecoverable. Such events or circumstances may 

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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.

Developing the provisionfor income taxes requires significant judgment and expertise in international,federal and state income tax laws, regulations and strategies, including thedetermination of deferred tax assets and liabilities and, if necessary, anyvaluation allowances that may be required for deferred tax assets. Ourjudgments 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.

**Recent AccountingPronouncements**

In February 2007, the Financial Accounting StandardsBoard (“FASB”) issued Statement of Financial Accounting Standards (“SFAS”) No. 159,*The Fair Value for Financial Assets and FinancialLiabilities*. This Statement permits entities to choose to measurefinancial assets and liabilities, with certain exceptions, at fair value atspecified election dates. A business entity shall report unrealized gains andlosses on items for which the fair value option has been elected in earnings ateach subsequent reporting date. This Statement is effective as of the beginningof an entity’s first fiscal year that begins after November 15, 2007. TheCompany has not determined the effect, if any, that the adoption of SFAS No. 159will have on its financial statements.

On September 29, 2006, the FASB issued SFAS No. 158,*Employers’ Accounting for Defined Benefit Pensionand Other Postretirement Plans*. This Statement requires an employerto recognize the overfunded or underfunded status of a defined benefitpostretirement plan (other than a multiemployer plan) as an asset or liabilityin its statement of financial position and to recognize changes in that fundedstatus in the year in which the changes occur through comprehensive income. Thisstatement also requires an employer to measure the funded status of a plan asof the date of its year-end statement of financial position, with limitedexceptions. An employer with publicly traded equity securities is required toinitially recognize the funded status of a defined benefit postretirement planand to provide the required disclosures as of the end of the fiscal year endingafter December 15, 2006. The requirement to measure plan assets andbenefit obligations as of the date of the employer’s fiscal year-end statementof financial position is effective for fiscal years ending after December 15,2008. The adoption of SFAS No. 158 did not have a material impact on theCompany’s financial statements.

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On September 15, 2006 the FASB issued SFAS No. 157,*Fair Value Measurements.*The Statementprovides guidance for using fair value to measure assets and liabilities. ThisStatement references fair value as the price that would be received to sell anasset or paid to transfer a liability in an orderly transaction between marketparticipants in the market in which the reporting entity transacts. TheStatement applies whenever other standards require (or permit) assets orliabilities to be measured at fair value. The Statement does not expand the useof fair value in any new circumstances. It is effective for financialstatements issued for fiscal years beginning after November 15, 2007, andinterim periods within those fiscal years. The adoption of SFAS No. 157 isnot expected to have a material impact on the Company’s financial statements.

In March 2006, the FASB issued SFAS No. 156,Accounting for Servicing of Financial Assets, which amends FAS 140, *Accounting for Transfers and Servicing of Financial Assets andExtinguishments of Liabilities*. In a significant change to currentguidance, Statement No. 156 permits an entity to choose either of thefollowing subsequent measurement methods for each class of separatelyrecognized servicing assets and servicing liabilities: (1) AmortizationMethod or (2) Fair Value Measurement Method. Statement No. 156 iseffective as of the beginning of an entity’s first fiscal year that beginsafter September 15, 2006. The adoption of Statement No. 156 is notexpected to have a material impact on the Company’s financial statements.

In February 2006, the FASB issued Statement No. 155,*Accounting for Certain Hybrid Financial Instruments—anamendment of FASB Statements No. 133 and 140.*This Statementpermits fair value of remeasurement for any hybrid financial instrument thatcontains an embedded derivative that otherwise would require bifurcation;clarifies which interest-only strips and principal-only strips are not subjectto the requirements of SFAS No. 133, *Accounting for DerivativeInstruments and Hedging Activities,*establishes a requirement toevaluate interests in securitized financial assets to identify interests thatare freestanding derivatives or that are hybrid financial instruments thatcontain an embedded derivative requiring bifurcation; clarifies thatconcentrations of credit risk in the form of subordination are notembedded derivatives; and amended SFAS No. 140, *Accountingfor Transfers and Servicing of Financial Assets and Extinguishments ofLiabilities,*to eliminate the prohibition on a qualifyingspecial-purpose entity from holding a derivative financial instrument thatpertains to a beneficial interest other than another derivative financialinstrument. SFAS No. 155 is effective for all financial instruments acquired,issued, or subject to a remeasurement (new basis) event occurring after thebeginning of an entity’s first fiscal year that begins after September 15,2006. The adoption of SFAS No. 155 is not expected to have a materialimpact on the Company’s financial statements.

In July 2006, the FASB issued FIN No. 48,*Accounting for Uncertainty in Income Taxes*(“FIN No. 48”). FIN No. 48 clarifies the accounting for income taxesby prescribing the minimum recognition threshold a tax position is required tomeet before being recognized in the financial statements. FIN No. 48 alsoprovides guidance on derecognition, measurement, classification, interest andpenalties, accounting in interim periods, disclosure and transition. Inaddition, FIN No. 48 scopes out income taxes from FASB Statement No. 5,*Accounting for Contingencies*. FINNo. 48 is effective for fiscal years beginning after December 15,2006. The Company is in the process of determining the effect, if any, theadoption of the Interpretation will have on its financial statements; however,the adoption of FIN No. 48 is not expected to have a material impact onthe Company’s financial statements.

In May 2005, the FASBissued SFAS 154, *Accounting Changes and Error Corrections, areplacement of APB Opinion No. 20 and FASB Statement No. 3.*TheStatement requires retrospective application to prior periods’ financialstatements of a voluntary change in accounting principle unless it is deemedimpracticable, unless the change in accounting relates to the principle methodof depreciation, amortization, or depletion for long-lived, non-financialassets in which case the the change is accounted for as a change in accountingestimate that is affected by a change in accounting principle. The Statement iseffective for accounting changes and corrections of errors made occurring infiscal years beginning after 

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December 15,2005. The adoption of SFAS No. 154 did not have a material impact on theCompany’s financial position or results of operations.

**ITEM 7A.**   QUANTITATIVEAND 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.

**Foreign CurrencyExchange 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 wedid not enter into any forward contracts in 2006, 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 the Company were to sell the securities prior to their maturitydate. There was less than $0.1 million in realized losses from sale ofinvestments in the year ended December 31, 2006. At December 31,2006, the Company had total net unrealized losses from marketable securities of$0.9 million.

**Market Risk onVariable Rate Debt**

In connection withborrowings incurred under the senior secured revolving credit facility arrangedby UBS Securities LLC, 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 whileborrowings under the senior secured credit facility are outstanding. On December 31,2006 there was no debt outstanding under this facility.

**Market Risk onFixed 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, 2006was $150.0 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 million at December 31, 2006 had a fair value of $171million based on quoted market rates.

**ITEM 8.**   FINANCIALSTATEMENTS AND SUPPLEMENTARY DATA

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

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**ITEM 9.**   CHANGESIN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE

None.

**ITEM 9A.**   CONTROLSAND PROCEDURES

**Evaluation ofDisclosure 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, summarizedand 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 Sciele Pharma’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 31,2006.

**Management’s Reporton Internal Control over Financial Reporting**

**Statement ofmanagement’s responsibility for establishing and maintaining adequate internalcontrol over financial reporting for the Company.**

Our management is responsible for establishing andmaintaining adequate internal control over financial reporting for the Company.

**Statement ofmanagement’s assessment of the effectiveness of the Company’s internal controlover financial reporting as of the end of the Company’s most recent fiscalyear.**

Our internal control overfinancial reporting includes those policies and procedures that pertain to the maintenanceof records that, in reasonable detail, accurately and fairly reflecttransactions and dispositions of assets; provide reasonable assurances thattransactions are recorded as necessary to permit preparation of financialstatements in accordance with U.S. generally accepted accounting principles,and that receipts and expenditures are being made only in accordance withauthorizations of management and the directors of the Company; and providereasonable assurance regarding prevention or timely detection of unauthorizedacquisition, use or disposition of the Company’s assets that could have amaterial effect on our financial statements. Basedon our evaluation of our internal control over financial reporting for theperiod for which this report is filed, our management, including our Presidentand Chief Executive Officer and Chief Financial Officer, concluded that ourinternal control over financial reporting was effective as of December 31,2006. However, because of the inherent limitations in all control systems, noevaluation of controls can provide absolute assurance that all control issueswithin Sciele Pharma have been or will be detected. Even effective internalcontrol over financial reporting can only provide reasonable assurance withrespect to financial statement preparation. Furthermore, because of changes inconditions, the effectiveness of internal control over financial reporting mayvary over time. Our management, including our President and Chief ExecutiveOfficer and Chief Financial Officer, does not expect that our controls andprocedures will prevent all errors.

**Statementidentifying the framework used by management to evaluate the effectiveness ofthe Company’s internal control over financial reporting.**

In order to ensure that our internal control overfinancial reporting is effective, management is responsible for regularlyassessing such controls and did so most recently for its financial reporting asof December 31, 2006. We are committed to a continuing process ofidentifying, evaluating and implementing improvements to the effectiveness ofour disclosure and internal controls and procedures. Our 

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management based itsassessment of the effectiveness of our internal control over financialreporting on criteria for effective internal control over financial reporting setforth by the Committee of Sponsoring Organizations of the Treadway Commission(COSO) in the Internal Control—Integrate Framework. The scope of management’sassessment of the effectiveness of internal control over financial reportingincludes all of our businesses.

**Statement that theregistered public accounting firm that audited the Company’s financialstatements included in the annual report has issued an attestation report onmanagement’s assessment of the Company’s internal control over financial reporting.**

Our Board of Directors, acting through its AuditCommittee, is responsible for the oversight of our accounting policies,financial reporting and internal control. The Audit Committee of the Board ofDirectors is comprised entirely of outside directors who are independent ofmanagement. The independent registered public accounting firm has full andunlimited access to the Audit Committee, with or without management, to discussthe adequacy of internal control over financial reporting, and any othermatters which they believe should be brought to the attention of the AuditCommittee.

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 internalcontrol our financial reporting.**

Our management has notidentified any changes in our internal controls over financial reporting duringour fourth fiscal quarter of 2006 that have materially affected, or arereasonably likely to materially affect, our internal controls over financialreporting.

**Report ofIndependent Registered Public Accounting Firm**

To the Board of Directors and Stockholders ofSciele Pharma, Inc.Atlanta, Georgia

We have audited management’s assessment, included inthe accompanying Management’s Report on Internal Control Over FinancialReporting included at Item 9A, that Sciele Pharma, Inc. and subsidiaries(the “Company”) maintained effective internal control over financial reportingas of December 31, 2006, based on criteria established in *Internal Control—Integrated Framework*issued by the Committee of Sponsoring Organizations of the Treadway Commission(the COSO criteria). The Company’s management is responsible for maintainingeffective internal control over financial reporting and for its assessment ofthe effectiveness of internal control over financial reporting. Ourresponsibility is to express an opinion on management’s assessment and anopinion on the effectiveness of the Company’s internal control over financialreporting 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 effective internal control over financial reporting wasmaintained in all material respects. Our audit included obtaining anunderstanding of internal control over financial reporting, evaluatingmanagement’s assessment, testing and evaluating the design and operatingeffectiveness of internal control, and performing such other procedures as weconsidered necessary in the circumstances. We believe that our audit provides areasonable basis for our opinion.

A company’s internal control over financial reportingis a process designed to provide reasonable assurance regarding the reliabilityof financial reporting and the preparation of financial statements for externalpurposes in accordance with generally accepted accounting principles. A company’sinternal 

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control over financialreporting includes those policies and procedures that (1) pertain to themaintenance of records that, in reasonable detail, accurately and fairlyreflect the transactions and dispositions of the assets of the company; (2) providereasonable assurance that transactions are recorded as necessary to permitpreparation of financial statements in accordance with generally acceptedaccounting principles, and that receipts and expenditures of the company arebeing made only in accordance with authorizations of management and directorsof the company; and (3) provide reasonable assurance regarding preventionor timely detection of unauthorized acquisition, use, or disposition of thecompany’s assets that could have a material effect on the financial statements.

Because of the inherent limitations, internal controlover financial reporting, may not prevent or detect misstatements. Also,projections of any evaluation of effectiveness to future periods are subject tothe risk that the controls may become inadequate because of changes inconditions, or that the degree of compliance with the policies or proceduresmay deteriorate.

In our opinion, management’s assessment that theCompany maintained effective internal control over financial reporting as of December 31,2006, is fairly stated, in all material respects, based on the COSO criteria.Also in our opinion, the Company maintained, in all material respects,effective internal control over financial reporting as of December 31,2006, based on the COSO criteria.

We have also audited, in accordance with the standardsof the Public Company Accounting Oversight Board (United States), theconsolidated balance sheets of the Company as of December 31, 2006 and 2005 andthe related consolidated statements of operations, stockholders’ equity, cashflows, and the financial statement schedule for the years then ended and ourreport dated February 22, 2007 expressed an unqualified opinion on thoseconsolidated financial statements and financial statement schedule.

/s/ BDO Seidman LLPAtlanta, GeorgiaFebruary 22, 2007

**ITEM 9B.   OTHERINFORMATION**

None.

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**PART III**

**ITEM 10.   DIRECTORS, EXECUTIVE OFFICERS, ANDCORPORATE GOVERNANCE OF THE REGISTRANT**

This information isincorporated by reference from our Proxy Statement for the 2007 Annual Meetingof Stockholders under the headings “Proposal 1—Election of Class BDirectors” and in our Proxy Statement for our 2007 Annual Meeting ofStockholders or in a subsequent amendment to this Report. Information regardingcompliance by our directors and executive officers and owners of more than 10%of Sciele Pharma’s common stock with the reporting requirements of Section 16(a) ofthe Securities Exchange Act of 1934, as amended, will be set forth in andincorporated by reference from our Proxy Statement for the 2007 Annual Meetingof Stockholders under the heading “Section 16(a) Beneficial OwnershipReporting Compliance” or in a subsequent amendment to this Report.

**ITEM 11.   EXECUTIVECOMPENSATION**

This information isincorporated by reference from our Proxy Statement for the 2007 Annual Meetingof Stockholders under the heading “Executive Compensation” or in a subsequentamendment to this Report.

**ITEM 12.   SECURITY OWNERSHIP OF CERTAINBENEFICIAL OWNERS AND MANAGEMENT AND RELATED STOCKHOLDER MATTERS**

This information isincorporated by reference from our Proxy Statement for the 2007 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 AND DIRECTOR INDEPENDENCE**

This information isincorporated by reference from our Proxy Statement for the 2007 Annual Meetingof Stockholders under the heading “Certain Relationships and RelatedTransactions” or in a subsequent amendment to this Report.

**ITEM 14.   PRINCIPALACCOUNTANT FEES AND SERVICES**

This information is incorporated by reference from ourProxy Statement for the 2007 Annual Meeting of Stockholders under the heading “IndependentAccountant Matters” or in a subsequent amendment to this Report.

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**PART IV**

**ITEM 15.   EXHIBITS,FINANCIAL STATEMENT SCHEDULES**

(a)(1)                    FinancialStatements filed as part of this Report:
|                                                                                                                                       | ** ** | ** ** | **Pages** | ** ** | ** ** |
|---------------------------------------------------------------------------------------------------------------------------------------|------------|------------|-----------|------------|------------|
| Reports of Independent Registered Public Accounting Firms                                                                             |       |       | F-1       |       |       |
| Consolidated  Balance Sheets as of December 31, 2006 and 2005                                                                    |       |       | F-3       |       |       |
| Consolidated Statements of Operations for the fiscal  years ended December 31, 2006, 2005 and 2004                               |       |       | F-4       |       |       |
| Consolidated Statements of Stockholders Equity for the  fiscal years ended 2006, 2005 and 2004                                        |       |       | F-5       |       |       |
| Consolidated Statements of Cash Flows for the fiscal  years ended 2006, 2005 and 2004                                                 |       |       | F-6       |       |       |
| Notes to Consolidated Financial Statements                                                                                            |       |       | F-7       |       |       |
| Financial Statement Schedule—Valuation and Qualifying  Accounts for the fiscal years ended December 31, 2006, 2005 and 2004 |       |       | F-32      |       |       |
|                                                                                                                                       |            |            |           |            |            |  |

 

(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(13)        |       | —     |       | Amended and Restated Employment Agreement dated  January 24, 2006 between the Registrant and Patrick Fourteau                  |
| 10.13(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                                            |

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| 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(13)+ |   | — |   | Amendment to  Distribution and Inventory Management Services Agreement between the  Registrant and Cardinal Health dated December 16, 2005                                                                            |
| 10.32(13)+ |   | — |   | Second Amendment to  Inventory Management Agreement between the Registrant and McKesson  Corporation dated November 21, 2005                                                                                          |
| 10.33(13)+ |   | — |   | Amendment to New  Distribution Agreement between the Registrant and Bayer Healthcare  Aktiengesellschaft dated December 7, 2005                                                                                       |
| 10.34(13)  |   | — |   | Lease Agreement between  the Registrant and 485 Properties, LLC dated February 7, 2006                                                                                                                                |
| 10.35(13)  |   | — |   | Accelerated Vesting Plan  dated January 24, 2006                                                                                                                                                                      |
| 10.36(13)+ |   | — |   | Amended and Restated  Manufacturing and Supply Agreement between the Registrant and Patheon Inc.  dated January 1, 2004                                                                                               |
| 10.37(14)  |   | — |   | Employment Agreement  between the Registrant and Larry Dillaha dated April 26, 2006                                                                                                                                   |
| 10.38(15)  |   | — |   | Distribution Services  Agreement between the Registrant and Amerisource Bergen Drug Corporate dated July 19,  2006                                                                                                    |
| 10.39(15)  |   | — |   | Credit Agreement dated  September 18, 2006 between the Registrant and certain of its  subsidiaries as borrowers, UBS Securities LLC and LaSalle Bank National  Association as lead arrangers and the lenders therein  |

55

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| 10.40(15) |   | — |   | Security Agreement dated  September 18, 2006 between the Registrant and certain of its  subsidiaries as grantees and the grantors named therein |
|-----------|--------|--------|--------|------------------------------------------------------------------------------------------------------------------------------------------------------|
| 10.41(16) |   | — |   | Sciele Pharma, Inc.  Deferred Compensation Plan                                                                                                 |
| 10.42(17) |   | — |   | Employment Agreement  between the Registrant and Edward Schutter dated April 1, 2006                                                            |
| 14.1(13)  |   | — |   | 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.

+                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 from the Registrant’s Form 8-Kfiled on March 9, 2004 (Commission File No. 000-30123).

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

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

56

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(13) Incorporated by reference from the Registrant’s Form 10-Kfor the fiscal year ended December 31, 2005 (Commission File No. 000-30123).

(14) Incorporated by reference from the Registrant’s Form 10-Qfor the quarter ended March 31, 2006 (Commission File No. 000-30123).

(15) Incorporated by reference from the Registrant’s Form 10-Qfor the quarter ended September 30, 2006 (Commission File No. 000-30123).

(16) Incorporated by reference from the Registrant’s Form 8-Kfiled on December 31, 2006 (Commission File No. 000-30123).

(17)          Incorporated by reference from the Registrant’s Form 8-K filedApril 5, 2006 (Commission File No. 000-30123).

57

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**SIGNATURES**

Pursuantto the requirements Section 13 or 15(d) of the Securities ExchangeAct of 1934, the registrant has duly caused this report to be signed on itsbehalf by the undersigned, thereunto duly authorized.
|                         | **SCIELE PHARMA, INC.** |
|-------------------------|-------------------------|
| February 23,  2007 | By:                     | /s/ PATRICK  P. FOURTEAU |
|                    |                    | Patrick P.  Fourteau*President and Chief Executive Officer* |

 

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 23, 2007 |
|----------------------------------------|--------|----------------------------------------------|--------|------------------------|
| Patrick P. Fourteau                    |   | President (principal executive officer)      |   |                   |
| /s/  DARRELL  BORNE          |   | Executive Vice  President, Chief Financial   |   | February 23, 2007 |
| Darrell Borne                          |   | Officer, Treasurer and Secretary             |   |                   |
|                                   |   | (principal financial and accounting officer) |   |                   |
| /s/  PIERRE  LAPALME         |   | Chairman of the Board                        |   | February 23, 2007 |
| Pierre Lapalme                         |   |                                         |   |                   |
| /s/  JERRY  N. ELLIS         |   | Director                                     |   | February 23, 2007 |
| Jerry N. Ellis                         |   |                                         |   |                   |
| /s/  JERRY  C. GRIFFIN, M.D. |   | Director                                     |   | February 23, 2007 |
| Jerry Griffin                          |   |                                         |   |                   |
| /s/  WILLIAM  J. ROBINSON    |   | Director                                     |   | February 23, 2007 |
| William J. Robinson                    |   |                                         |   |                   |
| /s/  JON  S. SAXE            |   | Director                                     |   | February 23, 2007 |
| Jon S. Saxe                            |   |                                         |   |                   |
| /s/  PATRICK  J. ZENNER      |   | Director                                     |   | February 23, 2007 |
| Patrick J. Zenner                      |   |                                         |   |                   |

 

58

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**Report of Independent Registered PublicAccounting Firm**

To the Board of Directors and StockholdersofSciele Pharma, Inc.Atlanta, Georgia

We have audited the accompanyingconsolidated balance sheets of Sciele Pharma, Inc. (formerly First HorizonPharmaceutical Corporation) and subsidiaries (the “Company”) as of December 31,2006 and 2005 and the related consolidated statements of operations,stockholders’ equity, and cash flows for the years then ended. Our audits alsoincluded the financial statement schedule listed in the Index at Item 15. Theseconsolidated financial statements and financial statement schedule are theresponsibility of the Company’s management. Our responsibility is to express anopinion on the consolidated financial statements and financial statementschedule based on our audits.

We conducted our audits in accordance withthe standards 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 andschedule. An audit also includes examining, on a test basis, evidencesupporting the amounts and disclosures in the financial statements andschedule, assessing the accounting principles used and significant estimatesmade by management, as well as evaluating the overall presentation of thefinancial statements and schedule. We believe that our audits provide areasonable basis for our opinion.

In our opinion, the consolidated financialstatements referred to above present fairly, in all material respects, thefinancial position of the Company as of December 31, 2006 and 2005, andthe results of its operations and its cash flows for the years then ended, inconformity with accounting principles generally accepted in the United Statesof America. Also, in our opinion, the financial statement schedule as itrelates to the years ended December 31, 2006 and 2005, presents fairly, inall material respects, the information set forth therein.

As discussed in Note 1 to theConsolidated Financial Statements, effective January 1, 2006, the Companyadopted the provisions of Statement of Financial Accounting StandardsNo. 123 (Revised 2004), *Share-Based Payment*.

We have also audited, in accordance withthe standards of the Public Company Accounting Oversight Board (United States),the effectiveness of the Company’s internal control over financial reporting asof December 31, 2006, based on the criteria established in *Internal Control—Integrated Framework*issued by the Committee of Sponsoring Organizations of the Treadway Commissionand our report dated February 22, 2007, expressed an unqualified opinionthereon.

/s/ BDO Seidman, LLPAtlanta, GeorgiaFebruary 22, 2007

F-1

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**Report ofIndependent Registered Public Accounting Firm**

To the Board of Directors and Stockholders ofSciele Pharma, Inc.Atlanta, Georgia

We have audited the accompanying consolidated statementsof operations, stockholders’ equity, and cash flows for the year endedDecember 31, 2004 of Sciele Pharma, Inc. and subsidiaries (formerlyknown as First Horizon Pharmaceutical Corporation) (the “Company”). Our auditalso included the consolidated financial statement schedule listed in the Indexat Item 15 as it relates to the information as of December 2004 and for theyear then ended. These consolidated financial statements and consolidated financialstatement schedule are the responsibility of the Company’s management. Ourresponsibility is to express an opinion on the consolidated financialstatements and consolidated 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 consolidated financial statements and consolidatedfinancial statement schedule are free of material misstatement. An auditincludes examining, on a test basis, evidence supporting the amounts anddisclosures in the consolidated financial statements and consolidated financialstatement schedule. An audit also includes assessing the accounting principlesused and significant estimates made by management, as well as evaluating theoverall presentation of the consolidated financial statements and consolidatedfinancial statement schedule. We believe that our audit provides a reasonablebasis for our opinion.

In our opinion, such consolidated financial statementsreferred to above present fairly, in all material respects, the results of theCompany’s operations and its cash flows for the year ended December 31,2004, in conformity with accounting principles generally accepted in the UnitedStates of America. Also, in our opinion, such consolidated financial statementschedule as it relates to the information as of December 31, 2004 and forthe year then ended, when considered in relation to the basic consolidatedfinancial statements taken as a whole, presents fairly, in all materialrespects, the information set forth therein.

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

** **

F-2

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**SCIELE PHARMA, INC.CONSOLIDATED BALANCE SHEETS(IN THOUSANDS, EXCEPT SHARE DATA)**

| ** **                                                                                                                                                           | ** ** | **December 31,** | ** ** |
|----------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|-----------------------|------------|
| ** **                                                                                                                                                           | ** ** | **2006**              | ** ** | **2005** | ** ** |
| **ASSETS**                                                                                                                                                           |       |                  |       |   |   |
| Current assets:                                                                                                                                                      |       |                  |       |   |   |
| Cash and cash equivalents                                                                                                                                            |       | $                     | 45,261     |   | $ | 17,043 |   |
| Marketable securities                                                                                                                                                |       | 121,190               |       | 82,757 |   |
| Accounts receivable, net of allowances of $2,010 and $2,427 at  December 31, 2006 and December 31, 2005, respectively                                 |       | 47,551                |       | 48,353 |   |
| Inventories                                                                                                                                                          |       | 26,640                |       | 28,924 |   |
| Income taxes receivable                                                                                                                                              |       | 4,869                 |       | 547 |   |
| Current deferred tax assets                                                                                                                                          |       | 2,465                 |       | 3,705 |   |
| Other current assets                                                                                                                                                 |       | 21,091                |       | 23,059 |   |
| Total current assets                                                                                                                                                 |       | 269,067               |       | 204,388 |   |
| Property  and equipment, net                                                                                                                                         |       | 9,142                 |       | 5,148 |   |
| Other assets:                                                                                                                                                        |       |                  |       |   |   |
| Intangibles, net                                                                                                                                                     |       | 305,040               |       | 315,798 |   |
| Long term deferred tax assets                                                                                                                                        |       | 93                    |       | —- |   |
| Other                                                                                                                                                                |       | 6,663                 |       | 4,371 |   |
| Total other assets                                                                                                                                                   |       | 311,796               |       | 320,169 |   |
| Total assets                                                                                                                                                         |       | $                     | 590,005    |   | $ | 529,705 |   |
| **LIABILITIES AND  STOCKHOLDERS’ EQUITY**                                                                                                                       |       |                  |       |   |   |
| Current liabilities:                                                                                                                                                 |       |                  |       |   |   |
| Account payable                                                                                                                                                      |       | $                     | 18,874     |   | $ | 12,093 |   |
| Accrued expenses                                                                                                                                                     |       | 18,965                |       | 18,482 |   |
| Total current liabilities                                                                                                                                            |       | 37,839                |       | 30,575 |   |
| Long-term  liabilities:                                                                                                                                              |       |                  |       |   |   |
| Convertible debt                                                                                                                                                     |       | 150,000               |       | 150,000 |   |
| Deferred tax liabilities                                                                                                                                             |       | 12,368                |       | 8,803 |   |
| Other long-term liabilities                                                                                                                                          |       | 1,975                 |       | 191 |   |
| Total liabilities                                                                                                                                                    |       | 202,182               |       | 189,569 |   |
| 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;  35,873,121 and 35,907,376 issued at December 31, 2006 and  December 31, 2005, respectively |       | 36                    |       | 36 |   |
| Additional paid-in capital                                                                                                                                           |       | 282,718               |       | 292,639 |   |
| Retained earnings                                                                                                                                                    |       | 127,768               |       | 82,524 |   |
| Deferred compensation                                                                                                                                                |       | —                |       | (7,489 | ) |
| Accumulated other comprehensive loss                                                                                                                                 |       | (4,147                | )          | (4,384 | ) |
| Stockholders’s  equity before treasury stock                                                                                                                    |       | 406,375               |       | 363,326 |   |
| Less:  Treasury stock at cost,                                                                                                                                       |       |                  |       |   |   |
| Common  stock, 800,000 and 1,000,000 shares at December 31, 2006 and December 31,  2005, respectively                                                      |       | (18,552               | )          | (23,190 | ) |
| Total stockholders’ equity                                                                                                                                      |       | 387,823               |       | 340,136 |   |
| Total liabilities and stockholders’ equity                                                                                                                      |       | $                     | 590,005    |   | $ | 529,705 |   |

 

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

F-3

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**SCIELE PHARMA, INC.CONSOLIDATED STATEMENTS OF OPERATIONS(IN THOUSANDS, EXCEPT PER SHARE DATA)**

| ** **                                                    | ** ** | **Year Ended December 31,** | ** ** |
|---------------------------------------------------------------|------------|--------------------------------------------|------------|
| ** **                                                    | ** ** | **2006**                                   | ** ** | **2005** | ** ** | **2004** | ** ** |
| Net revenues                                                  |       | $                                          | 293,181    |   | $ | 216,358 |   | $ | 151,967 |   |
| Operating costs and  expenses:                                |       |                                       |       |   |   |   |   |
| Cost of revenues (exclusive of items shown  separately below) |       | 40,687                                     |       | 33,331 |   | 29,082 |   |
| Selling, general and administrative                           |       | 145,254                                    |       | 97,386 |   | 66,773 |   |
| Depreciation and amortization                                 |       | 25,942                                     |       | 22,666 |   | 16,907 |   |
| Research and development                                      |       | 16,587                                     |       | 4,075 |   | 1,546 |   |
| Total operating costs and expenses                            |       | 228,470                                    |       | 157,458 |   | 114,308 |   |
| Operating income                                              |       | 64,711                                     |       | 58,900 |   | 37,659 |   |
| Other income (expense):                                       |       |                                       |       |   |   |   |   |
| Interest expense                                              |       | (3,230                                     | )          | (3,013 | ) | (2,480 | ) |
| Interest income                                               |       | 4,943                                      |       | 3,209 |   | 3,802 |   |
| Other                                                         |       | (43                                        | )          | (710 | ) | (12 | ) |
| Total other income (expense)                                  |       | 1,670                                      |       | (514 | ) | 1,310 |   |
| Income before  provision for income taxes                     |       | 66,381                                     |       | 58,386 |   | 38,969 |   |
| Provision for  income taxes                                   |       | (21,137                                    | )          | (19,177 | ) | (12,415 | ) |
| Net income                                                    |       | $                                          | 45,244     |   | $ | 39,209 |   | $ | 26,554 |   |
| Other  comprehensive income (loss), net of taxes              |       | 237                                        |       | (4,297 | ) | (401 | ) |
| Comprehensive  income                                         |       | $                                          | 45,481     |   | $ | 34,912 |   | $ | 26,153 |   |
| Net income per common  share:                                 |       |                                       |       |   |   |   |   |
| Basic earnings per common share                               |       | $                                          | 1.29       |   | $ | 1.12 |   | $ | 0.74 |   |
| Diluted earnings per common share                             |       | $                                          | 1.20       |   | $ | 0.97 |   | $ | 0.66 |   |
| Weighted average common  shares outstanding:                  |       |                                       |       |   |   |   |   |
| Basic                                                         |       | 35,109                                     |       | 35,102 |   | 35,761 |   |
| Diluted                                                       |       | 38,218                                     |       | 42,514 |   | 42,429 |   |

 

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

F-4

----

**SCIELEPHARMA, INC.CONSOLIDATED 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, 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 |   |
| Reclass due to adoption of SFAS 123(R)               |       | —                  |       | —                |       | —      |       |         | —     |           |       |              | (7,489     | )            |       |                   | 7,489      |       |       |   | — |   |   |   | — |   |   | — |   |
| Stock options exercised                              |       | —                  |       | —                |       | 709,818     |       |         | —     |           |       |              | 5,257      |         |       |                   | —     |       |       |   | — |   |   |   | — |   |   | 5,257 |   |
| Shares contributed to employee stock ownership plan  |       | 200,000                 |       | 4,638                 |       | —      |       |         | —     |           |       |              | (1,220     | )            |       |                   | —     |       |       |   | — |   |   |   | — |   |   | 3,418 |   |
| Shares repurchased and retired                       |       | —                  |       | —                |       | (744,073    | )          |         | —     |           |       |              | (14,813    | )            |       |                   | —     |       |       |   | — |   |   |   | — |   |   | (14,813 | ) |
| Tax benefit from nonqualified stock option exercises |       | —                  |       | —                |       | —      |       |         | —     |           |       |              | 3,132      |         |       |                   | —     |       |       |   | — |   |   |   | — |   |   | 3,132 |   |
| Share based compensation expense                     |       | —                  |       | —                |       | —      |       |         | —     |           |       |              | 2,194      |         |       |                   | —     |       |       |   | — |   |   |   | — |   |   | 2,194 |   |
| Restricted share expense                             |       | —                  |       | —                |       | —      |       |         | —     |           |       |              | 3,018      |         |       |                   | —     |       |       |   | — |   |   |   | — |   |   | 3,018 |   |
| Net income                                           |       | —                  |       | —                |       | —      |       |         | —     |           |       |              | —     |         |       |                   | —     |       |       |   | 45,244 |   |   |   | — |   |   | 45,244 |   |
| Other comprehensive income                           |       | —                  |       | —                |       | —      |       |         | —     |           |       |              | —     |         |       |                   | —     |       |       |   | — |   |   |   | 237 |   |   | 237 |   |
| BALANCE,  December 31, 2006                     |       | (800,000                | )          | $                     | (18,552    | )           | 35,873,121 |         |       | $              | 36         |              |       |         | $          | 282,718                |       |       |       | $ | — |   |   |   | $ | 127,768 |   |   |   | $ | (4,147 | ) |   | $ | 387,823 |   |

 

The change in accumulated other comprehensive income(loss), net of tax, for the year ended December 31 is as follows (inthousands): 

| ** **                                                     | ** ** | **2006** | ** ** | **2005** | ** ** | **2004** | ** ** |
|----------------------------------------------------------------|------------|----------|------------|----------|------------|----------|------------|
| Market value adjustments for investments                       |       | $        | 661        |     | $          | (163     | )          | $ | (1,087 | ) |
| Foreign currency translation                                   |       | (424     | )          | (4,134   | )          | 686      |       |
| Total change in  other comprehensive income (loss), net of tax |       | $        | 237        |     | $          | (4,297   | )          | $ | (401 | ) |

 

Accumulated other comprehensive loss, net of tax, as ofDecember 31 is as follows (in thousands): 

| ** **                                  | ** ** | **2006** | ** ** | **2005** | ** ** |
|---------------------------------------------|------------|----------|------------|----------|------------|
| Market value adjustments for investments    |       | $        | (582       | )        | $          | (1,243 | ) |
| Foreign currency translation                |       | (3,565   | )          | (3,141   | )          |
| Total other  comprehensive loss, net of tax |       | $        | (4,147     | )        | $          | (4,384 | ) |

 

The accompanying notes are an integral part of theseconsolidated financial statements.

F-5

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**SCIELE PHARMA, INC.CONSOLIDATED STATEMENTS OF CASH FLOWS(IN THOUSANDS)**

| ** **                                                                         | ** ** | **Year Ended December 31,** | ** ** |
|------------------------------------------------------------------------------------|------------|--------------------------------------------|------------|
| ** **                                                                         | ** ** | **2006**                                   | ** ** | **2005** | ** ** | **2004** | ** ** |
| Cash flows from operating activities:                                              |       |                                       |       |   |   |   |   |
| Net income                                                                         |       | $                                          | 45,244     |   | $ | 39,209 |   | $ | 26,554 |   |
| Adjustments to reconcile  net income to net cash provided by operating activities: |       |                                       |       |   |   |   |   |
| Depreciation and  amortization                                                     |       | 25,942                                     |       | 22,666 |   | 16,907 |   |
| Non-cash  interest expense                                                         |       | 466                                        |       | 336 |   | 293 |   |
| Realized loss on  marketable securities                                            |       | 43                                         |       | 684 |   | — |   |
| Reduction in taxes  payable related to stock option exercises                      |       | —                                     |       | 997 |   | 7,441 |   |
| Deferred income  tax                                                               |       | 4,298                                      |       | 4,195 |   | 5,018 |   |
| Non-cash  compensation expense                                                     |       | 7,881                                      |       | 351 |   | — |   |
| Loss on disposal  of property and equipment                                        |       | 121                                        |       | — |   | — |   |
| Changes in assets and  liabilities, net of acquired assets and  liabilities:       |       |                                       |       |   |   |   |   |
| Accounts  receivable                                                               |       | 802                                        |       | (24,520 | ) | (8,074 | ) |
| Inventories                                                                        |       | 2,284                                      |       | (13,100 | ) | (4,636 | ) |
| Other current  assets and other assets                                             |       | 2,322                                      |       | (15,507 | ) | (4,712 | ) |
| Income taxes  receivable                                                           |       | (4,322                                     | )          | 4,891 |   | (599 | ) |
| Accounts payable                                                                   |       | 6,781                                      |       | (2,476 | ) | 8,908 |   |
| Accrued expenses  and other liabilities                                            |       | (50                                        | )          | 2,571 |   | 2,387 |   |
| Net cash provided  by operating activities                                         |       | 91,812                                     |       | 20,297 |   | 49,487 |   |
| Cash flows from investing activities:                                              |       |                                       |       |   |   |   |   |
| Purchase of  products                                                              |       | (11,884                                    | )          | (105,925 | ) | — |   |
| Advance payments  for product licenses                                             |       | —                                     |       | — |   | (5,426 | ) |
| Purchase of  property and equipment                                                |       | (4,400                                     | )          | (2,198 | ) | (3,484 | ) |
| Proceeds from  sales of of property, plant and equipment                           |       | 51                                         |       | — |   | — |   |
| Proceeds from  sales of marketable securities                                      |       | 162,149                                    |       | 97,576 |   | — |   |
| Purchase of  marketable securities                                                 |       | (199,457                                   | )          | (20,626 | ) | (152,422 | ) |
| Net cash used in  investing activities                                             |       | (53,541                                    | )          | (31,173 | ) | (161,332 | ) |
| Cash flows from financing activities:                                              |       |                                       |       |   |   |   |   |
| Capitalized  financing costs incurred                                              |       | (3,205                                     | )          | — |   | (5,015 | ) |
| Proceeds from long-term  debt                                                      |       | —                                     |       | — |   | 150,000 |   |
| Reduction in taxes  payable related to stock option exercises                      |       | 3,132                                      |       | — |   | — |   |
| Net proceeds from  issuance of common stock                                        |       | 5,257                                      |       | 2,001 |   | 11,461 |   |
| Acquisition of  treasury stock                                                     |       | —                                     |       | — |   | (23,190 | ) |
| Repurchase of  common stock                                                        |       | (14,813                                    | )          | (6,534 | ) | (19,233 | ) |
| Net cash (used in)  provided by financing activities                               |       | (9,629                                     | )          | (4,533 | ) | 114,023 |   |
| Effects of foreign  currency exchange rates on cash                                |       | (424                                       | )          | (4,134 | ) | 686 |   |
| Net change in cash  and cash equivalents                                           |       | 28,218                                     |       | (19,543 | ) | 2,864 |   |
| Cash and cash  equivalents, beginning of period                                    |       | 17,043                                     |       | 36,586 |   | 33,722 |   |
| Cash and cash  equivalents, end of period                                          |       | $                                          | 45,261     |   | $ | 17,043 |   | $ | 36,586 |   |
| Non-cash financing transactions:                                                   |       |                                       |       |   |   |   |   |
| Issuance of  restricted stock                                                      |       | $                                          | —     |   | $ | 7,840 |   | $ | — |   |
| Leasehold  improvements                                                            |       | $                                          | 2,316      |   | $ | — |   | $ | — |   |
| Supplemental cash flow information:                                                |       |                                       |       |   |   |   |   |
| Cash paid for  income taxes                                                        |       | $                                          | 18,042     |   | $ | 8,276 |   | $ | 5,682 |   |
| Cash paid for  interest                                                            |       | $                                          | 2,784      |   | $ | 2.957 |   | $ | 1,362 |   |

 

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

F-6

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**SCIELE PHARMA, INC.NOTES TO CONSOLIDATED FINANCIAL STATEMENTS**

**1.   SUMMARYOF SIGNIFICANT ACCOUNTING POLICIES**

In June of 2006, the stockholders ofFirst Horizon Pharmaceutical Corporation approved changing the name from FirstHorizon Pharmaceutical Corporation to Sciele Pharma, Inc. (the “Company”).The name change became effective on June 15, 2006.

Sciele Pharma, Inc. is a pharmaceutical company specializing insales, marketing and development of branded prescription products focused onCardiovascular/Diabetes and Women’s Health. The Company’sCardiovascular/Diabetes products treat patients with high cholesterol,hypertension, high tryglycerides, unstable angina, and Type 2 Diabetes. ItsWomen’s Health products are designed to improve the health and well-being ofwomen of all ages, as well as, expectant and nursing mothers and their babies. Ourkey marketed products include:

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

 

Our current operating plan focuses onmaximizing the sales of our existing product portfolio. We also plan to accelerategrowth by 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 Cardiovascular andDiabetes and Women’s Health categories that will allow us to leverage ourexisting sales force infrastructure as well as additional therapeutic areaswhich compliment our existing sales structure.

We currently market and sell 16 products,10 of which are actively promoted and accounted for approximately 95% of ourtotal sales for the year ended December 31, 2006. We promote our products throughour nationwide sales and marketing force targeting high-prescribing primarycare physicians, endocrinologists, cardiologists, obstetricians andgynecologists.

*Principles of Consolidation.**  *Theconsolidated financial statements include the accounts of the Company and itswholly owned subsidiaries. All intercompany balances and transactions have beeneliminated in consolidation.

*Use of Estimates.**  *The preparation offinancial statements in conformity with accounting principles generallyaccepted in the United States of America requires management to make estimatesand assumptions that affect certain reported amounts and disclosures.Accordingly, actual results could differ from those estimates.

*Revenue Recognition.**  *Revenue isrecognized when products are delivered and the customer takes ownership andassumes risk of loss, collection of the relevant receivable is probable,persuasive evidence of an arrangement exists and the sales price is fixed ordeterminable, and are shown net of sales adjustments for discounts, rebates tocustomers, returns and other adjustments, which are provided in the same periodthat the related sales are recorded.

*Revenue Deductions.**  *Rebate costs,which are recorded as a reduction of sales, include estimated amounts forvolume rebate programs, contractual price reductions with wholesalers andmanaged care 

F-7

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providers, andcertain other sales related deductions. Provision for these estimated costs arerecorded at the time of sale and are periodically adjusted to reflect actualexperiences.

*Product Returns.**  *The Company’scustomers generally may return product from six months prior to the expirationdate of the product until twelve months after expiration. In accordance withStatement of Financial Accounting Standards (“SFAS”) No. 48, “RevenueRecognition When Right of Return Exists,” a provision for these estimatedreturns is recorded at the time of sale based on historical returns of the product,product specific information provided by customers and information obtainedfrom independent sources regarding the levels of inventory being held bycustomers, as well as overall purchasing patterns by customers. The provisionis periodically adjusted to reflect actual experience. These costs are recordedas a reduction of sales.

In connection with the acquisition ofproduct rights, the Company also assumes certain liabilities for returns ofproduct shipped by the seller prior to the acquisition date. At the acquisitiondate, the Company estimates the amount of assumed liabilities based on actualsales return data from the seller. This amount is included in the purchaseprice allocation. The Company periodically reviews this estimated liability.

In connection with line extensions ofcurrent products, the Company accrues for returns at the historical rate ofreturns of the previous product line as the line extensions provide the sameeffective relief and treat the same conditions and patient populations as theoriginal version.

*Cost of Revenues.**  *Cost of revenuesis comprised of purchased product costs and freight-out. Costs related tofreight-out totaled $0.5 million, $0.5 million and $0.5 millions forthe years ended December 31, 2004, 2005 and 2006, respectively. TheCompany does not bill customers for freight costs.

*Royalties.**  *The Company paysroyalties on the sale of certain products. These costs are included in selling,general and administrative expenses in the accompanying statements ofoperations. Total royalties were $5.4 million, $14.9 million and$19.7 million for the years ending December 31, 2004, 2005 and 2006,respectively.

*Research and Development.**  *Research anddevelopment expenses consist primarily of costs incurred to developformulations, engage contract research organizations to conduct clinicalstudies, test products under development and engage medical and regulatoryconsultants. The Company expenses all research and development costs asincurred. Research and development costs were $1.5 million,$4.1 million and $16.6 million for the years ended December 31, 2004,2005 and 2006, respectively.

*Cash and Cash Equivalents.**  *The Companyconsiders only those investments that are highly liquid and readily convertibleto cash with an original maturity of three months or less to be cashequivalents.

*Financial Instruments.**  *The Companyclassifies its existing marketable securities as available-for-sale. Thesesecurities are carried at fair market value based on current market quotes,with unrealized gains and losses reported in stockholders equity as a componentof accumulated other comprehensive income (loss). Gains or losses on securitiessold are based on the specific identification method. The Company’s policy isto only invest in high-grade corporate bonds, government agencies andmunicipalities. The Company reviews its investment portfolio as deemednecessary and, where appropriate, adjusts individual securities forother-than-temporary impairments. The Company does not hold securities forspeculative or trading purposes.

The Company’s $150 million seniorsubordinated contingent convertible debt had a fair value of $138 million at December 31,2005 and $171 million at December 31, 2006 based on quoted marketrates.

The Company’s carrying value of otherfinancial instruments approximates fair value due to the short maturity ofthose instruments.

F-8

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*Concentration of Credit Risk.**  *TheCompany extends credit on an uncollateralized basis primarily to wholesale drugdistributors and retail pharmacy chains throughout the U.S. The Company isrequired to estimate the level of accounts receivable which ultimately will notbe paid. The Company calculates this estimate based on prior experiencesupplemented by a periodic customer specific review when needed. Historically,the Company has not experienced significant credit losses on its accounts. TheCompany’s three largest customers accounted for approximately 63% and 69% ofaccounts receivable at December 31, 2005 and 2006, respectively.

The Company’s sales mix changes as productsare added. On a combined basis, products with sales greater than 10% of theCompany’s sales comprised approximately 75%, 73% and 71%****oftotal sales for the years ended December 31, 2004, 2005 and 2006,respectively.

The following table presents a summary of sales to significantcustomers as a percentage of the Company’s total revenues:

| **Customer**                   | ** ** | ** ** | ** ** | **2006** | ** ** | **2005** | ** ** | **2004** | ** ** |
|--------------------------------|------------|------------|------------|----------|------------|----------|------------|----------|------------|
| McKesson  Corporation          |       |       | 34         | %        |       |     | 30         | %        |       |   | 31 | % |   |
| Cardinal  Health, Inc.    |       |       | 24         |     |       |     | 23         |     |       |   | 25 |   |   |
| AmerisourceBergen  Corporation |       |       | 11         |     |       |     | 10         |     |       |   | 22 |   |   |

 

The Company’s international sales representless than 1% of sales for the periods presented.

*Segment Reporting.**  *The Company isengaged 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 in theCardiovascular/Diabetes and Women’s Health Markets.

The following presents revenues for prescription products by area oftreatment for the years ended December 31, 2004, 2005 and 2006,respectively (in thousands):

| ** **              | ** ** | **2006** | ** ** | **2005** | ** ** | **2004** | ** ** |
|-------------------------|------------|----------|------------|----------|------------|----------|------------|
| Cardiovascular/Diabetes |       | $        | 223,039    |     | $          | 144,547  |       | $ | 75,252 |   |
| Women’s  Health(1) |       | 55,190   |       | 46,614   |       | 22,155   |       |
| Non  Promoted(1)        |       | 14,952   |       | 25,197   |       | 54,560   |       |
| Net Revenues            |       | $        | 293,181    |     | $          | 216,358  |       | $ | 151,967 |   |

----

(1)          2004 amounts have been adjusted to conform to the 2005 and 2006promoted products.

*Inventories.**  *Inventoriesconsist of purchased pharmaceutical products and are stated at the lower ofcost or market. Cost is determined using the first-in, first-out method, andmarket is considered to be net realizable value. Inventories consist offinished product and bulk product awaiting processing and packaging intofinished product. Inventories, net of reserves of $0.5 million and$0.3 million at December 31, 2005 and 2006, respectively, at December 31,2005 and 2006 consisted of (in thousands):

| ** **         | ** ** | **2006** | ** ** | **2005** | ** ** |
|--------------------|------------|----------|------------|----------|------------|
| Bulk  product      |       | $        | 8,559      |     | $          | 2,406 |   |
| Finished  product  |       | 18,081   |       | 26,518   |       |
| Total  inventories |       | $        | 26,640     |     | $          | 28,924 |   |

 

*Samples.**  *Samples primarily consist of productsamples used in the sales and marketing efforts of the Company’s products andare included in other current assets in the Company’s consolidated balancesheet. Samples are expensed upon distribution as a selling expense. Sampleinventories, net of reserves of 

F-9

----

$0.1 millionand $0.0 million at December 31, 2005 and 2006, respectively at December 31,2005 and 2006 were $9.7 million and $5.4 million, respectively.

*Property and Equipment.**  *Property andequipment 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.

Depreciation is provided for on the straight-line basis over the estimateduseful lives of the 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 |   |

 

The components of property and equipment at December 31, 2005 and2006 are as follows (in thousands):

| ** **                                | ** ** | **2006** | ** ** | **2005** | ** ** |
|-------------------------------------------|------------|----------|------------|----------|------------|
| Office  equipment, furniture and fixtures |       | $        | 2,207      |     | $          | 572 |   |
| Computer  hardware and software           |       | 9,631    |       | 7,175    |       |
| Leasehold  improvements                   |       | 2,806    |       | 716      |       |
| Property  and equipment, gross            |       | 14,644   |       | 8,463    |       |
| Less  accumulated depreciation            |       | (5,502   | )          | (3,315   | )          |
| Property and  equipment, net              |       | $        | 9,142      |     | $          | 5,148 |   |

 

Depreciation expense related to propertyand equipment for the years ended December 31, 2004, 2005 and 2006 was$1.2 million, $2.1 million and $2.5 million, respectively.

In the event that facts and circumstancesindicate that the carrying amounts of property and equipment may be impaired,an evaluation of recoverability is performed using the estimated futureundiscounted cash flows associated with the asset compared to the asset’scarrying amount to determine if a write-down is required, pursuant to theprovisions of SFAS No. 144, *Accounting for theImpairment 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, 2006.

*Intangible Assets.**  *Intangible assets,which include license rights, tradenames, managed care contracts anddistribution, manufacturing and supply agreements, are stated at cost, net ofaccumulated amortization. These costs are capitalized and amortized on astraight-line basis over the estimated periods benefited by the asset (5 to20 years). Amortization of such assets, excluding distribution,manufacturing and supply agreements, is included in depreciation andamortization expense in the accompanying statements of operations. Amortizationexpense for the years ended December 31, 2004, 2005 and 2006 totaled $15.7million, $20.6 million and $23.4 million, respectively. Thesedistribution, manufacturing and supply agreements are discussed in more detailin Notes 9 and 10.

In accordance with SFAS No. 144, theCompany 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 

F-10

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extent suchprojections indicate that the undiscounted cash flows are not expected to beadequate to recover the carrying amounts, the assets are written down to fairvalue as determined by discounting future cash flows.

The Company believes there are nointangible asset impairments and there were no other asset write-downs asof December 31, 2006.

*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 theircarrying amounts in the consolidated financial statements. A valuationallowance is provided for deferred tax assets if it is more likely than notthat these items will either expire before we are able to realize their benefitor if future deductibility is uncertain.

Developing the provision for income taxesrequires significant judgment and expertise in federal, state, andinternational income tax laws, regulations and strategies, including thedetermination of deferred tax assets and liabilities and, if necessary, anyvaluation allowances that may be required for deferred tax assets. Ourjudgments 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.

*Advertising Costs.**  *The Companycharges the costs of advertising to expense as incurred. Advertising expenseswere $5.1 million, $11.2 million and $23.0 million for the yearsended December 31, 2004, 2005 and 2006, respectively.

*Foreign Currency Exposure.**  *Certain of theCompany’s product purchases and sales are denominated in foreign currencies.Gains or losses on foreign currency transactions are included in income asincurred. The Company at its discretion enters into short term forward foreignexchange contracts in relation to certain purchases of three of its products.Historically, these forward contracts are not designated as hedging instrumentsand as such, any change in fair value while open is recognized currently inincome. This gain or loss offsets the transaction gain or loss on theunderlying foreign denominated payables. Foreign denominated payables,receivables and open exchange contracts as of December 31, 2005 and 2006were not material.

*Stock Based Compensation.**  *At December 31,2006, the Company had four stock-based employee compensation plans, whichare described more fully in Note 7.

Prior to January 1, 2006, the Companyaccounted for those plans under the recognition and measurement provisions ofAPB Opinion (“APB”) No. 25, *Accounting for StockIssued to Employees*, and related Interpretations, as permitted by Statementof Financial Accounting Standards (“SFAS”) No. 123 (revised 2004), *Accounting for Stock-Based Compensation*. No stock-basedemployee compensation cost related to stock options was recognized in theStatement of Operations for the years ended December 31, 2005 and 2004, asall options granted under those plans had an exercise price equal to the marketvalue of the underlying common stock on the date of grant. Effective January 1,2006, the Company adopted the fair value recognition provisions of SFAS No. 123R,“*Share-Based Payment*”, using themodified-prospective-transition method. Under that transition method,compensation cost recognized in the twelve months ended December 31, 2006includes: (a) compensation cost for all share-based payments granted priorto, but not yet vested as of January 1, 2006, based on the grant date fairvalue estimated in accordance with the original provisions of SFAS No. 123,and (b) compensation cost for all share-based payments granted subsequentto January 1, 2006, based on the grant-date fair value estimated inaccordance with the provisions of SFAS No. 123R. Results for prior periodshave not been restated.

As a result of adopting SFAS No. 123Ron January 1, 2006, the Company’s income before income taxes for the yearended December 31, 2006, was $2.2 million lower than if it had continuedto account for 

F-11

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share-basedcompensation under APB No. 25. Basic and diluted earnings per share forthe year ended December 31, 2006 would have been $0.04 higher, if theCompany had not adopted SFAS No. 123R

Prior to the adoption of SFAS No. 123R,the Company presented all tax benefits of deductions resulting from theexercise of stock options as operating cash flows in the Statement of CashFlows. SFAS 123R requires the cash flows resulting from the tax benefitsresulting from tax deductions in excess of compensation cost recognized forthose options (excess tax benefits) to be classified as financing cash flows. Uponthe adoption of SFAS No. 123R, the Company reclassed $7.5 million ofdeferred compensation to additional paid in capital.

The weighted average fair value per share of options granted during theyears 2006, 2005, and 2004 is estimated at $16.93, $18.14 and $15.17,respectively. The value of options is estimated on the date of the grant usingthe following weighted average assumptions:

| ** **               | ** ** | **2006**     | ** ** | **2005**     | ** ** | **2004** | ** ** |
|--------------------------|------------|--------------|------------|--------------|------------|----------|------------|
| Risk-free  interest rate |       | 5.08         | %          | 3.89         | %          | 3.4      | %          |
| Expected  dividend yield |       | —       |       | —       |       | —   |       |
| Expected  lives          |       | 5 years |       | 5 years |       | 5 years  |       |
| Expected  volatility     |       | 105.59       | %          | 115.2        | %          | 125.1    | %          |

 

The Company has granted stock options to officers, directors andemployees as follows (shares in thousands):

| ** **                             | ** ** | **Number of**

**Shares**

**Subject to**

**Issuance** | ** ** | **Weighted**

**Average**

**Exercise**

**Price** | ** ** | **Weighted**

**Average**

**Remaining**

**Contractual**

**Term** | ** ** | **Aggregate**

**Intrinsic**

**Value**

**($000)** | ** ** |
|----------------------------------------|------------|-------------------------------------------------------------------|------------|----------------------------------------------------|------------|---------------------------------------------------------------------|------------|-----------------------------------------------------|------------|
| Outstanding  at December 31, 2003 |       |                                                              | 3,832      |                                               |       |                                                                | $          | 9.65                                                |       |   |   |   |   |   |   |   |   |   |
| Granted                                |       |                                                              | 1,113      |                                               |       |                                                                | 16.64      |                                                |       |   |   |   |   |   |   |   |   |
| Cancelled                              |       |                                                              | (588       | )                                                  |       |                                                                | 17.86      |                                                |       |   |   |   |   |   |   |   |   |
| Exercised                              |       |                                                              | (1,538     | )                                                  |       |                                                                | 7.37       |                                                |       |   |   |   |   |   |   |   |   |
| Outstanding  at December 31, 2004 |       |                                                              | 2,819      |                                               |       |                                                                | $          | 11.97                                               |       |   |   |   |   |   |   |   |   |   |
| Granted                                |       |                                                              | 364        |                                               |       |                                                                | 18.10      |                                                |       |   |   |   |   |   |   |   |   |
| Cancelled                              |       |                                                              | (360       | )                                                  |       |                                                                | 11.87      |                                                |       |   |   |   |   |   |   |   |   |
| Exercised                              |       |                                                              | (244       | )                                                  |       |                                                                | 7.97       |                                                |       |   |   |   |   |   |   |   |   |
| Outstanding  at December 31, 2005 |       |                                                              | 2,579      |                                               |       |                                                                | $          | 13.15                                               |       |   |   |   |   |   |   |   |   |   |
| Granted                                |       |                                                              | 140        |                                               |       |                                                                | 16.93      |                                                |       |   |   |   |   |   |   |   |   |
| Cancelled                              |       |                                                              | (271       | )                                                  |       |                                                                | 14.26      |                                                |       |   |   |   |   |   |   |   |   |
| Exercised                              |       |                                                              | (577       | )                                                  |       |                                                                | 9.11       |                                                |       |   |   |   |   |   |   |   |   |
| Outstanding  at December 31, 2006 |       |                                                              | 1,871      |                                               |       |                                                                | $          | 14.53                                               |       |   |   | 4.1 years |   |   |   | $ | 27,184 |   |   |
| Unvested at  December 31, 2006         |       |                                                              | 778        |                                               |       |                                                                | 15.66      |                                                |       |   | 5.4 years |   |   |   | $12,183 |   |   |
| Exercisable  at December 31, 2006 |       |                                                              | 1,093      |                                               |       |                                                                | $          | 15.47                                               |       |   |   | 3.7 years |   |   |   | $ | 16,920 |   |   |

 

The Company had the following stock options available for exercise(shares in thousands):

| ** **              | ** ** | **Weighted  Average  Remaining  Contractual  Term** | ** ** | **Number of  Shares  Exercisable** | ** ** | **Aggregate  Intrinsic  Value ($000)** | ** ** |
|-------------------------|------------|-----------------------------------------------------|------------|-----------------------------------------|------------|---------------------------------------------|------------|
| December 31,  2006 |       |                                                | 3.7        |                                    |       |                                        | 1,093      |   |   |   | $ | 16,920 |   |   |
| December 31,  2005 |       |                                                | 4.1        |                                    |       |                                        | 1,242      |   |   |   | $ | 17,729 |   |   |

 

F-12

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Non-qualified stock options are priced atthe fair market value of the Company’s stock on the date of the grant andtypically vest at the rate of 25% per year commencing on the first anniversarydate of the grant and expire on the seventh anniversary date of the grant. TheCompany recognized $2.2 million of stock-based compensation expense for stockoptions in the year ended December 31, 2006. The Company did not recognizeany stock-based compensation expense for stock options in 2005 or 2004.

In 2005 and through December 31, 2006, the Company issuedrestricted stock to executives and employees. The following table summarizesrestricted stock outstanding at December 31, 2006 and changes during thetwelve months ended (shares in thousands):

| ** **                             | ** ** | ** **          | ** ** | ** **   | ** ** | **Weighted**    | ** ** | ** **    | ** ** |
|----------------------------------------|------------|---------------------|------------|--------------|------------|-----------------|------------|---------------|------------|
| ** **                             | ** ** | **Number of**  | ** ** | **Weighted** | ** ** | **Average**     | ** ** | ** **    | ** ** |
| ** **                             | ** ** | **Shares**          | ** ** | **Average**  | ** ** | **Remaining**   | ** ** | **Aggregate** | ** ** |
| ** **                             | ** ** | **Subject to** | ** ** | **Share**    | ** ** | **Contractual** | ** ** | **Value**     | ** ** |
| ** **                             | ** ** | **Issuance**        | ** ** | **Price**    | ** ** | **Term**        | ** ** | **($000)**    | ** ** |
| Outstanding  at December 31, 2004 |       |                | —     |         |       |            | $          | —        |       |   |   |   |   |   |   |   |   |   |
| Granted                                |       |                | 543        |         |       |            | 14.45      |          |       |   |   |   |   |   |   |   |   |
| Cancelled                              |       |                | —     |         |       |            | —     |          |       |   |   |   |   |   |   |   |   |
| Vested                                 |       |                | —     |         |       |            | —     |          |       |   |   |   |   |   |   |   |   |
| Outstanding  at December 31, 2005 |       |                | 543        |         |       |            | $          | 14.45         |       |   |   |   |   |   |   |   |   |   |
| Granted                                |       |                | 782        |         |       |            | 19.69      |          |       |   |   |   |   |   |   |   |   |
| Cancelled                              |       |                | (109       | )            |       |            | 14.95      |          |       |   |   |   |   |   |   |   |   |
| Vested                                 |       |                | (133       | )            |       |            | 14.63      |          |       |   |   |   |   |   |   |   |   |
| Outstanding  at December 31, 2006 |       |                | 1,083      |         |       |            | $          | 18.16         |       |   |   | 3.3 years |   |   |   | $ | 19,662 |   |   |
|                                        |            |                     |            |              |            |                 |            |               |            |  |  |  |  |  |  |  |  |  |  |

 

F-13

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The restrictedstock vests according to one of two schedules. Under one schedule, the shareswill vest when specific key performance objectives have been reached or on thefifth anniversary date of the issuance, whichever occurs first. Under thesecond schedule, the shares will vest 25% annually over four years. The fairvalue of the restricted stock is expensed over the period during which therestrictions lapse. For the years ended December 31, 2006 and December 31,2005, the Company recognized expense of $3.0 million and $0.3 million,respectively, related to the restricted shares. There was no comparativeexpenses in 2004.

Had compensation costs for the Company’s options been determined usingthe Black-Scholes option valuation model prescribed by SFAS No. 123, *Accounting for Stock Based Compensation*, the Company’s proforma net income per common share for the years ended December 31, 2005and 2004 would have been reported as follows: 

| ** **                                                                                                                             | ** ** | **2005** | ** ** | **2004** | ** ** |
|----------------------------------------------------------------------------------------------------------------------------------------|------------|----------|------------|----------|------------|
| Net income:                                                                                                                            |       |     |       |     |       |
| As  reported                                                                                                                           |       | $        | 39,209     |     | $          | 26,554 |   |
| Add:  Stock based compensation expense recorded, net of related tax effects                                                            |       | 235      |       | —   |       |
| Deduct:  Total stock-based employee compensation expense determined under fair  value based for all awards, net of related tax effects |       | (1,572   | )          | (2,054   | )          |
| Pro  forma                                                                                                                             |       | $        | 37,872     |     | $          | 24,500 |   |
| Net income  per common share—basic:                                                                                               |       |     |       |     |       |
| As reported                                                                                                                            |       | $        | 1.12       |     | $          | 0.74 |   |
| Pro forma                                                                                                                              |       | $        | 1.08       |     | $          | 0.69 |   |
| Net  income per common share—diluted:                                                                                             |       |     |       |     |       |
| As reported                                                                                                                            |       | $        | 0.97       |     | $          | 0.66 |   |
| Pro  forma                                                                                                                             |       | $        | 0.94       |     | $          | 0.61 |   |

 

TheBlack-Scholes option valuation model was not developed for use in valuingemployee stock options. Instead, this model was developed for use in estimatingthe fair value of traded options, which have no vesting restrictions, are fullytransferable, which differ significantly from the Company’s stock optionawards. In addition, option valuation models require the input of highlysubjective assumptions including the expected stock price volatility andexpected survival rates of the options.

In 2005, theCompany began a non-leveraged Employee Stock Ownership Plan (“ESOP”), whichprovides benefits to substantially all employees. The Company accounts for thisplan under the recognition and measurement provisions of Statement of Position93-6,*Employers’ Accounting for Employee Stock OwnershipPlans.*The annual contribution, if any, to the plan is at thediscretion of the Board of Directors of the Company. In February 2006, theCompany distributed 200,000 shares to employees under this plan, of which50,000 shares were allocated to the 2005 plan year and 150,000 shares wereallocated to the 2006 plan year. The Company records the expense related to theESOP in the period in which the employees earn the shares. In the years ended December 31,2006 and December 31, 2005, the Company recorded $2.7 million and $0.8million, respectively, in compensation expense for the ESOP. There were nocomparative expenses in 2004.

*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 dilutive 

F-14

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were exercisedor converted and that the proceeds from such exercises, if any, were used toacquire shares of common stock at the average market price during the period.

Below is the calculation of basic and diluted net income per commonshare (in thousands, except per share data):

| ** **                                                         | ** ** | **Year Ended December 31,** | ** ** |
|--------------------------------------------------------------------|------------|--------------------------------------------|------------|
| ** **                                                         | ** ** | **2006**                                   | ** ** | **2005** | ** ** | **2004** | ** ** |
| Net  income                                                        |       | $                                          | 45,244     |   | $ | 39,209 |   | $ | 26,554 |   |
| Add:  Interest expense on contingent convertible debt (net of tax) |       | 651                                        |       | 1,929 |   | 1,590 |   |
| Adjusted  net income                                               |       | $                                          | 45,895     |   | $ | 41,138 |   | $ | 28,144 |   |
| Weighted  average common shares outstanding—basic             |       | 35,109                                     |       | 35,102 |   | 35,761 |   |
| Dilutive  effect of stock options and restricted stock             |       | 852                                        |       | 640 |   | 1,121 |   |
| Dilutive  effect of contingent convertible debt                    |       | 2,257                                      |       | 6,772 |   | 5,547 |   |
| Weighted  average common shares outstanding—diluted           |       | 38,218                                     |       | 42,514 |   | 42,429 |   |
| Basic  net income per share                                        |       | $                                          | 1.29       |   | $ | 1.12 |   | $ | 0.74 |   |
| Diluted net  income per share                                      |       | $                                          | 1.20       |   | $ | 0.97 |   | $ | 0.66 |   |

 

In May 2006,the Company converted its $150.0 million senior subordinated contingentconvertible notes to being redeemed for cash instead of company stock. As aresult, the dilutive effect of contingent convertible debt was decreased by $0.10per dilutive share in 2006. The notes are discussed in Footnote 4.

The number ofoutstanding options (in thousands), which are excluded from the abovecalculation as their impact would be anti-dilutive, are 0.7 million,0.7 million and 0.5 million for the years ended December 31,2004, 2005 and 2006, respectively.

*ForeignCurrency 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.

*New Accounting Pronouncements*

In February2007, the Financial Accounting Standards Board (“FASB”) issued Statement ofFinancial Accounting Standards (“SFAS”) No. 159, The Fair Value forFinancial Assets and Financial Liabilities. This Statement permits entities tochoose to measure financial assets and liabilities, with certain exceptions, atfair value at specified election dates. A business entity shall reportunrealized gains and losses on items for which the fair value option has beenelected in earnings at each subsequent reporting date. This Statement iseffective as of the beginning of an entity’s first fiscal year that beginsafter November 15, 2007. SFAS No. 159 does not have an effect on theCompany’s financial statements for the year ended December 31, 2006. TheCompany has not determined the effect, if any, that the adoption of SFASNo. 159 will have on its financial statements.

On September 29,2006, the FASB issued SFAS No. 158, Employers’ Accounting for DefinedBenefit Pension and Other Postretirement Plans. This Statement requires anemployer to recognize the overfunded or underfunded status of a defined benefitpostretirement plan (other than a multiemployer plan) as an asset or liability inits statement of financial position and to recognize changes in that fundedstatus in the year in which the changes occur through comprehensive income. Thisstatement also requires an employer to measure the funded status of a plan asof the date of its year-end statement of financial position, with limitedexceptions. An employer with publicly traded equity securities is required toinitially recognize the funded status of a defined benefit postretirement planand to provide the required disclosures as of the end of the fiscal year endingafter December 15, 2006. The requirement to measure 

F-15

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planassets and benefit obligations as of the date of the employer’s fiscal year-endstatement of financial position is effective for fiscal years ending after December 15,2008. The adoption of SFAS No. 158 did not have a material impact on theCompany’s financial statements.

On September 15,2006, the FASB issued SFAS No. 157, *Fair Value Measurements.*TheStatement provides guidance for using fair value to measure assets andliabilities. This Statement references fair value as the price that would bereceived to sell an asset or paid to transfer a liability in an orderlytransaction between market participants in the market in which the reportingentity transacts. The Statement applies whenever other standards require (orpermit) assets or liabilities to be measured at fair value. The Statement doesnot expand the use of fair value in any new circumstances. It is effective forfinancial statements issued for fiscal years beginning after November 15,2007, and interim periods within those fiscal years. The adoption of SFAS No. 157is not expected to have a material impact on the Company’s financialstatements.

In March 2006,the FASB issued SFAS No. 156, *Accounting for Servicingof Financial Assets, which amends FAS 140, Accounting for Transfers andServicing of Financial Assets and Extinguishments of Liabilities.* Ina significant change to current guidance, the Statement of Financial AccountantStandards (“SFAS”) No. 156 permits an entity to choose either of thefollowing subsequent measurement methods for each class of separatelyrecognized servicing assets and servicing liabilities: (1) AmortizationMethod or (2) Fair Value Measurement Method. SFAS No. 156 iseffective as of the beginning of an entity’s first fiscal year that beginsafter September 15, 2006. The adoption of SFAS No. 156 is notexpected to have a material impact on the Company’s financial statements.

In February 2006,the FASB issued SFAS No. 155, *Accounting for CertainHybrid Financial Instruments—an amendment of FASB Statements No. 133 and140.*This Statement permits fair value of remeasurement for anyhybrid financial instrument that contains an embedded derivative that otherwisewould require bifurcation; clarifies which interest-only strips andprincipal-only strips are not subject to the requirements of SFAS No. 133,*Accounting for Derivative Instruments and HedgingActivities,*establishes a requirement to evaluate interests insecuritized financial assets to identify interests that are freestandingderivatives or that are hybrid financial instruments that contain an embeddedderivative requiring bifurcation; clarifies that concentrations of credit risk inthe form of subordination are not embedded derivatives; and amended SFAS No. 140,*Accounting for Transfers and Servicing of FinancialAssets and Extinguishments of Liabilities,*to eliminate theprohibition on a qualifying special-purpose entity from holding a derivativefinancial instrument that pertains to a beneficial interest other than anotherderivative financial instrument. SFAS No. 155 is effective for allfinancial instruments acquired, issued, or subject to a remeasurement (newbasis) event occurring after the beginning of an entity’s first fiscal yearthat begins after September 15, 2006. The adoption of SFAS No. 155 isnot expected to have a material impact on the Company’s financial statements.

In July 2006,the FASB issued FIN No. 48,*Accountingfor Uncertainty in Income Taxes* (“FIN No. 48”). FIN No. 48clarifies the accounting for income taxes by prescribing the minimumrecognition threshold a tax position is required to meet before beingrecognized in the financial statements. FIN No. 48 also provides guidanceon derecognition, measurement, classification, interest and penalties,accounting in interim periods, disclosure and transition. In addition, FIN No. 48scopes out income taxes from SFAS No. 5, *Accountingfor Contingencies*. FIN No. 48 is effective for fiscal yearsbeginning after December 15, 2006. The Company is in the process ofdetermining the effect, if any, the adoption of the Interpretation will have onits financial statements; however, the adoption of FIN No. 48 is not expectedto have a material impact on the Company’s financial statements.

**In May 2005, the FASB issued SFAS 154, *AccountingChanges and Error Corrections, a replacement of APB Opinion No. 20 andFASB Statement No. 3.*The Statement requires retrospectiveapplication to prior periods’ financial statements of a voluntary change inaccounting principle unless it is deemed impracticable, unless the change inaccounting relates to the principle method of depreciation,**

F-16

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**amortization, or depletion for long-lived, non-financialassets in which case the the change is accounted for as a change in accountingestimate that is affected by a change in accounting principle. The Statement iseffective for accounting changes and corrections of errors made occurring infiscal years beginning after December 15, 2005. The adoption of SFAS No. 154did not have a material impact on the Company’s financial position or resultsof operations.**

**2. CREDIT FACILITY**

On September 18,2006, the Company and certain of its subsidiaries entered into a secured creditagreement (the “Credit Agreement”) with UBS Securities LLC and LaSalle BankNational Association as lead arrangers, UBS AG, Stamford Branch, as issuingbank, administrative agent and collateral agent, Regents Bank, Fifth Third Bankand Bank of America, N.A. as co-documentation agents and UBS Loan Finance LLC,as swingline lender. The Credit Agreement provides the Company and its Cayman subsidiary,Sciele Pharma Cayman Ltd., with a five-year revolving credit facility of up to$100 million, with an option to expand the facility credit line by up to anadditional $75 million.

Amountsoutstanding under the new credit facility generally bear interest at thelenders’ corporate base rate or the LIBOR, plus a specified margin of between1.75% and 2.5% depending on the Company’s ratio of indebtedness to earnings.The Credit Agreement contains customary negative covenants and financialcovenants with which the Company is in full compliance as of December 31,2006.

The Companyterminated its existing credit agreement with LaSalle Bank NationalAssociation, dated February 11, 2003, as subsequently amended, when itentered into the new Credit Agreement.

The Company hadno borrowings on this credit facility as of December 31, 2006.

**3. MARKETABLE SECURITIES**

The Companyclassifies its existing marketable securities as available-for-sale. Allavailable-for-sale securities are classified as current as the Company has theability to use them for current operating and investing purposes. There were realizedlosses of less than $0.1 million and $0.7 million in the years ended December 31,2006 and 2005, respectively. There were no realized losses in 2004. At December 31,2006 and December 31, 2005, the Company had total net unrealized losses frommarketable securities of $0.9 million and $2.0 million, respectively.

The carrying amount of available-for-sale securities and theirapproximate fair values at December 31, 2006 were as follows (inthousands):

| ** **                                      | ** ** | **Amortized  Cost** | ** ** | **Gross  Unrealized  Gains** | ** ** | **Gross  Unrealized  Losses** | ** ** | **Fair  Value** | ** ** |
|-------------------------------------------------|------------|---------------------|------------|------------------------------|------------|-------------------------------|------------|-----------------|------------|
| U.S.  Government and Federal agency obligations |       | $                   | 52,437     |                         |       | $                             | —     |            |       |   | $ | (662 | ) |   | $ | 51,774 |   |
| Corporate  bonds                                |       | 69,685              |       |                         | 2          |                          |       |            | (272       | ) |   | 69,416 |   |
| Total                                           |       | $                   | 122,122    |                         |       | $                             | 2          |            |       |   | $ | (934 | ) |   | $ | 121,190 |   |

 

The following table presents the age of gross unrealized losses andfair value by investment category for all securities in a loss position as ofDecember 31, 2006 (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 |       | $                                      | 33,145     |                                 |       | $               | (175       | ) |   | $ | 18,629 |   |   | $ | (487 | ) |   | $ | 51,774 |   |   | $ | (662 | ) |   |
| Corporate  bonds                                |       | 56,343                                 |       |                                 | (121       | )               |       | 6,509 |   |   | (151 | ) |   | 62,852 |   |   | (272 | ) |   |
| Total                                           |       | $                                      | 89,488     |                                 |       | $               | (296       | ) |   | $ | 25,138 |   |   | $ | (638 | ) |   | $ | 114,626 |   |   | $ | (934 | ) |   |

 

F-17

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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 theCompany to hold the securities until maturity, as well as the credit worthinessof the investee. The Company expects that all losses will be recovered andintends to hold securities to recovery. If market, industry and/or investeeconditions deteriorate, we may incur future impairments.

Theamortized cost and estimated fair value of marketable securities at December 31,2006 by contractual maturity are shown below (in thousands):

| ** **                                | ** ** | **Cost** | ** ** | **Estimated  Fair Value** | ** ** |
|-------------------------------------------|------------|----------|------------|--------------------------------|------------|
| Due in one year  or less                  |       | $        | 95,245     |                           |       | $ | 94,950 |   |   |
| Due after one  year through three years   |       | 22,233   |       |                           | 21,680     |   |   |
| Due after three  years through five years |       | 3,734    |       |                           | 3,663      |   |   |
| Due after five years                      |       | 910      |       |                           | 897        |   |   |
|                                           |            |          |            |                                |            |  |  |  |  |

 

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 |   |

 

**4. LONG-TERMDEBT**

In March 2004, the Company issued a total of$150.0 million of its 1.75% senior subordinated contingent convertiblenotes due in 2024 (the “2004 Notes”) in transactions that were exempt fromregistration in reliance upon Rule 144A and other available exemptionsunder the Securities Act. In May 2006 and pursuant to a registeredexchange offer, the Company exchanged each outstanding 2004 Note with new notes(the “New Notes”) that, among other things, require the Company to redeem the$150.0 million 2004 Notes with cash instead of common stock. As an incentive tothe 2004 Note holders to exchange the 2004 Notes for New Notes, the Companypaid each exchanging holder an exchange fee equal to 0.75% of the face value ofeach New Note exchanged. The Company paid an aggregate exchange fee of$1,125,000. The New Notes are due March 8, 2024 and accrued interest ispayable semi-annually in arrears on March 8 and September 8 of eachyear, which commenced on September 8, 2004. In addition to the interest onthe New Notes, after March 8, 2007, the Company will also pay contingentinterest during specified six-month periods if the average trading price of theNew Notes per $1,000 principal amount for the five day trading period ending onthe third trading day immediately preceding the first day of the applicablesix-month period equals $1,200 or more. During any period when contingentinterest is payable, it will be payable at a rate equal to 0.5% per annum. Asthis contingent interest feature is based on the underlying trading price ofthe New Notes, the contingent interest qualifies as an embedded derivative. Asof December 31, 2006, management determined that the fair value of thiscontingent interest embedded derivative was not material. The net proceeds fromthis issuance, after deducting offering expenses, were approximately $145.4million. Financing costs of $4.6 million were incurred with the originalissuance and $1,125,000 with the exchange, which are being amortized on astraight-line basis over the life of the notes and are included in other assetsin the consolidated balance sheet.

Upon conversion, the Company will deliver, for eachNew Note, consideration (the “conversion value”) having a value equal to theproduct of the conversion rate (initially, approximately 45.1467, subject toadjustment) multiplied by the average of the closing price of our common stockon the Nasdaq Global 

F-18

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Select Market on each ofthe five consecutive trading days beginning on the third trading day following theconversion date of New Notes (the “applicable stock price”). This considerationvalue will be paid in cash (the “required cash amount”) in an amount equal tothe lesser of (a) the aggregate principal amount of New Notes on theconversion date or (b) the conversion value, and the remainder will bepaid in shares of our common stock. The number of shares to be delivered willequal (a)(i) the conversion value minus (ii) the required cashamount, divided by (b) the applicable stock price. Holders may convertthe New Notes only under the following circumstances: (1) during anycalendar quarter, if the closing sales price of the Company’s common stockexceeds 120% of the conversion price for at least 20 trading days in the 30consecutive trading days ending on the last trading day of the precedingcalendar quarter; (2) if the New Notes have been called for redemption; (3) duringthe five trading day period immediately following any nine consecutive tradingday period in which the trading price of the New Notes per $1,000 principalamount for each day of that period was less than 95% of the product of theclosing price of the Company’s common stock and the number of shares of commonstock issuable upon conversion of $1,000 principal amount of the New Notes; or (4) theoccurrence of specified corporate transactions.

A holder thatsurrenders New Notes for conversion in connection with certain fundamentalchanges that occur prior to March 13, 2007 may be entitled to anincrease in the conversion rate. However, in lieu of increasing the conversionrate applicable to those New Notes, the Company may in certaincircumstances elect to change its conversion obligation so that, in lieu ofdelivering cash, and, if applicable, shares of our common stock in respect of suchconversion obligation, the Company will deliver shares of the acquiring company’scommon stock. In addition to the events which would constitute a change ofcontrol (as defined in the indenture relating to the New Notes), a fundamentalchange will also include the occurrence of any transaction or event or anyseries of transactions or events in connection with which all orsubstantially all of our common stock is exchanged for, converted into,acquired for or constitutes solely the right to receive stock, othersecurities, other property, assets or cash, unless either:

(a)           the persons that “beneficiallyowned,” the shares of our voting stock immediately prior to such transaction, “beneficiallyown,” shares of the surviving or continuing corporation’s voting stockrepresenting at least a majority of the total voting power of all outstandingclasses of voting stock of such corporation or

(b)          both of the followingconditions are satisfied:

(i)            at least 90% of theconsideration (other than cash payments for fractional shares or pursuant tostatutory appraisal rights) in such transaction consists of common stock,ordinary shares or American Depository Shares, and any associated rights,traded on a U.S. national securities exchange or quoted on the Nasdaq NationalMarket (or that will be so traded or quoted when issued or exchanged inconnection with such transaction) and

(ii)        as a result of suchtransaction, the consideration due upon conversion of New Notes shall bepayable solely in shares of such securities, and any associated rights and cashfor fractional shares.

The Company has the option to redeem the New 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 New Notes have the option torequire the Company to repurchase the New Notes on March 8 of 2009, 2014and 2019, and upon a change in control, at a price equal to 100% of theiraggregate principal amount, plus accrued and unpaid interest, includingcontingent interest, if any.

The Company had no debt(including under its credit facility) other than the aforementioned notesoutstanding at December 31, 2006 or December 31, 2005.

F-19

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**5. ACCRUEDEXPENSES**

Accruedexpenses consist of the following (in thousands):

| ** **                          | ** ** | **2006** | ** ** | **2005** | ** ** |
|-------------------------------------|------------|----------|------------|----------|------------|
| Employee  compensation and benefits |       | $        | 3,706      |     | $          | 4,111 |   |
| Product returns                     |       | 1,568    |       | 1,090    |       |
| Product rebates                     |       | 1,763    |       | 2,441    |       |
| Sales deductions                    |       | 4,203    |       | 2,802    |       |
| Accrued royalties                   |       | 4,960    |       | 5,082    |       |
| Other                               |       | 2,765    |       | 2,956    |       |
| Total accrued expenses              |       | $        | 18,965     |     | $          | 18,482 |   |

 

**6. STOCKHOLDERS’EQUITY**

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, liquidationpreferences, sinking fund terms and the number of shares constituting anyseries or the designation of such series, without any further vote or action bythe stockholders. The issuance of preferred stock could adversely affect thevoting power of holders of common stock and the likelihood that such holderswill receive dividend payments and payments upon liquidation. The issuance ofpreferred stock may have the effect of delaying, deferring or preventing achange in control of the Company, which could have a depressive effect on themarket price of the common stock. The Company has no present plan to issue anyshares of preferred stock. As of December 31, 2005 and December 31,2006, there were no shares of preferred stock outstanding.

The Company issued 10,921 and 3,424 shares of commonstock under its employee stock purchase plan during 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 $8.0 millionin common stock until July 2003. Through July 2003, the Companyrepurchased 823,400 shares of its common stock at an aggregate cost ofapproximately $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 $5.0 million of common stock per quarter,became effective in August 2004, terminating and replacing the$10.0 million share repurchase program authorized by the Company’s Boardof Directors in fiscal 2002. 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 

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partnerships, at anaggregate cost of approximately $13.4 million. (At the time, Dr. Kapoorserved as a member of the Company’s Board of Directors. He retired from theBoard of Directors in December 2006.)These shares have been retired. In thefourth quarter of 2004, as part of the plan that became effective in August 2004,the Company repurchased 65,427 shares of common stock. These shares have beenretired. This share repurchase program expired in August 2005.

In December 2004, the Company, with Board of Directorsapproval, purchased 1.0 million shares of common stock at an aggregatecost of approximately $23.2 million, which was at a fair market valueequal to the December 10, 2004 closing price of the Company’s common stockas 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 authorized the repurchase of up to $20.0million of its outstanding shares of common stock over the next twelve months withno periodic sub-limits on the amount of repurchases. 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. In the second quarter of 2006, the Companyrepurchased 334,100 shares of common stock at an average cost of $20.71 pershare, or $6.9 million. These shares have been retired. This plan replacedall prior share repurchase plans and expired on August 2, 2006.

The Company adopted a newshare repurchase program effective August 3, 2006, that authorizes therepurchase of up to $30.0 million of its outstanding shares of common stockover the next twelve months with no periodic sub-limits on the amount ofrepurchases. In the third quarter of 2006, the Company repurchased 409,973shares of common stock at an average cost of $19.19 per share, or $7.9 million.These shares have been retired. This plan replaces all prior share repurchaseplans and will expire on August 2, 2007.

**7. STOCK BASEDCOMPENSATION**

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 period withinwhich options may be exercised, the restrictions on stock awards, and the otherterms and conditions of awards. All options granted under the 2000 Plan includeaccelerated vesting provisions in the event of a change in control, as definedin the plan. The 2000 Plan will terminate in February 2010. In May 2002,the Company determined that no additional options will be granted or awardedunder this plan. At December 31, 2006, 223,898 options remained issued andoutstanding under the 2000 plan.

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 

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plan shall be sevenpercent of the outstanding shares of common stock on the last day of thepreceding fiscal year less any options already granted under the 2002 Plan upto a maximum of 3,000,000 shares. The Company’s compensation committeeadministers the 2002 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 2002Plan include accelerated vesting provisions in the event of a change incontrol, as defined in the plan. On May 7, 2004, the Board of Directorsand stockholders approved the amendment and restatement of the 2002 Plan toreserve an additional 1,500,000 shares of common stock for issuance under thePlan. The 2002 Plan will terminate in May 2012. At December 31, 2006,2,208,475 shares were subject to outstanding stock-based awards under the 2002Plan, and there are 142,047 shares available for issue pursuant to stock-basedawards 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, 2006, 521,516 shares were subject to outstandingstock-based awards were issued and outstanding under the 2003 Plan, and thereare 201,820 shares available for issue under the 2003 Plan.

Upon the exercise of outstanding options, the Companybecame entitled to a tax effected benefit of $7.4 million,$1.0 million and $3.1** **millionin fiscal 2004, 2005 and 2006, 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 adopted anemployee stock purchase plan on February 14, 2000, which was terminated onJune 30, 2005. The purchase plan was intended to qualify as an employeestock purchase plan within the meaning of Section 423 of the InternalRevenue Code. The Company had reserved 750,000 shares of common stock for thestock purchase plan. In order to participate in the stock purchase plan, employeeswere required to meet eligibility requirements, including length of employment.Participating employees were able to direct the Company to make payrolldeductions of up to 7.0% of their compensation during an offering period forthe purchase of shares of the Company’s common stock. Each offering period wassix months. The stock purchase plan provided participating employees with theright, subject to specific limitations, to purchase the Company’s common stockat a price equal to 85.0% of the lesser of the fair market value of theCompany’s common stock on the first or last day of the offering period. TheBoard of Directors had the authority to amend, suspend or discontinue the stockpurchase plan as long as the change would not adversely affect participantswithout their consent and as long as the Company received the stockholderapproval required by law.

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**8.   INCOMETAXES**

Theincome tax provision for the years ended December 31, 2006, 2005 and 2004,respectively, consisted of the following (in thousands):

| ** ** | ** ** | **2006** | ** ** | **2005** | ** ** | **2004** | ** ** |
|------------|------------|----------|------------|----------|------------|----------|------------|
| Current    |       | $        | (16,839    | )        | $          | (14,982  | )          | $ | (7,397 | ) |
| Deferred   |       | (4,298   | )          | (4,195   | )          | (5,018   | )          |
|       |       | $        | (21,137    | )        | $          | (19,177  | )          | $ | (12,415 | ) |

 

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

| ** **                                | ** ** | **2006** | ** ** | **2005** | ** ** | **2004** | ** ** |
|-------------------------------------------|------------|----------|------------|----------|------------|----------|------------|
| Federal statutory  rate                   |       | 35.0     | %          | 35.0     | %          | 35.0     | %          |
| State income tax,  net of federal benefit |       | 1.5      |       | 1.9      |       | 2.7      |       |
| International  income tax                 |       | (4.6     | )          | (3.2     | )          | (5.7     | )          |
| Change in  valuation reserve              |       | (0.0     | )          | (1.6     | )          | 0.1      |       |
| Non-deductible  expenses and other        |       | (0.1     | )          | 0.7      |       | (0.2     | )          |
|                                      |       | 31.8     | %          | 32.8     | %          | 31.9     | %          |

 

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, 2006and 2005 are as follows (in thousands):

| ** **                             | ** ** | **2006** | ** ** | **2005** | ** ** |
|----------------------------------------|------------|----------|------------|----------|------------|
| Deferred tax  assets:                  |       |     |       |     |       |
| Accrued returns                        |       | $        | 559        |     | $          | 559 |   |
| Accrued  liabilities and reserves      |       | 2,142    |       | 2,168    |       |
| Net operating  loss carryforward       |       | 43       |       | 53       |       |
| Charitable  contributions carryforward |       | 1,778    |       | 2,483    |       |
| Stock based  compensation              |       | 882      |       | —   |       |
| Other assets                           |       | 879      |       | 1,180    |       |
| Total deferred  tax assets             |       | $        | 6,283      |     | $          | 6,443 |   |
| Deferred tax  liabilities:             |       |     |       |     |       |
| Intangibles                            |       | $        | 3,722      |     | $          | 3,027 |   |
| Interest accrual                       |       | 11,749   |       | 7,539    |       |
| Other liabilities                      |       | 579      |       | 932      |       |
| Total deferred  tax liabilities        |       | $        | 16,050     |     | $          | 11,498 |   |
| Valuation  allowance                   |       | 43       |       | 43       |       |
| Net deferred tax  liabilities          |       | $        | (9,810     | )        | $          | (5,098 | ) |

 

At December 31, 2006, the Company had netoperating loss carryforwards for state income tax purposes of less than $0.1** **million, tax effected, expiring at various datesthrough 2024. At December 31, 2006, the Company had charitablecontribution carryforwards of $1.8 million, tax effected, expiring at variousdates through 2009.

For any deferred tax assets where the Companydetermines that it is more likely than not that a deferred tax asset would notbe recovered, the Company records a valuation allowance. The valuation 

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allowance for deferred taxassets remained at less than $0.1 million in 2006. Before the provision forincome taxes, domestic income was $56.7 million and foreign income was$9.7 million for the year ended December 31, 2006.

At December 31, 2006,the Company had an aggregate of $24.6 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.   ACQUISITIONSAND INTANGIBLE ASSETS**

In May 2004, the Company entered into anagreement with SkyePharma PLC granting us the exclusive license for a term ofat least 15 years to market and distribute a fenofibrate product in the U.S.that was approved by the FDA in May 2005. We have since commencedmarketing and distribution of this product, labeled Triglide. Under itsAgreement with SkyePharma, the Company made a payment of $15 million toSkyePharma as a result of the approval during the quarter ended June 30,2005. SkyePharma is also entitled to royalties on net sales, as defined. Theintangible asset recorded in connection with the acquisition of Triglide isbeing amortized over a period of 15 years.

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 has contributed $6.2 million toward our sales andmarketing efforts, including product samples for the year ended December 31,2006, and will provide up to an additional $2.0 million in 2007. Over the termof the agreement, upon our achievement of certain sales levels, SkyePharma canreceive up to $30.0 million in additional milestone payments.

In February 2005, we amended the agreement withSkyePharma. This amendment provided for SkyePharma to deliver the fenofibrateproduct so that we could launch the product in the third****quarterof 2005. To provide additional assistance with our launch of the product,SkyePharma agreed to provide additional marketing support. In January 2006,we further amended our agreement with SkyePharma. In this amended agreement,SkyePharma increased its contribution toward our sales and marketing effortsfrom $5.0 million to $11.3 million and the parties further defined theirobligations with respect to the payment for samples.

In December 2004, the Company recorded anadditional $5.0 million in purchase price for licensing rights of Sular asa result of the Company reaching a performance milestone in the originalagreement. This milestone is being amortized over the remaining useful life ofthe asset. In January 2006, the Company paid Bayer Healthcare AG amilestone payment of $5.0 million for the licensing rights to Sular. InJuly 2006, the Company’s sales of Sular triggered the final $5.0 millionmilestone payment to Bayer Healthcare AG. This payment was made inOctober 2006. These milestone payments will be amortized over the remaininguseful life of Sular.

In September 2006, the Company launched Ostiva,an oral prescription nutritional supplement formulation with Metafolin,calcium, Magnesium, Vitamins B6, B12 and Vitamin D that gives women nutritionalsupport to help maintain healthy bones. Under its agreement with Pamlab, LLC,from which it acquired its rights to Ostiva, the Company made a payment of $0.9million for the launch of Ostiva. Pamlab is also entitled to royalties on netsales, as defined in the agreement. The intangible asset recorded in connectionwith the acquisition is expected to be amortized over a period of eight years.

In December 2006, the Company entered into apromotional agreement, which has an initial term of five years, with anaffiliate of Biovail Corporation to provide promotional support for Zovirax inthe United States. Under the terms of the agreement, beginning in the fourthquarter of 2006 the Company 

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will receive revenuesconsisting of ongoing fixed promotional fees and will be entitled to additionalincentive fees after certain dollar baseline targets are met. The Company has capitalized$1.7 million in fees relating to contract acquisition costs. These feeswill be expensed over the five year contract term.

In March 2005, the Company acquired the worldwiderights to Fortamet, Altoprev and Ostiva from Andrx Corporation. As of December 31,2005, the Company has paid Andrx $85.0 million. Andrx is also entitled toroyalties on net sales of these products.

With the assistance of valuation experts, the Companyallocated the purchase price to the fair value of the various intangible assetsacquired from Andrx Corporation (related to Fortamet and Altoprev), which arenot deemed 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.

Thefollowing table reflects the components of all intangible assets as of December 31,2006 (in thousands):

| ** **                      | ** ** | **Gross Amount** | ** ** | **Accumulated  Amortization** | ** ** | **Net Amount** | ** ** | **Average Life** | ** ** |
|---------------------------------|------------|-----------------------|------------|-------------------------------|------------|---------------------|------------|-----------------------|------------|
| Licensing rights                |       |                  | $          | 368,674                       |       |                |       | $                     | (79,734    | ) |   |   | $ | 288,940 |   |   | 10 to 20 years |   |
| Trade names                     |       |                  | 11,060     |                          |       |                | (2,845     | )                     |       |   | 8,215 |   |   | 15 to 20 years |   |
| Contracts                       |       |                  | 8,300      |                          |       |                | (8,049     | )                     |       |   | 251 |   |   | 5 years |   |
| Supply/Distribution  agreements |       |                  | 10,350     |                          |       |                | (4,986     | )                     |       |   | 5,364 |   |   | 10 years |   |
| Other intangibles               |       |                  | 3,108      |                          |       |                | (838       | )                     |       |   | 2,270 |   |   | 20 years |   |
| Total                           |       |                  | $          | 401,492                       |       |                |       | $                     | (96,452    | ) |   |   | $ | 305,040 |   |   |   |   |

 

Thefollowing table 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 |   |   |   |   |

 

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

| **Year ending December 31,** | ** ** | ** ** | ** ** | ** ** | ** ** |
|---------------------------------------------|------------|------------|------------|------------|------------|
| 2007                                        |       | $          | 22,593     |       |
| 2008                                        |       | 22,342     |       |
| 2009                                        |       | 22,342     |       |
| 2010                                        |       | 22,342     |       |
| 2011                                        |       | 22,342     |       |
|                                             |            |            |            |            |            |  |

 

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**10.   LICENSEAGREEMENTS AND PRODUCT RIGHTS**

In January 1999, the Company acquired exclusiverights in the U.S. to Robinul and Robinul Forte tablets from American HomeProducts Corporation. The Company must pay royalties on net sales under itslicense agreement with American Home Products. The Company entered agreementswith Mikart, dated April 23, 1999 and January 21, 2001, for Mikart tobecome qualified under applicable regulations to manufacture and supply theCompany’s requirements for Robinul. Mikart became qualified by the FDA tomanufacture Robinul on December 3, 2001 and began supplying the Robinulproducts to the Company in December 2001. Under these agreements, Mikartwill manufacture the products until either party elects not to renew. Thecurrent renewal term expires April 23, 2008 unless either party provides theother with written notice not to renew. The agreement with Mikart requires thatthe Company purchase certain designated minimum quantities.

In December 2001, the Company entered into alicense agreement with Wyeth-Ayerst Canada Inc. and Whitehall-Robins Inc.under which the Company acquired rights to have the product manufactured and tomarket and sell Robinul 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, the Company acquired exclusive U.S.rights to distribute, market and sell Nitrolingual from Pohl-Boskamp beginningon February 1, 2000 for five years plus an additional five-year renewalperiod. In October 2004, the distribution agreement was renewed for anadditional five years with an additional renewal period of two years. In 2005,we amended our agreement with Pohl-Boskamp. The amended agreement terminates in2010 with additional two-year renewal periods. Under the agreement, we must paya royalty on net sales of the product. Also, Pohl-Boskamp can terminate ourdistribution agreement for Nitrolingual if a company with a product competitivewith Nitrolingual 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.

In March 2002, the Company acquired exclusiveU.S. rights to distribute and sell Sular from AstraZeneca PLC and Bayer Health.We paid $184.3 million in cash, including $0.6 million in acquisitioncosts, plus the assumption of liabilities of $1.9 million related to thereturn of product shipped prior to the acquisition date. In December 2002,we increased our estimates for assumed liabilities by $0.7 million. Underthe asset purchase agreement, we acquired the regulatory approval to sell Sularin the U.S., current inventory, licensing rights to certain intellectualproperty, marketing materials for the promotion, advertising and marketing ofSular in the U.S., study materials relating to clinical studies of Sular, andcertain of AstraZeneca’s contracts relating to the marketing, sale anddistribution of Sular. 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 did not owe nor make any other milestone payments in 2006.

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 underthe amended agreement. This payment was made in 

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January 2006. In July 2006,the Company’s sales of Sular triggered the final $5.0 million milestone paymentto Bayer Healthcare AG. This payment was made in October 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.

In March 2005, the Company licensed and purchasedcertain rights to the type 2 diabetes prescription medication Fortamet and thecholesterol medication Altoprev from Andrx Laboratories. We paid $50.0 millionfor the Fortamet rights at closing and have paid $35.0 million for the Altoprevrights, a portion of which is subject to Andrx’s continuing ability to satisfycertain manufacturing service levels. We (i) purchased the Fortamet andAltoprev trademarks, worldwide marketing rights to Fortamet and Altoprev,certain Fortamet inventory, and marketing materials for the promotion,advertising and marketing of Fortamet and Altoprev, (ii) assumed certainof Andrx’s contracts relating to the sale of Fortamet and Altoprev and (iii) willpay Andrx a percentage of the net revenues associated with Fortamet andAltoprev on an ongoing basis. We also entered into an exclusive licenseagreement for the intellectual property associated with Fortamet and Altoprevon an ongoing basis.

We further entered into a long-term manufacturing andsupply agreement appointing Andrx as manufacturer of Fortamet and Altoprev. Theterms of the agreement require us to pay Andrx for the manufacture of Fortametand Altoprev on a per unit basis for a ten year term, subject to Andrx’sability to terminate as of the conclusion of the seventh year. The unit pricemay adjust based on changes in the cost of the active pharmaceuticalingredients as well as changes in an annual inflationary index.

In May 2004, the Company entered into anagreement with SkyePharma PLC granting us the exclusive license for a term ofat least 15 years to market and distribute a fenofibrate product in the U.S.that was approved by the FDA in May 2005. We have since commencedmarketing and distribution of this product, labeled Triglide. We have alsoobtained 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 $6.2 million toward our sales and marketing efforts and provided uswith free product samples for the year ended December 31, 2006, and willprovide up to an additional $2.0 million in 2007. Over the term of the agreement,upon our achievement of certain sales levels, SkyePharma can receive up to$30.0 million in additional milestone payments.

In February 2005, we amended the agreement withSkyePharma. This amendment provided for SkyePharma to deliver the fenofibrateproduct so that we could launch the product in the third****quarterof 2005. To provide additional assistance with our launch of the product,SkyePharma agreed to provide additional marketing support. In January 2006,we further amended our agreement with SkyePharma. In this amended agreement,SkyePharma increased its contribution toward our sales and marketing effortsfrom $5.0 million to $11.3 million and the parties further defined theirobligations with respect to the payment for samples.

In December 2006, the Company entered into apromotional agreement, which has an initial term of five years, with anaffiliate of Biovail Corporation to provide promotional support for Zovirax inthe United States. Under the terms of the agreement, the Company will receiveongoing promotional fees and will be entitled to additional incentive feesafter certain dollar baseline targets are met.

Each of the Company’s third-party manufacturingagreements require that the Company purchase all of their product requirementsfrom the manufacturers that are a party to those agreements.

In December 2000, the Company signed an agreementwith Westward Pharmaceuticals to manufacture Ponstel. This agreement expires inApril 2006 subject to automatic annual renewals. The Company must purchaseall of its requirements for Ponstel from Westward and is subject to minimum 

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purchase requirements. TheCompany 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, the Company must pay Westward milestone payments, as long as nogenerics have been introduced, upon certain anniversary dates of FDA approvalof the manufacture of Ponstel by Westward. During 2004, the Company paid $0.3 millionin milestone payments to Westward. The Company filed a site transferapplication with the FDA and received approval in February 2004. Westwardsupplies Cognex to us pursuant to an agreement that expires March 4, 2008and is renewable for two years. For the Cognex product, the Company negotiateda supply agreement with a Warner-Lambert affiliate to continue tomanufacture and supply Cognex and the active ingredient in Cognex for2 years subject to a one-year renewal. The Company will pay Warner-Lambert’saffiliate a production fee for its manufacture of Cognex and the activeingredient. The supply agreement contains designated quantities of Cognex andits active ingredient that Warner-Lambert’s affiliate will supply andthat the Company must purchase.

For the Prenate product line, under the terms of theasset purchase agreement, the Company was assigned a contract between Sanofiand Patheon Inc. to manufacture the product line. The Company finalized anew manufacturing agreement with Patheon in 2005 to manufacture Prenate Elite.This agreement expires in January 2009. The Company also assumed a supplyand packaging agreement with Banner Pharmacaps Inc. (“Banner”) and Sanofifor the supply and packaging of the products. Under the terms of the supply agreementwith Banner, as amended, the Company will pay Banner a royalty on net sales.The agreement with Banner was terminated in December 2004 as the Companydiscontinued Prenate GT and Prenate Advance. The Company amended its agreementwith Pamlab, LLC, the provider of the Prenate line’s Metafolin. Under theamended agreement the Company must meet certain value minimums and pay Pamlabroyalties.

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.

**11.   RETIREMENTPLAN**

In 1996, the Company began a qualified definedcontribution 401(k) 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. Employer contributions to the planfor the years ended December 31, 2004, 2005 and 2006 were$0.6 million, $0.7 million and $0.8 million, respectively.

In 2005, the Company beganan Employee Stock Ownership Plan (“ESOP”), which provides benefits tosubstantially all employees. The annual contribution, if any, to the plan is atthe discretion of the Board of Directors of the Company. In February 2006,the Company distributed 200,000 shares to employees under this plan. In theyears ended December 31, 2006 and December 31, 2005, the Companyrecorded $2.7 million and $0.8 million, respectively, in compensation expensefor the ESOP. There were no comparative expenses in 2004.

**12.   COMMITMENTSAND CONTINGENCIES**

In December 2001, the Company entered into alease agreement for its current warehouse and former corporate headquartersfacility. This lease expires in 2009. The total rent expense for the Companywas $0.6 million, $0.6 million and $1.5 million for the yearsended December 31, 2004, 2005, and 2006 respectively. On February 7,2006, the Company entered into a new lease agreement for office space  in Atlanta, Georgia for its corporateheadquarters. The eight year lease term, cancelable after five years, commencedon July 15, 2006. Lease rates began at $1.0 million per year and escalateduring the term to $1.2 million for the eighth year.

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The Company relocated its corporate and administrativefunctions to the new premises, but continues to maintain its warehouse andtraining functions at its prior facilities.

In December 2005, the Company entered into a newlease agreement for new office space in Dublin, Ireland. This space is leasedunder a cancelable operating lease that expires in September 2010. Thetotal rent expense for the Company was $25,000 for the year ended December 31,2006.

The Company leases vehicles for certain employeesunder non-cancelable lease agreements expiring in 2006. The total vehicle leaseexpense under the lease agreements for the years ended December 31, 2004,2005 and 2006 was $2.4 million, $4.3 million and $8.1 million,respectively.

Thetotal minimum future commitments under leases for years succeeding December 31,2006 is as follows (in thousands):

| **Period ending December 31,** | ** ** | ** ** | ** ** | ** ** | ** ** |
|-----------------------------------------------|------------|------------|------------|------------|------------|
| 2007                                          |       | $          | 7,233      |       |
| 2008                                          |       | 7,257      |       |
| 2009                                          |       | 3,635      |       |
| 2010                                          |       | 1,951      |       |
| 2011                                          |       | 594        |       |
| Total                                         |       | $          | 20,670     |       |

 

The Company has employment contracts with certainexecutives, which provide for certain levels of severance in the event oftermination without cause or for certain change of control events, as defined.

The Company, certain former and current officers anddirectors are defendants in a consolidated securities lawsuit filed on August 22,2002 in the United States District Court for the Northern District of Georgia.Plaintiffs in the class action alleged in general terms that we violatedSections 11 and 12(a)(a) of the Securities Act of 1933 and that weviolated Sections 10(b) and 20(a) of the Securities Exchange Act of1934 and Rule 10b-5 promulgated thereunder. In an amended complaint,Plaintiffs claim that we issued a series of materially false andmisleading statements to the market in connection with our public offering on April 24,2002 and thereafter relating to alleged “channel stuffing” activities. Theamended compliant also alleged controlling person liability on behalf ofcertain of our officers under Section 15 of the Securities Act of 1933 andSection 20 of the Securities Exchange Act of 1934. Plaintiffs seek anunspecified amount of compensatory damages.

On September 29, 2004, the U.S. District Courtfor the Northern District of Georgia dismissed, without prejudice, theclass action lawsuit. Although the lawsuit was dismissed, the courtgranted the plaintiffs the right to refile provided that the plaintiffs pay allof the defendant’s fees and costs associated with filing the motion to dismissthe lawsuit. Plaintiffs did not file a second amended complaint as permitted,but instead filed 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 secondamended complaint. Instead, plaintiffs filed an appeal to the United StatesCourt of Appeals for the Eleventh Circuit. The court has since ruled thatPlaintiffs may recast and refile their complaint. The Company shall continue tovigourously defend this action.

On September 18, 2006, the Eleventh Circuit Courtof Appeals affirmed the District Court’s determination that the AmendedComplaint was a “shotgun pleading” which did not satisfy the pleadingrequirements under the federal rules. The Court of Appeals,however, disagreed with the remedy ordered by the District Court. Insteadof dismissing the Amended Complaint with a right to further amend if Plaintiffspaid Defendants’ fees and costs, the Court of Appeals held that theDistrict Court should have 

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ordered Plaintiffsto replead under Federal Rule of Civil Procedure 12(e). The Court ofAppeals also held that Plaintiffs’ claims under the Securities Act of1933 must meet the heightened pleading standards of Federal Rule ofCivil Procedure 9(b) because those claims sound in fraud. Accordingly, theCourt of Appeals vacated the District Court’s orders and remanded withinstructions to order a repleading. No accrual is recorded in the Company’sfinancial statements related to this case as the Company believes that its riskof loss is remote.

The Company is alsoinvolved with other various legal proceedings incident to the course ofbusiness. None of these proceedings are expected to have a material adverseeffect on the consolidated financial statements.

**13.   RELATED-PARTYTRANSACTIONS**

In the third quarter of 2004, the Company purchased500,000 shares of common stock from one of Dr. Kapoor’s, the Company’s (thenChairman of the Board and a principal shareholder), family partnerships, at anaggregate 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.

**14.   QUARTERLYFINANCIAL INFORMATION (UNAUDITED)**

Thefollowing table sets forth summary quarterly financial information for theyears ended December 31, 2005 and 2006 (in thousands):

| **2006 by Quarter** | ** ** | ** ** | ** ** | **First Quarter** | ** ** | **Second Quarter** | ** ** | **Third Quarter** | ** ** | **Fourth Quarter** | ** ** |
|-------------------------------|------------|------------|------------|------------------------|------------|-------------------------|------------|------------------------|------------|-------------------------|------------|
| Net revenues                  |       |       | $          | 66,453                 |       |                    |       | $                      | 72,399     |                    |       |   | $ | 74,784 |   |   |   | $ | 79,545 |   |   |
| Gross profit                  |       |       | 57,101     |                   |       |                    | 61,853     |                   |       |                    | 64,501     |   |   |   | 69,039 |   |   |
| Operating income              |       |       | 13,212     |                   |       |                    | 14,840     |                   |       |                    | 17,335     |   |   |   | 19,324 |   |   |
| Net income                    |       |       | 9,127      |                   |       |                    | 10,172     |                   |       |                    | 12,301     |   |   |   | 13,644 |   |   |
| Earnings per share:           |       |       |       |                   |       |                    |       |                   |       |                    |       |   |   |   |   |   |   |
| Basic                         |       |       | $          | 0.26                   |       |                    |       | $                      | 0.29       |                    |       |   | $ | 0.35 |   |   |   | $ | 0.39 |   |   |
| Diluted                       |       |       | $          | 0.23                   |       |                    |       | $                      | 0.27       |                    |       |   | $ | 0.34 |   |   |   | $ | 0.38 |   |   |

 

| **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 |   |   |

 

**15.   SUBSEQUENTEVENTS**

On February 6, 2007, the Company announced thatit entered into an agreement with privately held Galephar PharmaceuticalResearch to develop and market a combination of fenofibrate and pravastatin totreat mixed dyslipidemia. Mixed dyslipidemia is the presence of elevated levelsof “bad” low-density 

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lipoprotein (LDL)cholesterol and triglycerides and low levels of “good” high-densitylipoproteins (HDL) cholesterol in the blood.

Under the terms of the agreement, the Company will haveexclusive rights to bring this combination therapy to market in the U.S.,Mexico and Canada. The Company will be responsible for the Phase III clinicaltrials and all regulatory filings with the FDA and expects to use data fromclinical trials that were conducted in Europe to supplement its regulatoryfiling in the U.S. The Company plans to begin enrolling patients in a pivotalPhase II efficacy and safety clinical trial in the U.S. in the first half of2007. The Company will pay to Galephar an upfront fee of $3.0 million, whichwill be expensed as research and development in the first quarter of 2007, plusa milestone payment after FDA approval of $3.0 million, and royalties on futureproduct sales, if any.

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**SCHEDULE II**

**SCIELE PHARMA, INC.**

**VALUATIONAND QUALIFYING ACCOUNTSYEARS ENDED DECEMBER 31, 2004, 2005 AND 2006(IN THOUSANDS)**

| **Classification** | ** ** | ** **                      | ** ** | **Balance at  Beginning of  Year** | ** ** | **Charged to Costs  and Expenses** | ** ** | **Deductions** | ** ** | **Balance End  of Year** | ** ** |
|--------------------|------------|---------------------------------|------------|----------------------------------------------|------------|---------------------------------------------------|------------|----------------|------------|------------------------------------|------------|
| 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 |   |   |
| 2006               |       | Accounts  receivable allowances |       |                                         | 2,427      |                                              |       |           | 25,490     |                               |       |   | (25,907 | ) |   |   | 2,010 |   |   |
|               |       | Allowance for  product returns  |       |                                         | 1,090      |                                              |       |           | 9,148      |                               |       |   | (8,670 | ) |   |   | 1,568 |   |   |
|               |       | Allowance for  product rebates  |       |                                         | 2,441      |                                              |       |           | 12,392     |                               |       |   | (13,070 | ) |   |   | 1,763 |   |   |
|               |       | Allowance for sales  deductions |       |                                         | 2,802      |                                              |       |           | 30,734     |                               |       |   | (29,333 | ) |   |   | 4,203 |   |   |
|                    |            |                                 |            |                                              |            |                                                   |            |                |            |                                    |            |  |  |  |  |  |  |  |  |  |  |

 

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