BIODELIVERY SCIENCES INTERNATIONAL INC - BDSI Annual Report (Small Business Issuers) (10KSB) Item 1. Description of Business.

The following is an excerpt from a 10KSB SEC Filing, filed by BIODELIVERY SCIENCES INTE ... on 4/17/2007.

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Item 1. Description of Business.

Overview

We are a specialty biopharmaceutical company that is utilizing its licensed, owned and proprietary patented drug delivery technologies to develop and commercialize, either on our own or in partnerships with third parties, clinically-significant new formulations of proven therapeutics.

Our development strategy focuses on the utilization of the U.S. Food and Drug Administration's 505(b)(2) approval process to obtain more timely and efficient approval of new formulations of previously approved therapeutics which incorporate our licensed drug delivery technologies. Because the 505(b)(2) approval process is designed to address new formulations of previously approved drugs, we believe it has the potential to be more cost efficient and less time consuming than other approval methods of the U.S. Food and Drug Administration, which we refer to herein as the FDA.

Our drug delivery technologies include:

• the patented BEMA™ (transmucosal, or applied to the inner cheek membrane) drug delivery technology, and

• the patented Bioral® nanocochleate drug delivery technology, designed for a potentially broad base of applications.

Utilizing our licensed delivery technologies, we are currently developing formulations of pharmaceuticals aimed principally at acute (i.e., short term) conditions occurring in cancer and surgical patients, mostly notably in the areas of pain and fungal infections. Our lead product, currently in Phase III clinical trials, is BEMA™ Fentanyl. We intend to announce the results of the Phase III efficacy study for BEMA™ Fentanyl in April 2007 and submit a New Drug Application, or NDA, to the FDA regarding BEMA™ Fentanyl with an indication for the treatment of "breakthrough" cancer pain as soon as possible thereafter.

We also believe our drug delivery technologies have the potential to be applied to other types of pharmaceuticals and also to other therapeutics such as small interfering RNA, or siRNA,

We currently generate revenue from licensing milestone payments and royalties, and have generated revenue from grants. Ultimately, if we secure approval from the FDA for our licensed and/or proprietary products and formulations, our goal will be to augment these revenues from sales of such products and formulations, on which we will also pay royalties or other fees to our licensors and/or third-party collaborators where they exist.

We intend to finance our research and development, commercialization and distribution efforts and our working capital needs primarily through:

• applying our licensed technologies to existing therapeutics to create our own proprietary formulations, which we will then seek to obtain FDA approval for and subsequently commercialize,

• licensing and joint venture arrangements with third parties, including pharmaceutical companies whose own proprietary pharmaceutical products may benefit from our drug delivery technologies,

• partnering with pharmaceutical companies to assist in the distribution of our products for which we will receive milestone and royalty payments, and

• proceeds raised from our public and private financings and strategic transactions.

BEMA™ Technology and Products in Development

Our BEMA™ drug delivery technology consists of a small, dissolvable polymer disc for application to mucosal (inner lining of cheek) membranes. BEMA™ discs deliver a rapid, reliable dose of drug across mucous membranes for time-critical conditions like "breakthrough" cancer pain (i.e., episodes of severe pain which "break through" the medication used to control the persistent pain), or trauma cases where intravenous lines or injections are unavailable or not practical. We license the BEMA™ drug delivery technology in the United States on an exclusive basis from Atrix Laboratories, Inc. (now a wholly-owned subsidiary of QLT Inc.), which we refer to herein as QLT. In August 2006, we entered into an agreement with QLT to purchase the non-U.S. rights to the BEMA™ technology. This agreement includes an exclusive option to purchase the U.S. rights within 12 months of the effective date of this agreement. After purchasing the intellectual property rights from QLT, we will not owe any future milestone payments or royalties.

Our lead BEMA™ product under development is BEMA™ Fentanyl, a treatment for breakthrough cancer pain. This product entered into Phase III trials for breakthrough cancer pain in the second half 2005. In February of 2006, enrollment in the Phase III clinical program commenced. In April and May 2006, we announced results from pharmacokinetic studies demonstrating dose proportionality and reproducibility with BEMA™ Fentanyl. In September 2006, we conducted a second meeting with the FDA to discuss the status of the BEMA™ Fentanyl development program. At such meeting, we received confirmation from the FDA regarding the process being undertaken for the BEMA™ Fentanyl program. In January 2007 we announced that the results of the Phase III efficacy trial and an update on the program status will be available in April 2007.

On July 15, 2005, we entered into a clinical development and licensing agreement (which agreement we refer to herein as the CDLA) with Clinical Development Capital, LLC, which we refer to herein as CDC, under which CDC has provided $7 million toward the Phase III clinical development of BEMA™ Fentanyl. The CDLA was subsequently assigned to CDC IV, LLC, an affiliate entity of Clinical Development Capital, LLC. On February 16, 2006, we announced that, as a result of our achievement of certain milestones called for under the CDLA, CDC made an initial $2 million payment to us.

On May 17, 2006, we consummated a transaction with CDC pursuant to which $7 million in funds previously committed by CDC under the CDLA to fund our clinical development of BEMA™ Fentanyl was converted into shares of our common stock at a value of $3.50 per share. As a result of this transaction, CDC was issued 2 million shares of our common stock in return for accelerating the funding of the $4.2 million balance of $7 million of aggregate commitment under the CDLA and for eliminating the $7 million milestone payable to CDC upon the approval by the FDA of BEMA™ Fentanyl which had been required under the CDLA.

In August 2006, we entered into a definitive agreement with Meda AB, or Meda, to license the European development and commercial rights to BEMA™ Fentanyl to Meda AB. We received an upfront license payment of $2.5 million, are eligible to earn up to $7.5 million more upon achievement of certain milestones and will receive a double digit royalty on net sales of BEMA™ Fentanyl in Europe.

A second product under development, BEMA™ Long Acting Analgesic, which we refer to herein as BEMA™ LA, is a BEMA™ formulation of an already approved product in the U.S. that will target a broader range of pain conditions including post operative and, potentially, chronic pain due to osteoarthritis, lower back disorders and rheumatoid arthritis. In early December 2005, we submitted an Investigational New Drug Application, or IND, with FDA for BEMA™ LA. In mid-2006, we conducted our first Phase I study with BEMA™ LA in normal volunteers. The data from this study confirmed that we can deliver the active ingredient of BEMA™ LA at therapeutic plasma (blood) concentrations based on other work done in other deliver forms of the active ingredient. We therefore expect that we will be able to demonstrate efficacy with BEMA™ LA for the treatment of certain types of pain. Additional formulation work with BEMA™ LA is ongoing and we project to start Phase II trials by the end of 2007 or early in 2008.

A third product under development, BEMA™ Zolpidem, is a BEMA™ formulation of the most widely prescribed drug for the treatment of insomnia. Given funding constraints and our focus on applying the majority of our resources to the Phase III BEMA™ Fentanyl program, the initiation of the BEMA™ Zolpidem program was delayed in 2006. The timing of the restart of this program will be evaluated in 2007.

Bioral® Technology and Products in Development

Our Bioral® (cochleate) drug delivery technology encapsulates (encochleates) the selected drug or therapeutic in a nanocrystalline structure termed a "cochleate" cylinder. All of the components of the cochleate cylinder are naturally occurring substances. We believe that the cochleate cylinder provides an effective delivery mechanism without forming a chemical bond, or otherwise chemically altering, the selected drug. We believe this technology will allow us to take certain drugs that were only available by intravenous injection and convert them to formulations that can be taken orally. Our Bioral® drug delivery technology was developed in collaboration with The University of Medicine and Dentistry of New Jersey, which we refer to herein as UMDNJ, and the Albany Medical College, which we refer to herein, collectively with UMDNJ, as the Universities, each of which has granted us the exclusive worldwide licenses under applicable patents.

Our lead Bioral® formulation is an encochleated version of Amphotericin B, an anti-fungal treatment for treating systemic fungal infections. A Bioral® formulation of Amphotericin B (which we refer to as CAMB) would have the potential for oral delivery of a drug that is currently only given by intravenous injection. Following the completion of preclinical testing in 2006, we submitted an IND to the FDA for CAMB in December 2006 which was accepted by the FDA. We believe that the opportunity to move forward with testing a Bioral ® formulation in humans represents a major milestone for us given the time and resources we have spent in developing the technology. The next step for CAMB will be to manufacture clinical supplies and proceed with our first Phase I trial in normal volunteers to evaluate the safety of the product and its pharmacokinetics. If financing permits, we expect to begin this program in 2007.

A second Bioral® formulation for the intranasal administration of Amphotericin B to treat chronic rhinosinusitis, or CRS, is now in initial in vitro studies. These studies suggest that CAMB may provide enhanced efficacy and stability. In April 2004, we licensed this second opportunity to Accentia Biopharmaceuticals, Inc., an affiliate of ours which we refer to herein as Accentia, for the use in the treatment of CRS and asthma. Certain of our officers and directors are officers, directors and/or stockholders of Accentia or its subsidiaries.

We have also explored other potential applications of our Bioral ® encochleation technology, including the creation of cochleate formulations of siRNA therapeutics, other therapeutics, certain vaccines and important nutrients. In 2005 and 2006, we entered into agreements with third parties for the evaluation of cochleate formulations of siRNA therapeutics. The results of one of these collaborations demonstrated that the Bioral®technology showed the potential to deliver the siRNA resulting in the "knock down" of the targeted enzyme (meaning the siRNA positively effected the enzyme in question in such a way so as to potentially achieve a therapeutic effect). This was established in two sets of experiments (which we announced in August 2006) in a mouse model of influenza where intra-nasally and intravenously administered Bioral® siRNAs reduced the viral titer significantly. We believe this may represent a significant opportunity to deliver these therapeutics, which are normally difficult to use and which are easily destroyed in the plasma by the body's natural enzymes, to patients. We have an ongoing evaluation agreement with a major companies developing siRNA therapeutics and we are seeking additional collaborations and strategic partners in this area.

Additionally, we have ongoing evaluation agreements in place with other companies to evaluate their proprietary molecules in the Bioral® delivery system. In 2006, we signed a master research agreement with a major pharmaceutical company where we can evaluate a series of compounds from the sponsor company with predefined terms. If any of the evaluations from this agreement are positive, we will have an option to license the Bioral® technology for use with the specified compound. To date, no opportunity for such an option has arisen.

Emezine®

We have also been developing Emezine ®, a formulation of prochlorperazine, which we believe would be the first drug to be delivered transmucousally for treatment of nausea and vomiting. In February 2005, we announced that we completed the clinical studies required for our Emezine® NDA, and on April 29, 2005, we submitted such NDA. The FDA accepted our NDA for filing on June 30, 2005. On February 28, 2006, however, we received a non-approvable letter from the FDA regarding our Emezine® NDA. The non-approvable letter stated that additional information would be required to address remaining questions. On May 17, 2006, we met with the Gastroenterology Division of the FDA to discuss the nonapprovable letter we received for Emezine®. The FDA's position was that while a 505(b)(2) submission is still an acceptable regulatory pathway for Emezine®, additional clinical trials would be required to support the use of Emezine® in the target population of the proposed indication. The FDA further suggested that a Special Protocol Assessment could potentially fulfill the remaining requirements. Based on the FDA feedback, on July 14, 2006, we submitted two draft pharmacokinetic protocols for review as a Special Protocol Assessment along with a proposal as to how the data from these protocols would address the deficiencies noted in the nonapprovable letter. We are currently involved in discussions with clinical consultants to determine how and whether we will proceed with the continued development of Emezine ® based on the feedback we received from FDA on the information we submitted on July 14, 2006. Given the opportunity that the BEMA™ Fentanyl and BEMA™ LA products currently present to us in terms of potential commercial value, any continued spending on Emezine® based on the challenges of meeting FDA's requirements for the ultimate approval of Emezine ® may not be warranted. We therefore plan to continue to monitor, but not spend material resources, on the Emezine® project for the foreseeable future. Despite the fact Emezine ® represents a relatively small portion of our potential future revenues, the failure to ultimately achieve FDA approval of Emezine®could have an adverse effect on our business. We do not, however, expect that such failure would seriously impair our overall potential future revenue growth. We license Emezine ® from Reckitt Benckiser Healthcare (UK) Limited, which we refer to herein as Reckitt.

During 2006, we actively pursued strategic financings and related partnerships regarding certain of our proposed formulations and products as we attempt to move them through the development,

approval and commercialization phases. Unfortunately, the FDA non-approvable notification regarding Emezine ® meant that revenues we had previously projected as potentially being generated upon the launch of Emezine® in 2006 were not realized. Therefore, in part to offset the potential loss of projected Emezine® revenue but primarily due to our interest in securing distribution partners for our products, we aggressively pursued these types of transactions in 2006 and will continue to do so in 2007. As a result, we were able to execute a European transaction involving the distribution rights of BEMA™ Fentanyl with Meda (European based pharmaceutical company with a focus in pain) that included a signing milestone payment of $2.5 million. We are currently in discussions with several companies regarding the same distribution rights for BEMA Fentanyl in the U.S.

Recent and Historical Events

Laurus Financings

On February 22, 2005, we consummated a $2.5 million secured convertible debt financing from Laurus Master Fund, Ltd., which we refer to herein as Laurus. Net proceeds from the financing were used primarily to retire our secured equipment loan with Gold Bank (on which approximately $300,000 was owed and was paid at the closing of the Laurus transaction), to support our research and development opportunities and for general working capital purposes.

The February Laurus investment took the form of a convertible note secured by certain of our assets. The note had a 3-year term and an interest rate equal to prime plus 2% per annum. The note was convertible, under certain conditions, into shares of our common stock at a price equal to $3.10 per share. As a result of the anti-dilution provisions of the February Laurus note and the pricing of our October 2005 public offering, the conversion price of the February Laurus note was lowered to $2.45.

Due to the exercise by Laurus from time to time of its right to convert its note into shares of our common stock, the February 2005 Laurus note has been fully converted into shares of our common stock as of the date of this Report.

In connection with this financing, we also issued Laurus a common stock purchase warrant to purchase up to 350,000 shares of our common stock at a price equal to $3.88 per share. A registration statement we filed with the SEC to register the shares of common stock underlying the February Laurus note and the warrant was declared effective on June 20, 2005. This warrant was exercised on April 10, 2007. See "Subsequent Events" below.

On May 31, 2005, we closed an additional $2.5 million secured convertible debt financing from Laurus. As with the February 2005 Laurus financing, this financing takes the form of a secured convertible note and a warrant to purchase 483,871 shares of our common stock. This warrant was exercised on April 10, 2007. See "Subsequent Events" below. Net proceeds from the May Laurus financing were used to support our research, development and commercialization opportunities and for general working capital purposes. As a result of the anti-dilution provisions of the May Laurus note and the pricing of our October 2005 public offering, the conversion price of the May Laurus note is now $2.45.

On June 29, 2005, we entered into two separate amendments to our February and May 2005 financing agreements with Laurus under which Laurus agreed to defer payments by us of principal under the February and May 2005 Laurus notes until December 1, 2005. In consideration of Laurus' agreement, we issued to Laurus two warrants, one to purchase 22,500 shares of our common stock (in connection with the February amendment) and a second to purchase 7,500 shares of our common stock (in connection with the May amendment). In each case, such warrants are exercisable into shares of our common stock at an exercise price of $.001 per share and expire on June 29, 2012. Except for the exercise price of the warrants, the warrants issued to Laurus in connection with the foregoing amendments are substantially similar to the warrants issued to Laurus on February 22, 2005 and May 31, 2005. We agreed to register the shares of common stock underlying the May note and warrant and the June warrants with Laurus with the SEC, which registration statement was declared effective on July 11, 2005.

On December 28, 2005, we entered into two separate second amendments to our February and May 2005 financing agreements with Laurus under which Laurus agreed to defer payments by us of certain monthly principal amounts, as well as all of the previously postponed principal amounts due to Laurus addressed in our June 29 amendments, until July 1, 2006. In consideration of Laurus' agreement to postpone such payments, we issued to Laurus two additional warrants, one to purchase 39,574 shares of our common stock (in connection with the February amendment) and a second to purchase 29,700 shares of our common stock (in connection with the May amendment). In each case, such warrants are exercisable into shares of our common stock at an exercise price of $.001 per share and expire on December 28, 2012. Except for the exercise price of the warrants, the warrants issued to Laurus in December 2005 are substantially similar to the warrants issued to Laurus on February, May and June 29, 2005. We agreed to register the shares of common stock underlying the warrants issued in connection with these amendments, which registration statement was declared effective on May 16, 2006.

On July 31, 2006, we entered into two separate third amendments to our February and May 2005 financing agreements with Laurus. Under the third amendments, Laurus has agreed to defer payments by us of certain monthly principal amounts under the Laurus notes ($909,096 in the aggregate), as well as certain other previously postponed principal amounts due under such notes ($1,280,945 in the aggregate), until the first business day of January 2007. In consideration of Laurus' agreement enter into the third amendments, we issued to Laurus two warrants, one to purchase 62,887 shares of our common stock (in connection with the February amendment) and a second to purchase 47,113 shares of our common stock (in connection with the May amendment). In each case, such warrants are exercisable into shares of common stock at an exercise price of $3.00 per share and expire on July 31, 2013. Except for the exercise price, these warrants are substantially similar to the warrants issued to Laurus on February 22, 2005, May 31, 2005, June 29, 2005 and December 28, 2005. We have agreed to register the shares of common stock underlying the July 2006 warrants with the Securities and Exchange Commission pursuant to a registration statement required to be filed by no later than May 25, 2007.

On December 28, 2006, we entered into two separate fourth amendments to our February and May 2005 financing agreements with Laurus. Under the fourth amendments, Laurus has agreed to defer payments by us of certain monthly principal amounts under the Laurus notes ($1,818,192 in the aggregate), as well as certain other previously postponed principal amounts due under such notes ($2,018,541 in the aggregate), until the first business day of January 2008. In consideration of Laurus' agreement enter into the third amendments, we issued to Laurus two warrants, one to purchase 943,305 shares of our common stock (in connection with the February amendment) and a second to purchase 556,695 shares of our common stock (in connection with the May amendment). In each case, such warrants are exercisable into shares of common stock at an exercise price of $3.05 per share and expire on December 28, 2013. Except for the exercise price, these warrants are substantially similar to the warrants issued to Laurus on February 22, 2005, May 31, 2005, June 29, 2005, December 28, 2005 and July 31, 2006. We have agreed to register the shares of common stock underlying the July 2006 warrants with the Securities and Exchange Commission pursuant to a registration statement required to be filed by no later than May 25, 2007.

During the first quarter of 2007, Laurus exercised its right to convert an additional $3.044 million of aggregate principal and $0.119 million of interest under its two notes with us into 1,290,861 shares of common stock. On April 10, 2007, Laurus agreed to defer all remaining principal to July 1, 2008. As of the date of this report, the remaining principal due to Laurus is $1.262 million. See "Subsequent Events" below.

CDC Clinical Development and Licensing Agreement

On July 15, 2005, we entered into the CDLA with CDC. On February 16, 2006, we announced that, as a result of our achievement of certain milestones called for under our CDC agreement, CDC made its initial $2 million payment to us. On May 16, 2006, we consummated a transaction with CDC pursuant to which $7 million in funds previously committed by CDC under the CDLA to fund our clinical development of BEMA™ Fentanyl was converted into shares of our common stock at a value of $3.50 per share. As a result of this transaction, CDC was issued 2 million shares of our common stock in return for accelerating the funding of the $4.2 million balance of $7 million of aggregate commitment under the CDLA and for eliminating the $7 million milestone payable to CDC upon the approval by the FDA of BEMA™ Fentanyl which had been required under the CDLA.

Under the CDLA, CDC is entitled to receive:

• royalties based on net sales of BEMA™ Fentanyl (including minimum royalties); and

• a portion of any licensing revenue received by us prior to FDA approval of BEMA™ Fentanyl, which will be credited against our initial milestone payment to CDC.

In addition, we granted CDC a warrant exercisable for up to 500,000 shares of our common stock at an exercise price of $3.50 per share. As a result of the anti-dilution provisions of the CDC warrant and the pricing of our October 2005 public offering, the conversion price of the CDC warrant is now $2.91. We also issued to CDC a warrant to purchase 904,000 shares of our common stock in connection with the May 2006 amendment to the CDLA. Such warrant is exercisable at $3.00 per share. All of the shares of common stock issued to CDC (as well as the shares underlying CDC's warrants) as described above have been registered with the SEC.

Upon execution of the CDLA, all data, information, and intellectual property rights concerning BEMA ™ Fentanyl were exclusively licensed to CDC, subject to CDC's return grant of an exclusive license for us to utilize all such information and rights. Further, CDC shall own all data generated in the course of the product development supported by its funds, provided that we shall have an exclusive license to use such data for purposes of our development and commercialization of BEMA™ Fentanyl.

Royalties under the CDLA are subject to upward adjustments: (i) for delays in obtaining regulatory approval for BEMA™ Fentanyl, (ii) for the market entry of certain defined competing products in the United States prior to the first commercial sale of BEMA™ Fentanyl, or (iii) if the average selling price of BEMA ™ Fentanyl is less than that of certain defined competing products. In the event we do not diligently pursue the development and regulatory approval of BEMA™ Fentanyl or if we encounter certain specified negative circumstances regarding the development of BEMA™ Fentanyl, CDC has the right to pursue development and commercialization of BEMA™ Fentanyl pursuant to an exclusive, world-wide, royalty-free license, which includes the right to sublicense, and the assignment of our BEMA™ Fentanyl assets to CDC, provided that, under certain conditions, we may, despite such negative circumstances, retain our rights to BEMA™ Fentanyl and continue pursuing its development and/or commercialization itself subject to the reimbursement of all funding provided by CDC and payment of all royalties due, pro rated based on the amount of funding provided by CDC, under the development agreement.

The warrant issued to CDC in July 2005 is currently exercisable at $2.91 per share (originally $3.50, which exercise price was adjusted as a result of our October 2005 public financing) and contains certain anti-dilution provisions with respect to certain issuances of stock (or issuance of securities convertible into stock) at a price per share less than the exercise price stated in the warrant during the six months following its issuance. Also, the number of shares for which the warrant may be exercised are subject to adjustment based on the amount of funding provided by CDC, provided the warrant shall not, in any event, be exercisable for less than 100,000 shares of our common stock. Finally, such warrant expires after the earlier of: (i) 5:00 p.m. Eastern Time on the second anniversary of the approval by the FDA of the first NDA relating to BEMA™ Fentanyl, (ii) the closing of a sale of all or substantially all of our assets or the acquisition of our company by another entity by means of merger or other transaction as a result of which our stockholders immediately prior to such acquisition possess a minority of the voting power of the acquiring entity immediately following such acquisition, or (iii) any liquidation or winding up of our company.

Pursuant to the CDLA, and concurrently with the timing of CDC's initial $2.0 million payment to us, we entered into a security agreement granting CDC a security interest in assets related to BEMA™ Fentanyl. The formal security interest terminates at the time of FDA approval of BEMA™ Fentanyl. CDC retains the right to reclaim the assets in the event of a default under the CDLA as long as payments are due as royalties. Events of default would include failure to pay royalties, acceleration of a debt in excess of $1.0 million, judgment of $500,000, or insolvency, among other things.

On August 30, 2006, we delivered to CDC a notice in which we claimed that CDC breached the CDLA and damaged us when it acted or failed to act in accordance with or in contravention of the terms of the CDLA. In our notice, we reserved the right to make additional claims against CDC. Also on August 30, 2006, we received written notice from CDC of CDC's claim of termination of the CDLA. In its notice, CDC alleged that we undertook certain actions which materially breached the CDLA, which breaches, CDC alleged, require the Company to transfer certain specified rights and assets relating to BEMATM Fentanyl to CDC. Pursuant to the CDLA, any claim of breach of material terms is subject to the dispute resolutions procedures, including arbitration, contained within the CDLA. These matters were settled in March 2007. See "Subsequent Events" below.

2005 Public Offering

In early October 2005, we announced the consummation of a "follow on" public offering of 4,400,000 shares of our common stock, resulting in gross proceeds of $8.8 million to us. The public price per share for the offering was $2.00. The offering was underwritten by Ferris, Baker Watts Incorporated, Maxim Group LLC and GunnAllen Financial, Inc. The underwriters were granted an option to purchase up to an additional 660,000 shares of our common stock to cover over-allotments, which option was partially exercised in late October 2005, generating additional gross proceeds of $107,900.

Acquisition of Arius Pharmaceuticals, Inc.

On August 24, 2004, we consummated the acquisition of Arius Pharmaceuticals, Inc. Arius was a specialty drug delivery company developing products for the "acute" treatment opportunities such as pain, anxiety, nausea and vomiting, targeted primarily to surgical and oncology patients. In 2004, Arius acquired an exclusive worldwide license to the BEMA ™ delivery technology developed by QLT, and also acquired the U.S. license rights to a transmucousally delivered tablet formulation of Emezine®.

Simultaneously with the closing of the Arius acquisition, Mark A. Sirgo, Pharm.D., a founder and the President and CEO of Arius, entered into an employment agreement with us and was named Senior Vice President of Commercialization and Corporate Development. Andrew L. Finn, Pharm.D., also a founder and the Chief Operating Officer of Arius, also entered into an employment agreement with us and was named our Senior Vice President of Product Development. Subsequent to the Arius closing, Dr. Sirgo was promoted through several positions and currently serves as the President and Chief Executive Officer of our company. Dr. Finn was, subsequent to the Arius closing, promoted to the position of Executive Vice President of Clinical Development and Regulatory Affairs of our company and now serves as Executive Vice President of Product Development.

As consideration for our acquisition of Arius, we issued the former Arius stockholders an aggregate of 1,647,059 shares of our Series A Non-Voting Convertible Preferred Stock, which we refer to herein as the Series A Preferred. Drs. Sirgo and Finn, as the principal stockholders of Arius, were each issued 797,414 shares of Series A Stock, representing an aggregate of approximately 97% of the outstanding shares of Series A Stock. The Series A Stock were convertible into shares of our common stock under certain conditions on a one-for-one basis at a value of $4.25 per share. All shares of Series A Stock have subsequently been exchanged by the holders thereof for shares of newly-designated Series C Non-Voting Convertible Preferred Stock, which we refer to herein as the Series C Stock. See "Subsequent Events" below.

Hopkins Capital Group Equity Line of Credit

On September 3, 2004, we entered into an Equity Line of Credit Agreement with Hopkins Capital Group II, LLC, which we refer to herein as HCG, a principal stockholder of our company which is controlled and partially-owned by Dr. Francis E. O'Donnell, Jr., our Chairman of the Board. Pursuant to the Equity Line Agreement, HCG will, at our request, invest up to $4.0 million in our company from August 23, 2004 through March 31, 2006 in consideration of shares of a newly created class of Series B Convertible Preferred Stock, or Series B Preferred. On March 30, 2006, we amended our agreement with HCG to extend the commitment period from March 31, 2006 to December 31, 2006. This agreement with HCG expired on December 31, 2006 and all shares of Series B Preferred have subsequently converted by HCG into shares of our common stock.

Sigma-Tau License and Stock Purchase Transaction

On January 20, 2005, we signed a definitive licensing agreement with Sigma-Tau Industrie Farmaceutiche Riunite S.p.A., or Sigma-Tau Pharma, for the application of our Bioral® nanocochleate delivery technology to formulate up to four proprietary pharmaceutical compounds currently under development by Sigma-Tau Pharma. Sigma-Tau Pharma is an affiliate of The Sigma-Tau Group, one of Italy's leading pharmaceutical companies. Simultaneously with this licensing agreement, we entered into a stock purchase agreement with, and received a non-refundable upfront payment of US$250,000 from, Sigma-Tau, a holding company of The Sigma-Tau Group. This upfront payment was applied toward the purchase by Sigma Tau of unregistered shares of our common stock priced at $4.25 a share. The stock purchase agreement with Sigma-Tau provides for the purchase by Sigma-Tau, upon the occurrence of specified developmental milestones associated with the license, of additional unregistered shares of our common stock, up to an aggregate potential of $1.5 million worth of such shares. These milestones lead up to and include the submission of product INDs by Sigma-Tau Pharma for one or more of the four subject encochleated compounds. Sigma-Tau, through other holding entities, is currently a stockholder of our company. In addition to the milestone payments, we will receive a royalty on future sales of each of the four products which may arise from the encochleated compounds.

We continued to work with Sigma-Tau on this project during 2006. Working with Sigma-Tau's immunosuppressant compound, we were able during 2006 to undertake additional vivo efficacy studies versus a subcutaneous formulation of the compound and a 28 day toxicology test. With the completion of this test, we have demonstrated of proof of principle. This was formally recognized by Sigma Tau in February 2007. BDSI received a $250,000 payment which took the form of a purchase of our common stock by Sigma-Tau as described above.

Subsequent Events

The following material events occurred subsequent to December 31, 2006:

CDC

On March 12, 2007, we entered into a Dispute Resolution Agreement, which we refer to herein as the DRA, with CDC, pursuant to which we and CDC have terminated the previously instituted dispute resolution procedures between the parties relating to the allegations and demands made by the parties against each other in August 2006. The effect of the DRA is that CDC has withdrawn its claims to ownership of the BEMA™ Fentanyl asset, which had been asserted by CDC as part of the disputed matters, and we have withdrawn our claims against CDC. We had previously rejected CDC's August 2006 allegations and demands. The resolution of the disputes under the DRA is without prejudice to the disputed matters of both us and CDC.

Simultaneously with our entry into the DRA, we entered into an amendment to the CDLA. The purpose of the amendment to the CDLA is to clarify certain reporting and other obligations between the parties regarding the development and commercialization of BEMA™ Fentanyl.

Concurrently with the parties' negotiation of the DRA, CDC alleged that we had violated CDC's financing right of first refusal (which we refer to as the ROFN) provided for in the May 2006 Securities Purchase Agreement between the parties. Specifically, in January 2007, CDC alleged by written notice that our December 2006 note deferral agreements with Laurus triggered the ROFN provisions. As described above, under such transaction, we deferred all principal and interest under Laurus' existing convertible notes in exchange for a warrant to purchase shares of our common stock.

In order for us avoid CDC's continued assertion of its alleged ROFN with respect to the Laurus deferral transaction, and in order to enter into the DRA with the resulting resolution of the August 2006 disputes, CDC required that, simultaneously with the entry into the DRA, we enter into to a $1.9 million financing with CDC. This new financing is intended to resolve CDC's January 2007 ROFN claims, notwithstanding our rejection of CDC's assertion that the ROFN was triggered by the Laurus deferral transaction.

The new CDC financing involves a one-year, 10.25% loan from CDC and a warrant to purchase 1 million shares of our common stock with an exercise price of $3.80. We are not required to file a registration statement to register the shares of common stock underlying such warrant for a period of one year (i.e., a registration statement must be filed by March 12, 2008). CDC was also granted "piggyback" registration rights with respect to such shares of common stock which come into effect only after March 12, 2008. This warrant contains "weighted average" anti-dilution protection. The proceeds from this financing are being used for general corporate purposes and for the continued development of BEMA™ Fentanyl.

Laurus

On April 10, 2007, we entered into a fifth amendment to our May 2005 convertible note with Laurus. Pursuant to the fifth amendment, Laurus agreed: (i) to exercise an aggregate of 833,871 warrants previously issued to Laurus to purchase a like number of shares of our common stock, resulting in cash proceeds of $3,183,567 to us and (ii) to defer all principal payments under our May 2005 note with Laurus (which currently stands at $1.262 million) until the first business day of July 2008. In consideration of these agreements, we issued to Laurus a new warrant to purchase 833,871 shares of our common stock at $5.00 per share. We agreed to file a registration statement registering the shares underlying such warrant by May 25, 2007.

Sigma Tau

In January 2007, under our development agreement with Sigma Tau, we were paid a milestone payment of $.25 million for which we issued 73,964 shares of common stock at $3.38.

Other

On April 13, 2007, the Compensation Committee of our board of directors awarded the following options to the following senior executives of our company: Mark Sirgo: 434,000 options; James McNulty: 100,000 options; and Andrew Finn 100, 000 options. All of the foregoing options vest in three equals installments beginning on the first anniversary of the grant date (April 13, 2008) and have an exercise price of $6.63 per option share.

On March 30, 2007, HCG funded a $1.0 million unsecured, non-interest bearing note, due June 30, 2007. As consideration for the loan made by HCG, we granted HCG the right, for a period of six months, to participate in and enter into a royalty purchase agreement. The consideration to be paid upon exercise of the right, which can be demanded by either us or HCG at any time before September 30, 2007, is $5.0 million. The royalty is to be paid based on low single digit, tiered percentage of net sales of BEMA™ Fentanyl, once the product is approved and commercial sales begin. In addition, if the royalty purchase agreement is entered into, we would issue a warrant to HCG to purchase 475,000 shares of our common stock at $5.55 per share (the closing price on April 2, 2007). No assurances can be given the either we or HCG will elect to enter into the royalty purchase agreement.

On February 22, 2007, we designed the Series C Stock. Concurrently with the creation of the Series C Stock, we exchanged all 1,647,059 outstanding shares of our Series A Stock with the holders thereof for an aggregate of 1,647,059 shares of Series C Stock. Following such exchange, all shares of Series A Stock were cancelled. The designation of the Series C Stock and the exchange were undertaken in light of the significant contributions of Drs. Sirgo and Finn to our company.

The rights associated with the Series C Stock are identical to those associated with the Series A Stock in all material respects except that the Series C Stock has different terms of conversion into shares of our common stock. Shares of Series A Stock were convertible into shares of our common stock upon the earliest to occur of: (i) (30) days written notice by a holder thereof to us following the occurrence of the Conversion Event (as defined below); (ii) the first approval by the FDA for the marketing and sale by us or any of our subsidiaries of any of the following products: Emezine ®, BEMA™ Fentanyl, BEMA™ Sumitriptan or any product which primarily incorporates technology similar to the foregoing for the buccal delivery of pharmaceuticals; or (iii) August 24, 2009. The term "Conversion Event" meant our failure to provide at least $3,000,000 to Arius as required to: (i) pay Atrix Laboratories, Inc. $1,000,000 by August 24, 2004 and (ii) fund, in a total amount of no less than $2,000,000, the operations of Arius in accordance with an agreed upon business plan. Since the triggers for a Conversion Event have been satisfied, the term is not associated with the Series C Stock.

Shares of Series C Stock are convertible into shares of our common stock upon the earliest to occur of: (i) our public announcement of positive outcome of our Phase III efficacy trials (FEN-201) for BEMA™ Fentanyl, with the term "positive outcome" meaning a statistically significant difference (p less than or equal to 0.05) in the primary efficacy endpoint comparing active to placebo; or (ii) August 24, 2009.

As a result of certain previous issuances by us of our securities at prices below the then current market price of our common stock (including a warrant to issued to Laurus in April 2007 as described above), the exercise price of our publicly-traded warrants was, effective April 10, 2007, adjusted downward from $6.30 to $6.11 pursuant to the terms of the warrant agreement entered into in connection with our June 2002 initial public offering. Our publicly-traded warrants expire on June 24, 2007.

Overview of "Specialty Pharmaceuticals" and the 505(b)(2) Regulatory Pathway

The drug delivery industry develops technologies for the improved administration of certain drugs. These technologies, including our own, have focused primarily on safety, efficacy, ease of patient use and patient compliance.

Since our inception, we have focused primarily on research and development of our licensed Bioral® encochleation technology and the application of such technology to specific drugs. In 2004, however, and in particular as a result of our acquisition of Arius, we began (and continue) to shift our corporate focus to what we call the area of "specialty pharmaceuticals": applying our licensed technologies to existing therapeutics to create our own proprietary formulations, for which we then seek to obtain FDA approval and subsequently commercialize. We believe that focusing our drug delivery technologies for use with existing FDA approved drugs to be less risky than attempting to discover new drugs, sometimes called new chemical entities, or NCEs. This transition in corporate focus continued in 2005 and 2006 as we continued development of our principal products and formulations toward regulatory submissions.

An important part of our strategy is to attempt to capitalize on the FDA's 505(b)(2) approval process to obtain more timely and efficient approval of our formulations of previously approved therapeutics. Under the 505(b)(2) approval process, we are able to seek FDA approval of a new dosage form, dosage regimen or new indication of a pharmaceutical that has previously been approved by the FDA. This regulation enables us to partially rely on the findings of third parties which the FDA has published on approved pharmaceuticals, including clinical and non-clinical testing, thereby reducing, though not eliminating, the need to engage in these costly and time consuming activities. A typical development program for a 505(b)(2) submission will include:

• a single genotoxicity study with the drug substance,

• a 14 or 28-day multiple dose toxicity study in a single species,

• limited pharmacokinetic evaluation of the new dosage form in humans,

• two placebo controlled studies in humans,

• stability of drug substance,

• full description of drug product manufacturing process,

• 1 year stability data on 3 batches at commercial scale, and

• special studies specific to the formulation.

This approval program is designed to be significantly less extensive and lengthy and, as a result, we believe, more cost efficient than attempting to gain approval of an NCE. By utilizing this regulatory process and focusing on creating new formulations of established pharmaceuticals that could potentially benefit from association with our delivery technologies, we believe that we will more quickly and efficiently navigate the FDA approval process, and, if such approval is obtained, of which no assurances can be given, move our formulations to market.

As part of our strategy, however, we will also continue to seek partners, such as Sigma Tau and Accentia, to whom we can license our delivery technologies so that they may be applied to the proprietary products of such partners. Drug delivery technologies can provide pharmaceutical and biotechnology companies with an avenue for developing new drugs, as well as extending existing drug patent protections. Drug delivery companies can also apply their technologies to drugs no longer patent protected. Pharmaceutical and biotechnology companies view new and improved delivery technology as a way to gain competitive advantage through enhanced safety, efficacy, convenience and patient compliance of their drugs, and we will continue to attempt to leverage this desire in the pharmaceutical industry for improved delivery systems.

We have and intend to continue to primarily target drugs that have large established markets for which there is an established medical need but an opportunity to introduce a new form of delivery of that product in order to meet an unmet treatment need. As a result of employing well known drugs in our technologies, we believe doctors will be familiar with the drug compounds and accustomed to prescribing them. As with BEMA™ Fentanyl and CAMB, we anticipate that many of the drug candidates we target will have been through the regulatory process and therefore the safety and efficacy of the drug has been previously established. Consequently, we believe that our clinical trials would primarily need to show that our Bioral® or BEMA™ technologies deliver the drug without harming the patient or changing the clinical attributes of the drug. Focusing on drug delivery compared to drug discovery should allow us to potentially form a number of collaborations to deliver a wide variety of medicines without limiting rights to utilize our proprietary technology with additional drug opportunities.

Pipeline of Proposed Formulations and Products

The following table summarizes the status of our currently proposed formulations and products:

Product/Formulation Indication Development Status Commercial Status BEMA™ Fentanyl Breakthrough cancer pain Phase III Partner being sought in US, certain rights to be retained.

Partnered in EU with Meda AB

BEMA™ Long Acting Moderate and Severe Pain Phase I In-house Analgesic commercialization for specialty indications, primary care rights to be partnered

Bioral® Amphotercin Fungal infections IND Filed/ Phase I Partner will be
B sought in US with co promote option for specialty indication

BEMA™ Zolpidem Insomnia Pre-clinical In-house commercialization for specialty indications, primary care rights to be partnered

Emezine® Nausea/Vomiting FDA non-approvable received* Partnered

* Discussions with FDA complete; corporate decision forthcoming on next steps

Although we have investigated other projects in the past, including certain of those discussed under "Licensing Opportunities and Other Projects" below, we are presently dedicating most of our corporate resources toward the development and commercialization of BEMA™ Fentanyl, BEMA™ LA and CAMB. After these programs, and depending on the availability of corporate resources, we will consider funding the development of BEMA™ Zolpidem, Bioral® siRNA and potentially other programs.

Description of Our Drug Delivery Technologies and Proposed Formulations and Products

We have based our estimates of development costs and related matters described below on our market research, third party reports and publicly available information which we consider reliable. However, readers are advised that the projected dates for filing INDs or NDAs, our estimates of developments costs and our projected sales associated with each of our formulations discussed below and elsewhere in this Report are merely estimates and subject to many factors, many of which may be beyond our control, which could cause delays and or cost overruns or otherwise cause us to revise such estimates. Readers are also advised that our projected sales figures do not take into account the royalties and other payments we will need to make to our licensors and strategic partners. Our estimates are based upon our management's reasonable judgments given the information available and their previous experiences, but no assurances can be given that such estimates will prove to be accurate.

BEMA™ Technology Overview

BEMA™ stands for bioerodible mucoadhesive. BEMA™ discs are approximately the size of a coin and are composed of an adhesive layer and a non-adhesive backing layer made of polymers, with both layers capable of holding the desired drug. Upon application, the disc adheres to the mucosal surface (inner lining of the cheek) and delivers the dose of medication rapidly and efficiently, making it a potentially excellent delivery system for time-critical conditions such as pain, nausea, vomiting or trauma cases where intravenous lines or injections are unavailable or not practical. The BEMA™ system permits control of two critical factors allowing for better dose to dose reproducibility: (i) the contact area for mucosal drug delivery, and (ii) the time the drug is in contact with that area, known as residence time.

In contrast to competing transmucosal delivery systems like lozenges and matrix-based delivery systems placed under the tongue or sprayed in the oral cavity, BEMA™ products:

• Adhere to mucosa in seconds and dissolve in minutes;

• Permit absorption to be determined by the product, with patients not being required to swish or move the product around in the mouth for absorption;

• Have a narrow, reproducible delivery rate, not susceptible to varying or intermittent contact with mucus membranes;

• Dissolve completely, leaving no residual product or waste; and

• Have relatively inexpensive cost of goods.

The U.S. rights to the BEMA™ technology are licensed from QLT and the non-U.S. rights are owned by us, having been acquired (subject to scheduled payments) from QLT in August 2006. We have an option to purchase the U.S. rights of the BEMA™ technology from QLT, which option expires on August 2, 2007. After purchasing the intellectual property rights from QLT, we will not owe any future milestone payments or royalties.

Current BEMA™ Formulations In Development

BEMA™ Fentanyl

Datamonitor estimates the global market for pain medication will generate $30 billion in 2008. The market in the U.S. for "breakthrough" cancer pain (the proposed indicated for BEMA™ Fentanyl) is projected to grow to over $1.5 billion in the next 5 years. The leading fentanyl product for the treatment of breakthrough cancer pain is the U.S. market is Actiq® which is marketed by Cephalon. Cephalon introduced a second fast dissolving fentanyl product, Fentora™ in 2006. The reported combined sales of these products in 2006 was $659 million.

We believe that BEMA™ Fentanyl potentially has significant advantages over the marketed and pipeline Fentanyl products:

Actiq® Fentora® Rapinyl® BEMA™ Fentanyl buccal lozenge buccal tab sublingual tab* buccal disc* Attribute (Cephalon) (Cephalon) (Endo) (BDSI) Strengths 200 - 1600 µg 100 - 800 µg 100 - 1200 µg 200 - 1200 µg

Dose Linearity Yes Up to 800 µg TBD Yes

Taste issue potential Yes Higher Higher Low

Irritation Occurred in >1% 10% of all of patients in patients long term study 3% of all patients with ulcerations TBD Low

* projected as neither product is marketed

We believe there is a clear need and growing market for additional narcotic agents in alternative dosage forms to provide rapid pain relief. Fentanyl belongs to the group of medicines called narcotic analgesics. Narcotic analgesics are used to relieve pain. The transmucosal form of fentanyl is a powerful narcotic used to treat breakthrough cancer pain. Fentanyl applied with our licensed BEMA™ technology has the potential to meet the need for new narcotics and, we believe, will be ideal for breakthrough pain in opioid-tolerant patients.

After receiving approval for the initial indication of break-through cancer pain, we may pursue additional indications for BEMA™ Fentanyl in:

• Breakthrough pain in non cancer patients;

• Post-operative patients following step-down from intravenous narcotics;

• Hospitalized patients or outpatients without intravenous access; and

• Emergency room patients where available intravenous lines are limited or impractical.

In March 2005, we announced that we received confirmation from the U.S. Food and Drug Administration that we will be able to utilize the FDA's 505(b)(2) process for regulatory approval consideration of our licensed BEMA™ Fentanyl formulation. In September 2006, we announced that we had conducted a second meeting with the FDA regarding the BEMA™ Fentanyl development program and the program is progressing towards a NDA submission.

In November 2005, we announced the results of a key 12 subject study comparing BEMA™ Fentanyl and Actiq®. The results showed that the BEMA™ Fentanyl formulation showed greater bioavailability (absorption), higher maximum plasma concentrations (Cmax) and faster concentrations of fentanyl in the plasma (t-first and t-max) compared to Actiq®.

In April 2006, we announced the results from two key pharmacokinetic studies regarding BEMA™ Fentanyl. The first was a 12 subject study comparing three doses of BEMA™ Fentanyl. The results showed that increasing the dose of BEMA™ Fentanyl from 200 mcg to 1,200 mcg resulted in a proportionate increase in maximum and total plasma concentrations meaning the dosage form is maintaining linear pharmacokinetics. This is important from the standpoint that our BEMA™ dosage form delivered a reliable and consistent plasma concentration of fentanyl each time that it is given and as one increases the dose or strength. In other words, a 400 mcg dose provides approximately twice the plasma concentration of a 200 mcg dose and an 800 mcg dose provides approximately twice the plasma concentration of a 400 mcg dose. This represents an important finding for the BEMA™ technology. Among other things it means that BEMA™ Fentanyl should provide a reliable level of fentanyl as patients titrate to an acceptable strength or dose to control their pain.

The second study, announced in May 2006, was also a 12 subject study comparing the effects of multiple doses of BEMA™ Fentanyl. The results of the study showed that a 600mcg dose given on two different days demonstrated reproducible plasma concentrations. This demonstrates dose to dose reliability or reproducibility within the same patient. Additionally, when three 600mcg doses were given 1 hour apart the peak plasma concentration was proportionate to the increased dose.

We began preparing for Phase III clinical studies of BEMA™ Fentanyl in the fourth quarter of 2005. Enrollment in the program was initiated in early 2006. In February 2007, we announced an update on the progress of the clinical program. In this announcement, we disclosed that the data from the Phase III efficacy program and an update on the entire program will be available in April 2007.

In November 2005, we announced that we entered into a supply agreement with Aveva Drug Delivery Systems, Inc., or Aveva, under which Aveva will prepare clinical supplies for our Phase III BEMA™ Fentanyl trials and provide commercial manufacturing for BEMA™ Fentanyl in the United States. Effective December 15, 2006, we entered into a Process Development Agreement with LTS Lohmann Therapie-Systeme AG, or LTS, pursuant to which LTS will undertake process development and scale up activities and supply BEMA™ Fentanyl product to us for clinical trials in Europe. Under the terms of this agreement, LTS is anticipated to be the sole supplier of BEMA™ Fentanyl for clinical trials and commercial distribution within the European Union.

Commercially, in 2006 we disclosed that we will pursue one of three approaches or a

combination thereof to marketing BEMA™ Fentanyl. We may consider licensing the products to appropriate partners so that they can market and distribute the products for us. This would allow us to avoid building the commercial infrastructure required to do so and the associated risks particularly around launching ones first product. Alternatively, we may consider marketing and selling BEMA™ Fentanyl ourselves. If we pursue this route, our commercial efforts will be primarily focused on hospitals, oncologists and pain centers to maintain cost efficiency. We would plan to initiate the sales organization around the launch of BEMA™ Fentanyl with 75-100 representatives focused on physicians, hospitals and groups who treat cancer patients. These representatives may be our employees. A third option is to use a contract sales organization to market and sell our products. Although we would have the costs associated with such a relationship we would not bear the burden of having these individuals as BDSI employees. These contracts can also be written to allow for termination of the effort if sales are not going as planned or to convert these employees to permanent BDSI employees at a future time where a good deal of the risk of the product launch and the early years of distribution has passed. A final option is to use a mix of BDSI employees and a contract sales organization with an option again to convert these contract representatives to BDSI employees at a future date.

Outside of the U.S., we expect to create distribution partnerships with suitable partners such as our August 2006 agreement Meda AB of Sweden. Meda, a large European specialty pharmaceutical company with a focus in pain, licensed BEMA™ Fentanyl for an upfront payment of $2.5 million and additional payments that could total up to $10 million. Meda will be responsible for development of the product in Europe and will pay us a double digit royalty on net sales of BEMA™ Fentanyl in Europe.

We believe that BEMA™ Fentanyl may have the potential to capture a significant share of the breakthrough cancer pain market in the U.S., which we estimate could result in annual peak sales of approximately $250 million, although no assurances can be given of this estimation. Additionally, we expect to pursue secondary indications as part of a lifecycle management plan, including non-cancer breakthrough pain that could potentially double the peak sales estimates for BEMA™ Fentanyl if obtained.

BEMA™ Long Acting Analgesic

In addition to our lead BEMA™ Fentanyl product, we are also developing a second analgesic product with a longer duration of action suited for a broad range of pain conditions. In November 2005, we announced our intention to enter clinical development with BEMA™ LA in the first quarter of 2006 and our expectation of commencing Phase III trials in the second half of 2006. Also, in early January 2006, we announced that we submitted an IND with the FDA for BEMA™ LA. In August 2006, we announced the completion of the initial Phase I study for BEMA™ LA. The results of this study demonstrated achievement of plasma concentrations that are associated with analgesia. This data potentially indicates that BEMA™ LA has the potential to be the first long acting opioid analgesic that can be delivered buccally in the U.S. We intend to progress the development of BEMA™ LA through scale up of manufacturing and pursuit of further clinical studies working towards an NDA. However, due to financial constraints in 2006 and our focus on BEMA™ Fentanyl, we did not progress BEMA™ LA into Phase II. We do plan to begin that program in the second half of 2007 and based on those results proceed into Phase III.

BEMA™ LA contains a marketed opioid analgesic which has equal potency to morphine but with a lower propensity for adverse reactions, abuse and addiction. The lower potential for abuse and addiction places BEMA™ LA as a Schedule III controlled substance versus the majority of the other potent opioids, such as morphine and oxycodone, which are Schedule II. It is our belief that this attribute will help create a broader market opportunity for BEMA™ LA as many doctors are reluctant to prescribe narcotics particularly on a chronic basis for the fear of addiction. In addition, physicians are able to

phone Schedule III prescriptions into the pharmacy whereas the prescription for a Schedule II controlled substance must be obtained by the patient from the doctor's office which the patient then must take to the pharmacy. Since the active ingredient in BEMA™ LA is a Schedule III controlled substance, physicians will be able to phone or fax in the prescription to the pharmacy and also allow for refills to be included on the prescription, thus making chronic therapy easier for both the patient and the physician. Consequently, we believe that BEMA™ LA will have the potency of a product such as morphine but with the attributes afforded a Schedule III narcotic.

The FDA-approved compound which forms the basis of BEMA™ LA has been shown to produce comparable pain relief to morphine, with an improved safety profile and extended duration of action, but poor oral bioavailability. The BEMA™ delivery system may enable us to provide this product in a form suitable for ambulatory care and, because of the safety advantage associated with this product, we believe that BEMA™ LA will be an ideal next step product for patients with incomplete pain relief on non-narcotic analgesics.

Our BEMA™ LA is intended to meet the need for a new narcotic and will be ideally used for:

• Post-operative pain; and

• Chronic pain, including lower back, osteoarthritis and rheumatoid arthritis.

Compared to currently marketed products and products under development, we believe that BEMA™ LA will be differentiated based on the following features:

• efficacy equivalent to morphine but unlike morphine is a Schedule III narcotic making it less addicting and more convenient for physicians to prescribe, pharmacists to dispense, and patients to obtain,

• broad applicability across a wide spectrum of patients with varying types of moderate to severe pain either used in combination with less potent analgesics such as nonsteroidal anti-inflammatory drugs, or NSAIDS, or used as sole therapy,

• a longer half life which allows for less frequent dosing, thus potentially increasing patient compliance,

• an established safety profile compared to the agents in development, and

• potential for improved safety, including a lower incidence of constipation and, based on its Schedule III designation, a lower propensity for addiction and abuse versus other opioid analgesics.

The pain market is well established, with many pharmaceutical companies marketing innovative products as well as generic versions of older, non patent protected products. Datamonitor estimates that the global pain market is projected to generate $30 billion in 2008. Of this, approximately $7 billion are for opioid therapies. The total market for pain treatment is projected to grow to approximately $33 billion by 2014.

Due to the ability of BEMA™ LA to potentially participate in the principal key pain markets (chronic pain as well as acute and post-operative pain), we believe that BEMA™ LA has the potential to achieve up to a 2% share of the total worldwide pain market. This would translate into an estimated $500 million in peak annual sales, although no assurances can be given of this estimation.

BEMA™ Zolpidem

In addition to our two BEMA™ analgesic products, we intend to develop a BEMA™ formulation of Zolpidem, an FDA-approved compound that has been shown to effectively treat transient and chronic insomnia with few next day residual effects. The standard form of Zolpidem, a swallowed pill, has a typical onset of action 30-45 minutes after taking an oral dose, although this could vary depending on, among other things, the content of the stomach at the time of ingestion. The BEMA™ delivery system may enable us to provide an onset of action which is in the 10-15 minute range and, since the digestive tract is avoided, potentially provide drug absorption on a more consistent basis. Our proposed BEMA™ formulation of Zolpidem is intended to meet the need for a product to treat insomnia that has a rapid onset and will be ideally used as a short term treatment for patients with insomnia.

The global insomnia market is well established with many pharmaceutical companies marketing new products as well as generic versions of older, non patent protected products. The global market for insomnia treatments has been projected to be approximately $3.6 billion for 2005 and is estimated to grow to approximately $5.2 billion by 2009 and to approximately $5.5 billion in 2014. BEMA™ Zolpidem will compete in this market with an indication for the short term treatment of insomnia. Zolpidem is the active ingredient in Ambien® . Ambien® is the world's best selling product for insomnia with 2005 sales of $1.5 billion. Lunesta ® , which contains a different active ingredient and was launched in 2005, achieved sales of $329 million in 2005.

Compared to currently marketed products and potential products in development, we believe that BEMA™ Zolpidem is differentiated based on the following features:

• onset of effect in 10-15 minutes versus 30-45 minutes with orally dosed products, no water necessary for administration, reducing the need for elderly patients to urinate during the night, and

• absorption not effected by delayed stomach emptying or first pass metabolism therefore provides for a predictable response every time it is used.

Due to these advantages, we believe that BEMA™ Zolpidem will effectively compete against current and future insomnia products.

Based primarily on conserving and targeting our financial and human resources to more near term products, BDSI strategically decided to focus primarily on the continued development of BEMA™ Fentanyl in 2006. Subsequently, we did not initiate the development of the BEMA™ Zolpidem program in 2006. In 2007, financial and human resources permitting we plan to finalize a formulation for BEMA™ Zolpidem and file an IND. This will allow us to enter Phase I clinical trials in 2008. Based on the outcome of several Phase I studies to determine the ideal strength and formulation of BEMA™ Zolpidem, we would then anticipate entering into Phase II clinical trials.

Due to the rapid onset characteristics of BEMA™ Zolpidem, our market research indicates that BEMA™ Zolpidem has the potential to achieve a 5% share of the total worldwide insomnia market which has a 2010 projected value of approximately $5 billion. This would translate into an estimated $250 million in peak annual sales, although no assurances can be given of this estimation.

Encochleation Technology Overview

Our licensed Bioral® drug delivery technology is based upon encapsulating (or "encochleating")

drugs to potentially deliver the drug safely and effectively. Over the years, biochemists and biophysicists have studied artificial membrane systems to understand their properties and potential applications, as well as to gain insight into the workings of more complex biological membrane systems. In the late 1960's, scientists began investigating the interactions of divalent cations with negatively charged lipid bilayers. They reported that the addition of calcium ions to small phosphatidylserine vesicles induced their collapse into discs which fused into large sheets of lipid. In order to minimize their interaction with water, these lipid sheets rolled up into nanocrystalline structures, termed "cochleates," after the Greek name for a snail with a spiral shell.

Our licensed Bioral® cochleate technology is based upon components which are believed to be non-toxic. The primary chemical components of our Bioral® cochleate technology are phosphatidylserine, or PS, and calcium. PS is a natural component of essentially all biological membranes, and is most concentrated in the brain. Clinical studies by other investigators (more than 30 have been published of which we are aware) to evaluate the potential of phosphatidylserine as a nutrient supplement indicate that PS is safe and may play a role in the support of mental functions in the aging brain. As an indication of its non-toxic nature, today phosphatidylserine isolated from soybeans is sold in health food stores as a nutritional supplement.

Research and development of cochleates has been conducted at the Universities for a number of years. Our scientists, some of whom were former researchers and others who still hold teaching positions with these Universities, supervised their cochleate research programs. As a result of the relationship between our scientists and the Universities, we became the exclusive worldwide licensee to develop this cochleate technology and in some cases co-own the patents with them.

Potential Advantages

We believe that our licensed Bioral® drug delivery technology represents a potentially important new delivery mechanism. While the characteristics and benefits of this technology will ultimately be established through FDA clinical trials, our research, based upon pre-clinical studies indicates that our Bioral® technology may have the following characteristics:

• All-natural ingredients. Our Bioral® drug delivery technology uses phosphatidylserine, which can be sourced from soy beans, and calcium. Phosphatidylserine from soybeans is available commercially as a nutritional supplement with FDA-allowed health promotion claims

• Encapsulation. Our Bioral® drug delivery encapsulates, or entraps within a crystal matrix, the subject drug, rather than chemically bonding with the drug.

• Enhanced Availability. Our Bioral® drug delivery technology is being developed to enable oral availability of a broad spectrum of compounds, such as those with poor water solubility, and protein and peptide biopharmaceuticals, which have been difficult to administer. Our Bioral® drug delivery technology also has the potential to be applied to substances which are not currently deliverable by traditional means so that they may be delivered via injection or orally.

• Minimizing Side Effects. Our Bioral® drug delivery technology may reduce toxicity, stomach irritation and other side effects of the encapsulated drug.

• Cellular Delivery. Our Bioral® drug delivery technology is being developed as membrane fusion intermediates. We believe that, when drugs encapsulated in our Bioral ® drug delivery technology come into close approximation to a target

membrane, a fusion event between the outer layer of the cochleate cylinder and the cell membrane may occur. This fusion may result in the delivery of a small amount of the encochleated material into the cytoplasm of the target cell. Further, we believe that drugs encapsulated in our Bioral® drug delivery technology may slowly fuse or break free of the cell and be available for another fusion event, either with this or another cell.

• Stability. Our Bioral® drug delivery technology employs cochleates which consist of multi-layered structures of large, continuous, solid, lipid bilayer sheets, either stacked or rolled up in a spiral, with little or no internal aqueous space. We believe that our cochleate preparations can be stored in cation-containing buffer, or dried, by freezing in a high vacuum environment, to a powder, which is then stored at room temperature and reconstituted with liquid prior to administration. Our cochleate preparations have been shown to be stable for more than two years in cation-containing buffer, and at least one year as a powder at room temperature.

• Resistance to Environmental Attack. Our Bioral® drug delivery technology is being developed to provide protection from degradation of the encochleated drug. Traditionally, many drugs can be damaged from exposure to adverse environmental conditions such as sunlight, oxygen, water and temperature. Since the multilayered structure consists of a series of solid layers, we believe that components within the interior of the cochleate structure remain intact, even though the outer layers of the cochleate may be exposed to these conditions.

• Patient Compliance. We believe that a potential benefit of our cochleate cylinders may include reducing unpleasant taste, unpleasant intestinal irritation, and in some cases providing oral availability.

• Release Characteristics. Our cochleate technology may offer the potential to be tailored to control the release of the drug depending on desired application.

Initial Bioral® Products in Development

We believe a diverse pipeline of products can be developed by applying our Bioral® drug delivery technology to a potentially broad array of established and promising pharmaceuticals. Each intended Bioral® product (i.e., drug encapsulated with our drug delivery technology) will, upon completion of development, require separate FDA regulatory approval, and accordingly, will be subject to the uncertainty, time and expense generally associated with the FDA regulatory process. Even though we are targeting FDA approved, market-accepted drugs for encapsulation, each of the products currently in development face development hurdles, regulatory requirements and uncertainty before market introduction. Due to our current availability of corporate resources, in connection with our Bioral ® portfolio, we are currently focusing primarily on our Bioral ® Amphotericin B (CAMB) formulation, as described below.

Bioral® Amphotericin B

Systemic fungal infections continue to be a major domestic and international health care problem. Amphotericin B, which is delivered intravenously, is an established, commonly used drug to treat these infections. We are currently developing a Bioral ® formulation of Amphotericin B for treatment of fungal infections which we expect will be for the treatment of esophageal candidiasis.

In February 2007, we announced the acceptance by the FDA of our CAMB IND application we made at the end of 2006. This represents the first IND that involves the Bioral® technology. If financial and human resources are available to us, we plan to scale up manufacturing and conduct an initial Phase I study late in 2007.

In late July 2005, we received an indication from National Institute of Allergy and Infectious Diseases, or NIAID, which is affiliated with the National Institutes of Health, or NIH, that the NIAID would, at its expense and following our achievement of certain milestones, conduct pre-clinical studies through an NIH contractor for oral, as well as intravenous, formulations of encochleated Amphotericin B. We believe these studies, if they occur, represent an important third-party validation of our encochleation technology. We also believe these studies will result in cost savings for us as they are being funded by NIAID.

In 2005, we were able to source PS from lecithin derived from soybeans rather than synthetic PS, thereby reducing the costs of goods for our delivery system. In addition, we have simplified our manufacturing approach to CAMB, thereby facilitating commercial scale-up. Also, we have changed the ratio of PS to active molecules, thus improving the efficacy while moderating costs. We continue investigating the pharmacology and toxicology.

Amphotericin B is often used to treat diseases that frequently strike patients with compromised immune systems. The use of the conventional injectable Amphotericin B to treat these infections is often limited by its propensity to cause kidney damage which we believe our Bioral ® products may minimize. CAMB may have uses in other diseases such as Leishmaniasis and Chagas disease.

The primary advantage which we are seeking for our proposed CAMB product is an oral formulation of the drug. Additional potential advantages include improved safety, extended shelf life, improved cellular uptake and reduced dosage. Assuming that we complete development of CAMB and that we obtain FDA approval, we believe that CAMB has the potential to provide an effective orally administered version of Amphotericin B which may be more effective and less toxic.

According to market research firm Visiongain, the global antifungal market was approximately $6 billion in 2003 and is projected to grow to as much as $8 billion by 2009. According to our market research, annually, there are an estimated 500,000 severe fungal infections globally for which we believe CAMB may be an appropriate treatment. Our market research indicates that CAMB may be able to achieve peak sales of approximately $400 million annually, although no assurances can be given of this estimation.

In the development of this drug, we have collaborated with the NIH, the Public Health Research Institute of New York and the University of Kentucky. Further, we have been awarded and received all funds under a grant totaling approximately $2.7 million from the NIH to support the further development of this drug formulation.

Separately, on April 12, 2004, we licensed a topical formulation of our encochleated Amphotericin B to Accentia. Accentia is commercializing technology licensed from Mayo Foundation for Medical Education and Research, or the Mayo Foundation, for the treatment of CRS and asthma on a worldwide basis. The technology consists of using low-dose topical antifungal to control the debilitating symptoms of CRS and asthma. Presently, Accentia is developing the encochleated Amphotericin B formulation (which is called BioNasal® ) for potential use in a pump spray for the treatment of CRS. Accentia has not yet determined if the application of Amphotericin B to the asthma field is feasible.

Accentia will not submit an IND regarding the asthma application of intrapulmonary Amphotericin B, either encochleated or unencochleated, until and if the proof of principle is completed by the Mayo Foundation pursuant to the terms of the Accentia license with the Mayo Foundation. Formulation efforts for the CRS product are underway. Initial in vitro studies suggest that CAMB may provide enhanced efficacy and stability in this context.

Our license agreement with Accentia was amended effective June 1, 2004, then modified in September 2004 by the asset purchase agreement with Accentia described below, and was amended with three separate letter amendments in March, April and June 2005, respectively, to make certain clarifications. According to the terms of the license as originally entered into, Accentia was to pay us a running royalty of 12-14% on net sales of covered products in the designated field. Accentia is responsible for all expenses related to the development of an encochleated BioNasal ® Amphotericin B for the indication of CRS and asthma on a worldwide basis, including expenses associated with, and the actual provision of, supplies, the submission of an IND and clinical trials. We shall retain world-wide rights to the oral and intravenous formulations of encochleated Amphotericin B.

On September 8, 2004, we entered into a definitive Asset Purchase Agreement with Accentia pursuant to which we sold to Accentia an asset consisting of a royalty revenue stream in consideration of a one-time, irrevocable cash payment of $2.5 million. The royalty revenue stream sold was a fifty percent (50%) interest in the future royalties earnable by us on sales by Accentia for products utilizing our topical formulation of our encochleated Amphotericin B for the treatment of CRS, thus effectively reducing our royalty on the sales of such CRS products by 50%. We agreed with Accentia, however, that the future royalty stream sold shall not include royalty payments that are payable by Accentia based on the sale of encochleated products exclusively intended to treat asthma, and the rights to such royalty payments, as originally set forth in the license agreement, shall remain with us.

Bioral® siRNA

Small interfering RNA, or siRNA, is a new class of oligonucleotides that may offer the ability to identify therapeutics directly based on genomic information of the host or pathogens. Like other oligonucleotide candidates such as antisense, siRNA is very susceptible to degradation by plasma enzymes. In 2006, we continued our collaboration and research efforts in this area. In August 2006, we announced the successful in vivo delivery of a Bioral® siRNA therapeutic in a mouse model of influenza. The results of the study demonstrated a decrease of viral titers by 200 fold when administered by inhalation and a reduction of viral titers by almost 20 fold when administered intravenously. We have an ongoing evaluation agreement with one of the major companies developing siRNA therapeutics and we are seeking additional collaborations and strategic partners. If the results of the collaborations are positive, we intend to pursue the licensing of certain rights associated with the delivery of nucleic acids to these partners.

Other Bioral® Products. Other products in the Bioral® system include Bioral® Paclitaxel, Bioral® NSAIDS the Subunit HIV Vaccine and the Autologous HIV therapy. In 2006, we decided that we would not apply at this time any internal resources to these programs. Due to this de-emphasis, no progress on these programs was made in 2006. We may decide to pursue them at some future date, and they remain available for licensing.

Bioral Nutrient Delivery, LLC. In January 2003, we formed Bioral Nutrient Delivery, LLC, or BND, to investigate the potential application of our proprietary encochleation technology for use in processed food and beverages and personal care products. While our preliminary findings suggested that, by using our encochleation technology, a variety of nutrients, which are substances with potentially beneficial properties, might be protected from degradation during the manufacturing process and

delivered with substantially all of the characteristics of the nutrient intact, the BND opportunity is not presently a high priority for us and we do not plan to utilize any corporate resources toward this application of the Bioral® technology. BND is therefore inactive at December 31, 2006.

Emezine ®

We have licensed the U.S. rights to a transmucousally delivered formulation of prochlorperazine called Emezine® , an anti-nausea and vomiting medication used for treating nausea and vomiting which occurs after surgeries, chemotherapy and for nausea and vomiting associated with flu and migraines. This is not a BEMA™ formulation, but rather a formulation administered by placing a tablet between the bridge of the upper front teeth and gum where it dissolves, enabling the active ingredient to be absorbed through the lining of the cheek. We license Emezine® from Reckitt.

On February 28, 2006, we received a non-approvable letter from the FDA regarding our Emezine® NDA. The non-approvable letter stated that additional information would be required to address remaining questions. Our receipt of this non-approvable notification regarding Emezine® was unexpected because:

• We believe we strictly adhered to the FDA sanctioned plan from March 2004 and generated data that, we believe, supported Emezine ®'s approvability;

• On June 30, 2005, the FDA accepted the Emezine® NDA for filing, meaning that such NDA contained all necessary elements for review by the FDA;

• The review appeared to be normal and customary based on prior experiences of our management and no obvious red flags were presented; and

• Emezine® contains prochlorperazine, which has been on the market in the U.S. for over 40 years in other dosage forms.

On May 17, 2006, we met with the Gastroenterology Division of the FDA to discuss the nonapprovable letter we received for Emezine ®. The FDA's position was that while a 505(b)(2) submission is still an acceptable regulatory pathway for Emezine®, additional clinical trials would be required to support the use of Emezine® in the target population of the proposed indication. The FDA further suggested that a Special Protocol Assessment could be a potential way to fulfill the remaining requirements. Based on the FDA feedback, on July 14, 2006, we submitted two draft pharmacokinetic protocols for review as a Special Protocol Assessment along with a proposal as to how the data from these protocols would address the deficiencies noted in the nonapprovable letter. We are currently involved in discussions with clinical consultants to determine how and whether we will proceed with the continued development of Emezine® based on the feedback we received from FDA on the information we submitted on July 14, 2006. However, there are no assurances that we will continue with the development of Emezine®.

Importantly, given the relatively small outlays we are actually making on this project, and given that our size of market projections regarding Emezine® are relatively small compared to other formulations in our pipeline such as BEMA™ Fentanyl, we do not presently believe that the failure of this project, though potentially continuing to negatively impact our market reputation and our stock price, among other matters, would seriously impair our overall potential future revenue growth.

Relationship with The University of Medicine and Dentistry of New Jersey and Historical Relationship with Albany Medical College

We have had and continue to have critical relationships with UMDNJ and Albany Medical College. Some of our scientists were former researchers and educators at these Universities researching cochleate technology. All of our current research and development is done using facilities provided to us on the campus of UMDNJ, pursuant to a lease, or at the facilities of our contractors or collaborators. Both of these Universities are stockholders in our company and have a substantial financial interest in our business.

In September 1995, our predecessor entered into a license agreement with the Universities to be the exclusive worldwide developer and sub-licensor of the cochleate technology. Under the license agreement, we and the Universities have also jointly patented certain aspects of the cochleate technology and co-own such patents with them. Pursuant to the license agreement, we agreed that each University would be issued an equity interest in our capital stock, originally equal to 2% of our outstanding capital stock. These arrangements were subsequently revised in December, 2002. On December 16, 2002, we amended our license agreement with the Universities to provide for a decrease in the royalty payments to be paid to the Universities on sublicenses in consideration of an increase in the royalty on product sales and the issuance to the Universities of options to purchase shares of our common stock. As of December 31, 2006, UMDNJ owned 139,522 shares (including shares issued under a research agreement) and options to purchase 9,951 shares of our common stock at $3.06 and 75,000 options to purchase our common stock at a price per share of $2.37. As of December 31, 2006, Albany Medical College owned 2,222 shares of our common stock and options to purchase 9,951 shares of our common stock at $3.06 and 75,000 options to purchase our common stock at a price per share of $2.37. There are no further requirements to provide either University any additional equity interests in our company.

The license agreement, as amended, grants us an exclusive license to the cochleate technology owned by these Universities and obligates us to pay a royalty fee structure as follows:

(a) For commercial sales made by us or our affiliates, we shall pay to the Universities a royalty equal to 5% of net sales of cochleate products; and

(b) For commercial sales of cochleate products made by any of our sublicensees, we shall pay to the Universities royalties up to 5% of our revenues received from the sublicensee from the sale of such products.

Our royalty payments to the Universities will be divided equally among them pursuant to the license. In 2004, we accrued a $125,000 royalty payment to the Universities in connection with our $2.5 million asset sale to Accentia.

In April 2001, we entered into a research agreement with UMDNJ whereby we agreed with UMDNJ to share the rights to new research and development that jointly takes place at UMDNJ's facilities until December 31, 2005. We also agreed to provide UMDNJ with progress and data updates and allow its researchers to publish certain projects. We lease our research facilities totaling approximately 8,000 square feet located on their campus pursuant a lease agreement ending December 31, 2005. The monthly rent was $3,340 for 2001, $3,840 for 2002, $4,340 for 2003, $4,840 for 2004 and $5,340 for 2005. The lease was renewed in December 2005 for a term of one year at a cost of $64,080 for the year, or $5,340 per month. We are currently negotiating the lease for 2007 with UMDNJ but anticipate that the monthly rent will not change from 2006 No assurances can be given that we will be able to extend or renew the lease, and we may decide to relocate, scale back and/or outsource such operations.

In addition to our rent payments, we have also agreed to pay for certain other services provided

by UMDNJ. This includes one employee from UMDNJ of approximately $125,000 and a budget to purchase supplies and chemicals (adjusted to exact cost).

Collaborative and Supply Relationships

We are a party to collaborative agreements with universities, government agencies, corporate partners, and contractors. Research collaboration may result in new inventions which are generally considered joint intellectual property. Our collaboration arrangements are intended to provide us with access to greater resources and scientific expertise in addition to our in-house capabilities. We also have supply arrangements with a few of the key component producers of our delivery technology. In addition to our relationship with CDC, our collaborative and supply relationships include:

• Atrix Laboratories, Inc. On May 27, 2004, prior to its acquisition by us, Arius entered into a worldwide, exclusive royalty-bearing license agreement with Atrix (now a subsidiary of QLT Inc.) to develop, market, and sell products incorporating QLT's BEMA™ technology, including its BEMA™ Fentanyl product, and to use the BEMA™ trademark in conjunction therewith. All research and development related to the BEMA™ technology, including three existing INDs, were transferred to Arius in accordance with the QLT license agreement.

• QLT. Under the terms of the license agreement with QLT, we are required to pay: (i) an upfront licensing fee of $1 million, which was paid in August 2004, (ii) additional cash payments upon achievement of certain developmental and regulatory milestones, (iii) for reimbursement for research and development support, and (iv) royalties on commercial sales of all BEMA™ products. A joint development management committee composed of representatives of our company and QLT oversees product development. We are responsible for the research and development of the products, including costs and expenses, and for their sale, marketing, manufacture and distribution. QLT retains certain co-promotion rights to the BEMA™ Fentanyl product.

In August 2006, we purchased from QLT all of the non-U.S. rights to the BEMA™ drug delivery technology, including all patent rights and related intellectual property. Besides the rights to the BEMA™ technology outside of the U.S., the agreement granted us an option to purchase the U.S. BEMA™ technology patents within 12 months ending August 2, 2008. The aggregate purchase price for the non-U.S. portion of the BEMA™ technology is $3 million, to be paid over time as follows: (1) $1 million was paid at closing, (2) $1 million by the end of first quarter 2007 (which was paid March 30, 2007) and, (3) $1 million to be paid within 30 days of FDA approval of the first non-U.S. BEMA™-related product. As part of the transaction as it relates to the non-U.S. portion of the former QLT /BDSI license, no further milestone payments or ongoing royalties will be due to QLT. In addition, we were granted the option to purchase the remaining U.S. asset for $7 million dollars. These payments will also be paid over time. After purchasing the intellectual property rights from QLT, we will not owe any future milestone payments or royalties.

• Meda AB (Sweden). In August 2006, we announced a collaboration with Meda AB to develop and commercialize BDSI's flagship BEMA™ Fentanyl product in Europe. Under terms of the agreement, we granted Meda rights to the European development and commercialization of BEMA™ Fentanyl, in exchange for an upfront fee to BDSI, certain milestone payments, and double digit royalties to be received by BDSI on product sales. Payments include a $2.5 million payment upon execution of the agreement and additional milestones that would, if achieved, provide BDSI with up to an additional aggregate of $7.5 million in revenue.

Meda will manage the clinical development and regulatory submissions in all of Europe. Upon regulatory approval, Meda will exclusively commercialize BEMA™ Fentanyl in Europe. BDSI retains all development and commercial rights in the U.S., Japan, Australia and other territories outside of Europe.

• Aveva Drug Delivery Systems. Effective October 17, 2005, we entered into an agreement with Aveva Drug Delivery Systems, Inc. pursuant to which Aveva will supply BEMA™ Fentanyl product to us for clinical trials and commercial sale. Under the terms of this agreement, Aveva will be the sole supplier of BEMA™ Fentanyl for the United States and Canada. We will pay for formulation, commercial quantity scale-up, and product development work and the manufacture of clinical supplies, as well as for the cost of commercial supplies of BEMA™ Fentanyl based on Aveva's fully-burdened cost of manufacturing such supplies. The agreement has an initial term which is subject to automatic renewal for additional terms unless either party provides notice of termination in advance of such renewal. In connection with this agreement, we issued Aveva a warrant to purchase up to 75,000 shares of our common stock (which shares vest based on the occurrence of specified milestones) at a price equal to $3.50 per share.

• LTS Lohmann Therapie-Systeme AG. Effective December 15, 2006, we entered into a Process Development Agreement with LTS Lohmann Therapie-Systeme AG, pursuant to which LTS will undertake process development and scale up activities and supply BEMA™ Fentanyl product to us for clinical trials. Under the terms of this agreement, LTS is anticipated to be the sole supplier of BEMA™ Fentanyl for clinical trials and commercial distribution within the European Union. Further, under the agreement LTS has granted a license to European Patent No. 0 949 925 in regard to BDSI's Fentanyl product in the European Union.

• Sigma-Tau. In January 2005, we signed a definitive licensing agreement with Sigma-Tau Pharma for the application of our Bioral ® nanocochleate delivery technology to formulate up to four proprietary pharmaceutical compounds currently under development by Sigma-Tau Pharma. Simultaneously with this licensing agreement, we entered into a stock purchase agreement with, and received a non-refundable upfront payment of US$250,000 from, Sigma-Tau. This upfront payment was made in consideration of unregistered shares of our common stock priced at $4.25 a share. The stock purchase agreement with Sigma-Tau provides for the acquisition by Sigma-Tau, upon the occurrence of specified developmental milestones associated with the license, of additional unregistered shares of our common stock, up to an aggregate potential of $1.5 million worth of such shares. These milestones lead up to and include the submission of product INDs by Sigma-Tau Pharma for one or more of the four subject encochleated compounds

We continued to work with Sigma-Tau on this project during 2006. Working with Sigma-Tau's immunosuppressant compound, we were able during 2006 to undertake additional vivo efficacy studies versus a subcutaneous formulation of the compound and a 28 day toxicology test. With the completion of this test, we have demonstrated proof of principle. This was formally recognized by Sigma Tau in February 2007. BDSI received a $250,000 payment which took the form of a purchase of our common stock by Sigma-Tau at a price of $3.38 per share.

• Walter Reed Army Institute for Research. In 2006, we entered into a Cooperative Research and Development Agreement (CRADA) with the Walter Reed Army Institute for Research (WRAIR) to investigate the use of Bioral® CAMB for the treatment of Leishmaniasis. Leishmaniasis is a disease that can cause skin and other organ problems in soldiers deployed to countries where it is common, such as Iraq and Afghanistan. Amphotericin B is highly effective in the treatment of Leishmaniasis, but the practicality of utilizing currently available formulations of Amphotericin B is significantly limited by the requirement for intravenous administration.

• Pharmaceutical Product Development, Inc. On December 31, 2002, we entered into an agreement with Pharmaceutical Product Development, Inc. (NASDAQ:PPDI), which we refer to herein as PPDI, pursuant to which PPDI was granted a license to apply our Bioral® nano-delivery technology to two therapeutic products. In connection therewith, we received a $2 million up-front royalty payment. In addition, the terms of the license require additional royalty payments based on regulatory milestones and a running royalty rate based on worldwide sales.

• Reckitt Benckiser Healthcare (UK) Limited. Effective January 6, 2004, Arius entered into an exclusive royalty-bearing license with Reckitt Benckiser Healthcare (UK) Limited to develop, market, and sell Reckitt's Emezine® (buccal prochlorperazine maleate) product for the treatment of nausea and vomiting in the United States, and to use the Emezine® trademark in conjunction therewith. Under the terms of the license agreement, we are required to pay Reckitt: (i) an upfront licensing fee, which has been previously paid in accordance with the Reckitt agreement,
(ii) an additional cash payment upon achievement of a certain developmental and regulatory milestone, and (iii) royalties on commercial sales of the licensed product. We are responsible for the development of the product, including costs and expenses, and for its sale, marketing, and distribution in the United States. In addition, we shall be required to obtain from Reckitt, and Reckitt shall be required to supply to us, at our expense, all product to be sold under the license. Our agreement with Reckitt can be terminated by either Reckitt or us at any time 30 months after the effective date if regulatory approval has not been obtained. We can give no assurances that the agreement will not be terminated by Reckitt or us.

• National Institutes of Health. To investigate the properties of new antifungal cochleate formulations, grants totaling approximately $2.7 million have been awarded to us by NIH for the development of our proposed Amphotericin B product. Additionally, we are conducting anti-fungal studies using our Bioral® drug delivery technology through NIH selected and paid contractors. The NIH has reserved broad and subjective authority over future disbursements under the grant. While no objective or specific milestones for future disbursements have been established by the NIH, we must generally demonstrate to the satisfaction of the NIH that our research and use of proceeds are consistent with the goal of developing a formulation for the oral delivery of Amphotericin B. Furthermore, we are required to submit to the NIH an annual report of activities under the grant.

Additionally, in late July 2005, we received an indication from the NIAID, which is affiliated with the NIH, that the NIAID would, at its expense and following our achievement of certain milestones, conduct pre-clinical studies through an NIH contractor for oral, as well as intravenous, formulations of Bioral® Amphotericin B. No assurances can be given that NIAID will proceed with or actually pay for this testing.

• Other Bioral® Collaborations. In 2006, we entered into additional collaborations to combine the Bioral® technology with other companies' intellectual property in the form of Evaluation and Material Transfer Agreements. If positive, these may turn into license with significant financial terms, though no assurances can be made that this will occur.

We also have agreements with entities that are affiliated with and partially-owned by key members of our board of directors and management to conduct research and license certain proposed drugs. See "Certain Relationships and Related Transactions" for affiliations with our management.

As of December 31, 2001, our board of directors appointed an audit committee consisting of independent directors. This committee, among other duties, is charged to review, and if appropriate, ratify all agreements and transactions which had been entered into with related parties, as well as review and ratify all future related party transactions. The audit committee independently ratified the agreements described below. At a subsequent meeting of independent board members, with Dr. O'Donnell abstaining, and after seeking and reviewing advice from the audit committee and an independent valuation firm and inquiring about the details of the various transactions, the independent board members ratified the below-described related party transactions. During 2004, after compliance with our internal policies and procedures, we also entered into several new related party contracts, some of which were amended in 2005 in accordance with the same policies and procedures. The following are the related-party agreements entered into prior to our initial public offering and subsequently:

• Accentia Biopharmaceuticals, Inc. We have several business relationships with Accentia Biopharmaceuticals, Inc. and its affiliates. Hopkins Capital Group (HCG), which is controlled by Dr. Francis E. O'Donnell, Jr., our Chairman of the Board and which owns a significant percentage of our common stock as of the date of this Report, is a significant stockholder of Accentia. In addition, Dr. O'Donnell is also the Chairman and CEO of Accentia. Also, James A. McNulty, our Secretary, Treasurer and CFO, is the Treasurer of Accentia and Dr. Raphael Mannino, our Chief Scientific Officer and a director, is a member of the board of directors of Biovest International, Inc. (OTC BB:BVTI), a subsidiary of Accentia.

• Amphotericin B License. On April 12, 2004, we licensed a topical formulation of our encochleated Amphotericin B to Accentia. Accentia is commercializing technology licensed from the Mayo Foundation for the treatment of CRS and asthma on a worldwide basis. The technology consists of using low-dose topical antifungals to control the debilitating symptoms of CRS and asthma. Accentia is responsible for all expenses related to the development of an encochleated BioNasal® Amphotericin B for the indications of CRS and asthma on a worldwide basis, including expenses associated with, and the actual provision of, supplies, the submission of an IND and clinical trials. We shall retain world-wide rights to the oral and intravenous formulations of encochleated Amphotericin B. The license agreement was amended effective June 1, 2004, then modified in September 2004 by our asset purchase agreement with Accentia, and was amended with three separate letter amendments in March, April and June 2005, respectively, to make certain clarifications.

• Arius/TEAMM Distribution Agreement. On March 17, 2004, Arius granted exclusive marketing and sales rights in the United States to TEAMM Pharmaceuticals, Inc., or TEAMM, with respect to Arius' licensed Emezine® product for the treatment of nausea and vomiting. TEAMM is a specialty

pharmaceutical company and wholly-owned subsidiary of Accentia. As part of this agreement, TEAMM has agreed to pay for the development costs of Emezine®. We received development cost reimbursements of $1.0 million in 2004 from Accentia in connection with this agreement. In 2005, we received $300,000 from TEAMM upon the acceptance by the FDA of the Emezine® NDA for filing. TEAMM now operates as Accentia Pharmaceuticals.

• Analytica International Market Studies. During 2004, Analytica International, a provider of research, commercialization, and communications services to the pharmaceutical and biotechnology industries and a subsidiary of Accentia, performed two market studies for us. We paid Analytica $47,800 for these reports, some of which we paid in 2005.

• RetinaPharma Technologies, Inc. We previously entered into a license agreement with this development-stage biotechnology company to use our delivery technology in connection with their proposed nutraceutical product with potential application for macular degeneration and retinitus pigmentosa, a disease affecting the retina, and through an agreement with Tatton Technologies, LLC (which subsequently merged into RetinaPharma), certain apoptotic drugs and apoptotic naturally occurring substances to treat certain neuro-degenerative diseases. This exclusive worldwide right to use our Bioral® drug delivery technology in conjunction with their effort to develop, commercialize and manufacture their proposed products, or to sublicense to a third party, is only for the purpose of treating antiapoptotic pharmaceutical and nutraceutical treatment of retinal disease and glaucoma. These licenses shall remain in effect as long as RetinaPharma remains in compliance with the terms of the agreements. HCG, one of our significant stockholders, and Dr. Francis E. O'Donnell, Jr., our Chairman of the Board, are affiliated as stockholders and a director of RetinaPharma.

• Biotech Specialty Partners, LLC. We have entered into a non-exclusive distribution agreement with Biotech Specialty Partners, LLC, or BSP, a development-stage distribution company, to market and distribute our proposed products once we have completed the commercialization of our products. Our financial arrangement with BSP requires us to sell to BSP all of our proposed products, as and when purchased by BSP at a cost which is the lesser of: (i) ten percent (10%) below the lowest wholesale acquisition cost, inclusive of rebates, quantity discounts, etc.; and
(ii) the lowest cost at which we are then selling the product(s) to any other purchaser. The term of the agreement shall be for a term of five years once a product becomes available for distribution. BSP is a start-up enterprise, which to date has not distributed any pharmaceutical products.

These agreements generally provide that, except for on-going development costs related to our cochleate drug delivery technology, we are not required to share in the costs of the development of the pharmaceutical product or technologies of these companies. In connection with our acquisition of Arius, BSP waived its rights under its distribution agreement w