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:

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:

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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.

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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.

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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,

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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.

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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.

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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:

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.

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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 ^® .

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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.

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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.

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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:

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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.

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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:

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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:

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:

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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

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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

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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:

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

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.

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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:

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”)

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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:

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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.

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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.

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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

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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:

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.

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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

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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:

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.

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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.

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.

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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.

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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:

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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 with us with respect to all of Arius’ products.

Under these affiliate agreements, we are entitled to receive the following royalty and other payments:

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In pursuing potential commercial opportunities, we intend to seek and rely upon additional collaborative relationships with corporate partners. Such relationships may include initial funding, milestone payments, licensing payments, royalties, access to proprietary drugs or potential applications of our drug delivery technologies or other relationships. Our agreements with PPDI, Accentia, Sigma-Tau and Meda are examples of these types of relationships, and we will continue to seek other similar arrangements.

Licenses, Patents and Proprietary Information

Our interest in the intellectual property is subject to and burdened by various royalty payment obligations and by other material contractual or license obligations.

In general, the patent position of biotechnology and pharmaceutical firms is frequently considered to be uncertain and involve complex legal and technical issues. There is considerable uncertainty regarding the breadth of claims allowed in such cases and the degree of protection afforded under such patents. While we believe that our intellectual property position is sound and that we can develop our drug delivery technologies, we cannot provide any assurances that our patent applications will be

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successful or that our current or future intellectual property will afford us the desired protection against competitors. It is possible that our intellectual property will be successfully challenged or that patents issued to others may preclude us from commercializing our drugs.

Other parties could have patent rights which may block our products. We are aware of two issued United States patents dealing with lipid formulations of Amphotericin B products. The first of these patents, United States Patent No. 4,978,654, claims an Amphotericin B liposome product. We do not believe that our patent or technology are in conflict with this existing patent, although there can be no assurance that a court of law in the United States’ patent authorities might determine otherwise. Our belief is based upon the fact that our cochleate product does not contain liposomes, which is required by the issued claims of this patent. The second of these patents, United States Patent No. 5,616,334, claims a composition of a lipid complex containing Amphotericin B defined during prosecution as a ribbon structure. Our Bioral ^® nano-encapsulation technology uses cochleates which are not ribbon structures. Accordingly, we do not believe that we require a license under this patent.

We are also aware of United States Patent No. 6,585,997, related to mucoadhesive erodible drug delivery devices. We do not believe that our BEMA™ Fentanyl product is in conflict with the existing patent, at least because there are limitations recited in the issued claims that are not met by our product. Accordingly, we do not believe that we require a license under this patent for BEMA™ Fentanyl. We are further aware of U.S. Patents Nos. 5,948,430, 6,177,096 and 6,284,264, and European Patent No. 0 949 925, which are owned by LTS Lohmann and which also relate to mucoadhesive erodible drug delivery devices. Under our December 2006 Process Development Agreement with LTS, LTS has granted us a license to European Patent No. 0 949 925 in regard to BEMA™ Fentanyl in the European Union. This agreement has an option for LTS to exclusively manufacture clinical trial and commercial supplies of BEMA™ Fentanyl in the European Union. Freedom to operate searches and analyses have not been completed for other proposed BEMA™ based products.

If a court were to determine that we infringe any of these patents and that these patents are valid, we might be required to seek one or more licenses to commercialize our Bioral ^® formulation of Amphotericin B and/or our BEMA™ products. There can be no assurance that we would be able to obtain such licenses from the patent holders. In addition, if we were unable to obtain a license, or if the terms of the license were onerous, there may be a material adverse effect upon our business plan to commercialize these products.

Most of the inventions claimed in our cochleate patents were made with the United States government support. Therefore, the United States government has certain rights in the technology, and we have certain obligations to the U.S. government, which could be inconsistent with our plans for commercial development of products and/or processes. We believe to the extent the United States government would have rights in our licensed Bioral ^® technology due to their funding, we have to either obtain a waiver from the United States government relating to the United States government’s rights in the technology, or have agreements with the United States government which would grant us exclusive rights.

We rely on trade secrets and confidentiality agreements with collaborators, advisors, employees, consultants, vendors and other service providers. No assurances can be given that these agreements will not be breached or that our trade secrets will not otherwise become known or be independently discovered by competitors. Our business would be adversely affected if our competitors were able to learn our secrets or if we were unable to protect our intellectual property.

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Cochleate Technology

With respect to our cochleate technology and liposome technology related to our autologous HIV therapy, we are the owner and/or the exclusive licensee of seven issued United States patents and seven foreign issued patents owned by the parties listed in the chart below. We believe that our licenses to this intellectual property will enable us to develop this new drug delivery technology based upon cochleate and cochleate related technology. Our intellectual property strategy is intended to maximize our potential patent portfolio, license agreements, proprietary rights and any future licensing opportunities we might pursue. With regard to our Bioral ^® cochleate technology, we intend to seek patent protection for not only our delivery technology, but also potentially for the combination of our delivery technology with various drugs no longer under patent protection. Below is a table summarizing patents we believe are currently important to our business and technology position.

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Through Arius, we license from QLT USA, Inc. the following U.S. and, and we own the following foreign patents and patent applications relating to the BEMA™ technology:

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Emezine ^®

With respect to Emezine ^® , we license from Reckitt U.S. Patent No. 4,717,723, issued January 5, 1988, entitled “Pharmaceutical Compositions.”

Competition

The biopharmaceutical industry in general is competitive and subject to rapid and substantial technological change. Developments by others may render our proposed Bioral ^® or BEMA™ technologies and proposed drug products and formulations under development noncompetitive or obsolete, or we may be unable to keep pace with technological developments or other market factors. Technological competition in the industry from pharmaceutical and biotechnology companies, universities, governmental entities and others diversifying into the field is intense and is expected to increase. Below are some examples of companies seeking to develop potentially competitive technologies, although the examples are not necessarily exhaustive. Many of these entities have significantly greater research and development capabilities than do we, as well as substantially more marketing, manufacturing, financial and managerial resources. These entities represent significant competition for us. In addition, acquisitions of, or investments in, competing pharmaceutical or biotechnology companies by large corporations could increase such competitors’ research, financial, marketing, manufacturing and other resources. Such potential competitive technologies may ultimately prove to be safer, more effective or less costly than any drugs which we are currently developing or may be able to develop. Additionally, our competitive position may be materially affected by our ability to develop or successfully commercialize our drugs and technologies before any such competitor.

BEMA™

Included among the companies which we believe are developing potentially competitive technologies to BEMA™ are Orexo AB, Inc. (SX:ORX), a publicly-traded company, and TransOral Pharmaceuticals, Inc., a privately-held company. We believe that these potential competitors are seeking to develop and commercialize technologies for the buccal or sublingual delivery for various therapeutics or groups of therapeutics. While our information concerning these competitors and their development strategy is limited, we believe our technology can be differentiated because the BEMA™ technology provides for a consistent delivery of each dose based on how the BEMA™ technology adheres to the buccal membrane and dissolves over a predetermined rate. We are aware that ULURU Inc. purchased a technology from Access Pharmaceuticals which is similar to BEMA™. Based on public disclosures, we are not aware of ULURU developing a competitive pain product as of the time of this writing.

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For BEMA™ Fentanyl, in the breakthrough cancer pain area, we believe the most advanced competitors are Cephalon, Inc. (NASDAQ:CEPH) and Endo Pharmaceutical Holdings (NASDAQ:ENDP) both publicly-traded companies. Cephalon’s first product for this indication is Actiq ^® , which generated $629 million in sales in 2006. Cephalon licensed a generic to this product to Barr Laboratories upon approval of Fentora™, formerly known as OraVescent Fentanyl. This product utilizes an effervescent tablet which is administered buccally. Fentora was approved and launched in 2006 generating $30 million in sales. Endo has licensed Rapinyl, which is a polymer formulated sublingual fentanyl tablet indicated for breakthrough cancer pain, from Orexo AB. This product is administered sublingually. Generex Biotechnology and Sosei Co. Ltd. (formerly Arakis, Ltd.) are developing sublingual spray formulations of opioids for breakthrough pain. LAB International, Inc. and YM Biosciences (formerly Delex Therapeutics) are developing inhaled formulations of fentanyl for administration either nasally or across the alveoli in the lungs. Javelin Pharmaceuticals, Inc. (OTC BB: JVPH.OB) is developing an intranasal morphine and Nycomed, a private company from Denmark is developing a Fentanyl Nasal Spray. While we have limited information regarding these potential competitors and their development status and strategy, we believe that our technology may be differentiated because unlike these potential competitors, BEMA™ Fentanyl has a predefined residence time on the buccal membrane providing for consistent drug delivery from dose to dose. We believe that all of the competitive formulations of fentanyl will have intra-dose variability meaning the patient may not get the same response each time the product is administered. In addition it is our belief that the other products will potentially have a higher level of abuse based on how they are delivered. In the chart below find all competitors in development to BEMA™ Fentanyl and their development status.

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BEMA™ LA will have several indications for the treatment of acute and chronic pain. It will be positioned as a first line therapy for post surgical patients. This would include hospital or outpatient surgeries. Market competitors for this indication include but are not limited to: non-steroidal anti-inflammatory (NSAIDs, e.g. ibuprofen), COX-2 inhibitors (Celebrex ^® from Pfizer), Tramadol (Ultracet ^® from Ortho McNeil), and potent opioids (hydrocodone and oxycodone combination products from various companies).

A second focus will be to position BEMA™ LA as a step up from an NSAID instead of Schedule II narcotics. Indications for such combination use with NSAIDs include pain associated with severe arthritis and lower back conditions. Marketed competitors for these indications include Tramadol (Ultram ^® ER from Biovail/Johnson and Johnson) and the potent opioids such as Opana™ from Penwest/Endo, OxyContin ^® from Purdue, Kadian ^® from Alpharma, Avinza ^® from King Pharmaceuticals (formerly Ligand) and Duragesic ^® from Johnson & Johnson.

Other competition includes multiple new chemical entities with different mechanisms of action. These include a glutamate antagonist from Neurocrine, a mixed delta/mu antagonist from Enhance Biotech/Alza and multiple COX-2 products from GSK, Sanofi-Aventis, Novartis and Sankyo.

Finally, there are also products under development in special delivery technologies including Tramadol flash dose from Biovail, Tramadol extended release from Labopharm/Purdue, Remoxy™ from Pain Therapeutics/King Pharmaceuticals, Oxytrex™ from Pain Therapeutics and sufentanil transdermal patch from Durect/Endo.

BEMA™ Zolpidem will compete in the insomnia 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. BEMA™ Zolpidem will be positioned primarily as a first line therapy for insomnia patients. This would include hospital and primary care applications. Market competitors for this indication include but are not limited to: Ambien ^® and Ambien CR ^® (Sanofi-Aventis), Lunesta ^® (Sepracor), Rozerem ^® (Takeda) and Sonata ^® (King Pharmaceuticals).

Other competition includes multiple new chemical entities. These include indiplon (Neurocrine), and gaboxadol (Lundbeck/Merck).

Finally, there are also approved products development in special delivery technologies including zolpidem Flashdose ^® from Biovail, Zolpidem Oral Spray from Novadel and Sonata ^® ER from King Pharmaceuticals.

Cochleate Technology

While many development activities are private, and therefore we cannot know what research or progress has actually been made, we are not aware of any other drug delivery technology using a naturally occurring drug delivery vehicle or carrier that can be used to simultaneously address two important clinical goals: oral delivery of drugs that normally require injection and targeted cell delivery once the drug is in the body.

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Included among the companies which we believe are developing potentially competitive technologies are Emisphere Technologies, Inc. (NASDAQ:EMIS) and Novavax, Inc. (NASDAQ:NVAX), each a publicly-traded company, and CyDex, Inc., each a privately-held company. We believe that these potential competitors are seeking to develop and commercialize technologies for the oral delivery of drugs which may require customization for various therapeutics or groups of therapeutics. While our information concerning these competitors and their development strategy is limited, we believe our technology can be differentiated because our cochleate technology is seeking to deliver a potential broad base of water soluble and water insoluble (fat or lipid soluble) compounds with limited customization for each specific drug.

We believe that our technology may have cell-targeted delivery attributes as well. Additional companies which are developing potentially competitive technologies in this area may include Valentis Inc. (NASDAQ:VLTS), Enzon Pharmaceuticals Inc. (NASDAQ:ENZN), Flamel Technologies S.A. (NASDAQ:FLML), Nastech Pharmaceutical Company Inc. (NASDAQ: NSTK) and Inex Pharmaceuticals Corporation (TSX: INEX), each publicly-traded companies, which we believe may be seeking to develop technologies for cell-targeted delivery of drugs. In 2005, American Pharmaceutical Partners, Inc. (NASDAQ:APPX) received approval for Abraxane, which is a formulation of paclitaxel, which is bound to albumin. This provides for cellular delivery via the gp60 receptor. While we have limited information regarding these potential competitors and their development status and strategy, we believe that our technology may be differentiated because unlike these potential competitors, we seek to use our cochleate to encapsulate the therapeutic to achieve drug delivery into the interior of the cells such as inflammatory cells.

Although the competitors mentioned above are developing drug delivery techniques conceptually similar to ours with respect to encapsulation, or more specifically “nano-encapsulation,” we believe that our approach is different, proprietary and protected under our licensed and patented technology. One primary way we can be differentiated from our competitors is in our approach of using naturally occurring substances to form a cochleate which encapsulates the drug in a scroll-like multilayered delivery vehicle.

Manufacturing

During drug development and the regulatory approval process, we plan to rely on third-party manufacturers to produce our compounds for research purposes and for pre-clinical and clinical trials. We currently are parties to the following manufacturing agreements. Except as described below, we do not presently have manufacturing arrangements with respect to our intended products.

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 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. 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.

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As our other intended products near market introduction, we intend to outsource manufacturing to third party manufacturers, which comply with the FDA’s applicable Good Manufacturing Practices. We are currently seeking manufacturing partners for certain of our products and formulations and believe that such commercial manufacturing arrangements are likely to be available to us.

We have and intend to purchase component raw materials from various suppliers. As our intended products near market introduction, we intend to seek multiple suppliers of all required components although there may not actually be more than one at that time.

Sales and Marketing

Assuming completion of our drug delivery technologies, product and formulation development and regulatory approval, we will pursue one of three approaches or a combination thereof to marketing our products. 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 our approved formulations and products under the Bioral ^® , BEMA™ or other brand names which we either own or license from third parties. 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.

For sales and marketing into primary care and geographies outside of the United States, we will explore a wide range of potential arrangements, such as licensing, direct sales, co-marketing, joint venture and other arrangements. Such arrangements may be with large or small pharmaceutical companies, general or specialty distributors, biotechnology companies, physicians or clinics, or otherwise.

We have licensed the commercial rights to Emezine ^® to Accentia. Accentia is responsible for the sales and marketing of Emezine ^® .

In Europe, we have licensed the commercial and development rights to BEMA™ Fentanyl to Meda AB. We have a non-exclusive distribution arrangement with Biotech Specialty Partners, LLC, an early-stage alliance of specialty pharmaceutical and biotechnology companies, although BSP has waived its rights with respect to Arius’ products.

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Government Regulation

The manufacturing and marketing of any drug which we formulate with our licensed Bioral ^® or BEMA™ technologies and Emezine ^® , as well as our related research and development activities, are subject to regulation for safety, efficacy and quality by numerous governmental authorities in the United States and other countries. We anticipate that these regulations will apply separately to each drug formulation with our drug delivery technologies. We believe that complying with these regulations will involve a considerable level of time, expense and uncertainty.

In the United States, drugs are subject to rigorous federal regulation and, to a lesser extent, state regulation. The Federal Food, Drug and Cosmetic Act, as amended, and the regulations promulgated thereunder, and other federal and state statutes and regulations govern, among other things, the testing, manufacture, safety, efficacy, labeling, storage, record keeping, approval, advertising and promotion of our drugs. Drug development and approval within this regulatory framework is difficult to predict and will take a number of years and involve the expenditure of substantial resources.

The steps required before a pharmaceutical agent may be marketed in the United States include

In addition to obtaining FDA approval for each product, each product-manufacturing establishment must be registered with, and approved by, the FDA. Manufacturing establishments are subject to biennial inspections by the FDA and must comply with the FDA’s Good Manufacturing Practices for products, drugs and devices.

Pre-clinical Trials

Pre-clinical testing includes laboratory evaluation of chemistry and formulation, as well as tissue culture and animal studies to assess the safety and potential efficacy of the product. Pre-clinical safety tests must be conducted by laboratories that comply with FDA regulations regarding Good Laboratory Practices. No assurances can be given as to the ultimate outcome of such pre-clinical testing. The results of pre-clinical testing are submitted to the FDA as part of an IND and are reviewed by the FDA prior to the commencement of clinical trials. Unless the FDA objects to an IND, clinical studies may begin thirty (30) days after the IND is submitted.

We intend to largely rely upon contractors to perform pre-clinical trials.

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Clinical Trials

Clinical trials involve the administration of the investigational product to healthy volunteers or to patients under the supervision of a qualified investigator. Clinical trials must be conducted in accordance with Good Clinical Practices under protocols that detail the objectives of the study, the parameters to be used to monitor safety and the efficacy criteria to be evaluated. Each protocol must be submitted to the FDA prior to its conduct. Further, each clinical study must be conducted under the auspices of an independent institutional review board at the institution where the study will be conducted. The institutional review board will consider, among other things, ethical factors, the safety of human subjects and the possible liability of the institution. The drug product used in clinical trials must be manufactured according to Good Manufacturing Practices.

Clinical trials are typically conducted in three sequential phases, but the phases may overlap. In Phase I, the initial introduction of the product into healthy human subjects, the drug is tested for safety (adverse side effects), absorption, dosage tolerance, metabolism, bio-distribution, excretion and pharmacodynamics (clinical pharmacology). Phase II is the proof of principle stage and involves studies in a limited patient population in order to:

When there is evidence that the product may be effective and has an acceptable safety profile in Phase II evaluations, Phase III trials are undertaken to establish the clinical efficacy and the safety profile of the product within a larger population at geographically dispersed clinical study sites. Phase III frequently involves randomized controlled trials and, whenever possible, studies are conducted in a manner so that neither the patient nor the investigator knows what treatment is being administered. We, or the FDA, may suspend clinical trials at any time if it is believed that the individuals participating in such trials are being exposed to unacceptable health risks.

We intend to rely upon third party contractors to advise and assist us in the preparation of our INDs and clinical trials that will be conducted under the INDs. Two studies were conducted in 2004 under the Emezine ^® IND, although additional studies may be required based on the non-approvable letter we received from the FDA on Emezine ^® in late February 2006.

Five studies were started in 2006 under the IND for BEMA™ Fentanyl. Multiple preclinical studies were conducted with Bioral ^® Amphotericin B. One study was conducted with BEMA™ LA in 2006. We expect that additional studies will be required in 2007 on these and other proposed products and formulations.

New Drug Application and FDA Approval Process

The results of the manufacturing process development work, pre-clinical studies and clinical studies are submitted to the FDA in the form of a New Drug Application for approval to market and sale of the product. The testing and approval process is likely to require substantial time and effort. In addition to the results of pre-clinical and clinical testing, the NDA applicant must submit detailed information about chemistry, manufacturing and controls that will describe how the product is made. The approval process is affected by a number of factors, including the severity of the disease, the availability of alternative treatments and the risks and benefits demonstrated in clinical trials. Consequently, there can

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be no assurance that any approval will be granted on a timely basis, if at all. The FDA may deny a New Drug Application if applicable regulatory criteria are not satisfied, require additional testing or information or require post-marketing testing (Phase IV) and surveillance to monitor the safety of a company’s product if it does not believe the NDA contains adequate evidence of the safety and efficacy of the drug. Moreover, if regulatory approval of a drug is granted, such approval may entail limitations on the indicated uses for which it may be marketed. Finally, product approvals may be withdrawn if compliance with regulatory standards is not maintained or if problems occur following initial marketing. Post approval studies may be conducted to explore further intervention, new indications or new product uses.

Among the conditions for NDA approval is the requirement that any prospective manufacturer’s quality control and manufacturing procedures conform to Good Manufacturing Practices and the specifications approved in the NDA. In complying with standards set forth in these regulations, manufacturers must continue to expend time, money and effort in the area of drug and quality control to ensure full technical compliance. Manufacturing establishments, both foreign and domestic, also are subject to inspections by or under the authority of the FDA and by other federal, state or local agencies. Additionally, in the event of non-compliance, FDA may issue warning letters and seek criminal and civil penalties, enjoin manufacture, seize product or revoke approval.

International Approval

Whether or not FDA approval has been obtained, approval of a product by regulatory authorities in foreign countries must be obtained prior to the commencement of commercial sales of the drug in such countries. The requirements governing the conduct of clinical trials and drug approvals vary widely from country to country, and the time required for approval may be longer or shorter than that required for FDA approval. Although there are some procedures for unified filings for certain European countries, in general, each country at this time has its own procedures and requirements.

Other Regulation

In addition to regulations enforced by the FDA, we are also subject to regulation under the Controlled Substances Act, the Occupational Safety and Health Act, the Environmental Protection Act, the Toxic Substances Control Act, the Resource Conservation and Recovery Act and other present and potential future federal, state or local regulations. Our research and development may involve the controlled use of hazardous materials, chemicals, and various radioactive compounds. Although we believe that our safety procedures for handling and disposing of such materials comply with the standards prescribed by state and federal regulations, the risk of accidental contamination or injury from these materials cannot be completely eliminated. In the event of any accident, we could be held liable for any damages that result and any such liability could exceed our resources.

Employees

As of April 13, 2007, we have 12 full-time employees and 4 part-time employees; 4 are laboratory scientists and 12 are involved in our clinical and program development, operations, administration, accounting and information technology. Advanced degrees of our staff include four Ph.D’s, two Pharm.D’s, on R.Ph. and two CPA’s. None of our employees are covered by collective bargaining agreements. From time to time, we also employ independent contractors to support our engineering and support and administrative functions. We consider relations with our employees to be good. Each of our current scientific personnel has entered into confidentiality and non-competition agreements with us.

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RISK FACTORS

An investment in our company is extremely risky. You should carefully consider the following risks, in addition to the other information presented in this Report before deciding to buy or exercise our securities. If any of the following risks actually materialize, our business and prospects could be seriously harmed, the price and value of our securities could decline and you could lose all or part of your investment.

Risks Relating to Our Business

Since we have a limited operating history and have not generated any revenues from the sale of products to date, you cannot rely upon our limited historical performance to make an investment decision.

Since our inception in January 1997 and through December 31, 2006, we have recorded accumulated losses totaling approximately $43.5 million. As of December 31, 2006, we had negative working capital of approximately $9.6 million. Our ability to generate revenue and achieve profitability depends upon our ability, alone or with others, to complete the development of our proposed formulations and products, obtain the required regulatory approvals and manufacture, market and sell our proposed formulations and products.

Although we have generated some licensing-related and other revenue to date, we have not generated any revenue from the commercial sale of products. Since our inception, we have engaged primarily in research and development, licensing technology, seeking grants, raising capital and recruiting scientific and management personnel, although since 2005 we have shifted our focus towards commercialization activities, mostly relating to BEMA ^® Fentanyl. This limited operating history may not be adequate to enable you to fully assess our ability to develop and commercialize our technologies and proposed formulations or products, obtain FDA approval and achieve market acceptance of our proposed formulations or products and respond to competition. No assurances can be given as to exactly when, if at all, we will be able to fully develop, commercialize, market, sell and derive material revenues from our proposed formulations or products in development.

We will need to raise additional capital to continue our operations, and our failure to do so would impair our ability to fund our operations, develop our technologies or promote our formulations or products.

Our operations have relied almost entirely on external financing to fund our operations. Such financing has historically come primarily from the sale of common and preferred stock and convertible

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debt to third parties and to a lesser degree from grants, loans and revenue from license and royalty fees. We anticipate, based on our current proposed plans and assumptions relating to our operations (including the timetable of, and costs associated with, new product development) and financings we have undertaken prior to the date of this Report, that our current working capital and available financing will be sufficient to satisfy our contemplated cash requirements into approximately the first quarter of 2008, assuming that we do not accelerate the development of other opportunities available to us, engage in an extraordinary transaction or otherwise face unexpected events or contingencies, any of which could effect our cash requirements. Thereafter, and given that our current cash on hand will not fully fund all development costs of our leading product formulations, we will need to raise additional capital to fund our anticipated operating expenses and future expansion. Among other things, external financing will be required to allow us to pay, by March 31, 2007 (which we paid March 30, 2007), $1 million to QLT in connection with our August 2006 acquisition of the non-U.S. BEMA ^® assets and also cover the further development of our product formulations and other operating costs. While we expect that we will be able to find the needed capital to progress our business plan, we cannot assure you that financing, whether from external sources or related parties, will be available. If additional financing is not available when required or is not available on acceptable terms, we may be unable to fund our operations and planned growth, develop or enhance our technologies, take advantage of business opportunities or respond to competitive market pressures. Any negative impact on our operations may make capital raising more difficult and may also result in a lower price for our securities.

We may have difficulty raising needed capital in the future as a result of, among other factors, our limited operating history and business risks associated with our company. Our business currently does not generate any sales, and current sources of revenue are limited and will not be sufficient to meet our present and future capital requirements. We do not know when this will change. We have expended and will continue to expend substantial funds in the research, development and clinical and pre-clinical testing of our drug delivery technologies and product formulations incorporating such technologies. We will require additional funds to conduct research and development, establish and conduct clinical and pre-clinical trials, commercial-scale manufacturing arrangements and to provide for the marketing and distribution. While we expect that we will have access to financial resources so that we will be able to progress with our business plan, if adequate funds are unavailable, we may have to delay, reduce the scope of or eliminate one or more of our research, development or commercialization programs or product launches or marketing efforts which may materially harm our business, financial condition and results of operations.

Our long term capital requirements are expected to depend on many factors, including, among others:

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We may consume available resources more rapidly than currently anticipated, resulting in the need for additional funding. We may seek to raise any necessary additional funds through the exercising of our public warrants, equity or debt financings, collaborative arrangements with corporate partners or other sources, which may be dilutive to existing stockholders or otherwise have a material effect on our current or future business prospects. If adequate funds are not available, we may be required to significantly reduce or refocus our development and commercialization efforts with regards to our delivery technologies and our proposed formulations and products.

Additionally, investors are cautioned that the total projected development costs for BEMA ^® Fentanyl will exceed the maximum amounts CDC has funded to us. As a result, we have and will continue to require additional financial resources to complete the development of BEMA ^® Fentanyl, which resources may not be available to us.

Our additional financing requirements could result in dilution to existing stockholders.

The additional financings which we have undertaken and which we will require have and may in the future be obtained through one or more transactions which have diluted or will dilute (either economically or in percentage terms) the ownership interests of our stockholders. Further, we may not be able to secure such additional financing on terms acceptable to us, if at all. We have the authority to issue additional shares of common stock and preferred stock, as well as additional classes or series of ownership interests or debt obligations which may be convertible into any one or more classes or series of ownership interests. We are authorized to issue 45 million shares of common stock and 5 million shares of preferred stock. Such securities may be issued without the approval or other consent of our stockholders.

CDC has claimed that we have breached the CDLA and has sought to gain control of our BEMA ^® Fentanyl asset.

In August 2006, CDC provided us with a written notice in which they claimed that we had materially breached the CDLA. Such notice also contained a demand that we transfer to CDC all rights associated with BEMA ^® Fentanyl. Although we settled this dispute in March 2007, such resolution was without prejudice to CDC’s or our claims, and no assurances can be given however that CDC will not in the future make similar or additional claims against us. Our dispute with CDC has forced us to spend corporate resources in our defense and has distracted management’s attention from key projects. Moreover, under our agreements with CDC, if we do not meet certain conditions, CDC can assume control of the BEMA ^® Fentanyl project and related intellectual property assets. For example, in the event that we do not diligently pursue the development and regulatory approval of BEMA ^® Fentanyl or encounter certain specified negative circumstances regarding the development of BEMA ^® Fentanyl, CDC

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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. In addition to the time and cost associated with defending ourselves from CDC, which have negatively impacted us, if CDC were to prevail, our loss of BEMA ^® Fentanyl to CDC would have a material adverse effect on our business.

CDC’s right of first negotiation on future financings of ours could impede our ability to raise capital.

Under our May 2006 Securities Purchase Agreement, until such time as we achieve a market capitalization of $85 million, in the event that we seek to raise money through the offer and sale of debt or equity securities, we must first offer CDC an opportunity to provide financing to us. If CDC elects to exercise its right to such opportunity, we must negotiate exclusively with CDC the terms of a financing for 60 days. If no terms are agreed to, we may pursue a financing with a third party for 120 days, but only on terms superior and similar in structure to those offered by CDC. CDC has exercised this right of first negotiation to our detriment in the past, and the right of first negotiation was the subject of a now settled litigation between us and CDC in October 2006. No assurances can be given that CDC will not seek to exercise the right again in the future. The existence of CDC’s right of first negotiation, or CDC’s exercise thereof, has and may in the future deter potential investors from providing us needed financing, which would have a material adverse effect on our operations and viability as a company.

If an event of default occurs under our convertible notes with Laurus Master Fund, Ltd., it could seriously harm our operations.

On February 22, 2005 and May 31, 2005, we issued two separate $2.5 million secured convertible term notes with Laurus. The notes and related agreements contain numerous events of default which include:

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If we default on the notes and the holder demands all payments due and payable, the cash required to pay such amounts would most likely come out of working capital, which may not be sufficient to repay the amounts due. In addition, since we rely on our working capital for our day to day operations, such a default on the note could materially adversely affect our business, operating results or financial condition to such extent that we are forced to restructure, file for bankruptcy, sell assets or cease operations. Further, our obligations under the notes are secured by substantially all of our assets. Failure to fulfill our obligations under the notes and related agreements could lead to loss of these assets, which would be detrimental to our operations.

Certain restrictions on our activities contained in the Laurus financing documents could negatively impact our ability to obtain financing from other sources.

So long as 25% of the principal amount of either of the February and May Laurus notes are outstanding, the Laurus financing documents restrict us from obtaining additional debt financing without Laurus’ approval and subject to certain specified exceptions. To the extent that Laurus declined to approve a debt financing that does not otherwise qualify for an exception to the consent requirement, we would be unable to obtain such debt financing. In addition, subject to certain exceptions, we have granted to Laurus a right of first refusal to provide additional financing to us in the event that we propose to engage in additional debt financing or to sell any of our equity securities. Laurus’ right of first refusal could act as a deterrent to third parties which may be interested in providing us with debt financing or purchasing our equity securities. To the extent that such a financing is required for us to conduct our operations, these restrictions could materially adversely impact our ability to achieve our operational objectives.

Low market prices for our common stock could result in greater dilution to our stockholders, and could negatively impact our ability to convert the Laurus debt into equity.

The market price of our common stock significantly impacts the extent to which the Laurus debt is convertible into shares of our common stock. The lower the market price of our common stock as of the respective times of conversion, the more shares we will need to issue to Laurus to convert the principal and interest payments then due. If the market price of our common stock falls below certain thresholds, we will be unable to convert any such repayments of principal and interest into equity, and we will be required to make such repayments in cash. Our operations could be materially adversely impacted if we are required to make repeated cash payments on the unrestricted portion of the Laurus debt.

The Laurus financing documents prohibit the payment of dividends by us. You should not invest in our securities on the expectation that you will receive dividends.

So long as 25% of the principal amount of either of the February or May Laurus notes are outstanding, we will be prohibited from paying dividends without the prior consent of Laurus. Moreover, we have not paid dividends on our common stock in the past, and we do not anticipate paying any such dividends for the foreseeable future. You should not invest in our securities on the expectation that you will receive dividends.

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We are dependent on our collaborative agreements for the development of our drug delivery technologies and business development which exposes us to the risk of reliance on the viability of third parties.

In conducting our research and development activities, we currently rely, and will continue to rely, on numerous collaborative agreements with universities, governmental agencies, manufacturers, contract research organizations and corporate partners for both strategic and financial resources. Our inability to secure such relationships as needed, or the loss of or failure to perform by us or our partners under any applicable agreements or arrangements, may substantially disrupt or delay our research and development and commercialization activities, including our in-process and anticipated clinical trials. Any such loss would likely increase our expenses and materially harm our business, financial condition and results of operation.

We currently rely on the facilities of the University of Medicine and Dentistry of New Jersey for all of our research activities relating to our Bioral ^® technology, which activities could be materially delayed should we lose access to those facilities.

We have no research and development facilities of our own. As of the date of this Report, we are entirely dependent on third parties to use their facilities to conduct research and development. To date, we have relied on UMDNJ for this purpose in relation to our Bioral ^® technology, as well as third party providers of testing and trial services.

Additionally, the Universities own certain of the patents to our encochleation drug delivery technology. Our inability to conduct research and development, or our inability to find suitable third party providers of research and development services on an outsourcing basis, may delay or impair our ability to gain FDA approval and commercialization of our drug delivery technologies, formulations and products.

We leased our research facility from UMDNJ, which lease expired December 31, 2005. We are currently leasing the space on a month to month basis, but are in negotiations to renew the lease. No assurances can be given that we will be able to enter into, extend or renew the lease, and we may decide to relocate, scale back and/or outsource such operations. Should the lease expire or if we are otherwise are required to relocate on short notice, we do not currently have an alternate facility where we could relocate. The cost and time to establish or locate an alternative research and development facility to develop our technologies, other than through the Universities, or to find suitable third party providers of research and development services on an outsourcing basis, could be substantial and might delay gaining FDA approval and commercializing our formulations and products, assuming that we have not defaulted on the terms of our intellectual property licenses and can continue with our approval process.

We may be unable to obtain, or elect not to pursue, extensions of our NIH grants and we may not be able to secure new NIH or similar grants in the future, which could deny us important funding.

In 2001, the NIH awarded us a Small Business Innovation Research Grant, or SBIR, which we utilized in our research and development efforts relating to our Bioral ^® Amphotericin B formulation. We have received all anticipated funding under this grant to date, and this grant expired in August 2004.

In 2002, the NIH awarded us a second SBIR grant which we have utilized in our research and development efforts relating to a proposed encochleated HIV subunit vaccine. This grant expired in December 2005 but was extended by the NIH in February 2006 until July 31, 2006, and we believe this

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will be the final extension for this grant. As a result of this extension, we expect to receive approximately $74,000 in additional funds from the NIH for this project. In 2005, we subcontracted the responsibilities under the NIH grant for this project to UMDNJ.

Also, 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 encochleated Amphotericin B. No assurances can be given that NIAID will proceed with or actually pay for this testing.

Moreover, although we may seek additional NIH funding for either of these or other programs, we may choose not to seek such funding or such funding may be unavailable to us even should we desire it. The absence of additional funding from the NIH could impair our ability to further develop our Bioral ^® Amphotericin B formulation or other projects. Furthermore, as a result of these expirations, we incurred a decline in sponsored research revenue with associated NIH grant expenditures in 2005.

We are exposed to product liability, clinical and pre-clinical liability risks which could place a substantial financial burden upon us, should we be sued, because we do not currently have product liability insurance above and beyond our general insurance coverage.

Our business exposes us to potential product liability and other liability risks that are inherent in the testing, manufacturing and marketing of pharmaceutical formulations and products. Such claims may be asserted against us. In addition, the use in our clinical trials of pharmaceutical formulations and products that our potential collaborators may develop and the subsequent sale of these formulations or products by us or our potential collaborators may cause us to bear a portion of or all product liability risks. A successful liability claim or series of claims brought against us could have a material adverse effect on our business, financial condition and results of operations.

Since we do not currently have any FDA-approved products or formulations, we do not currently have any product liability insurance covering commercialized products, and we maintain liability insurance relating only to clinical trials on our products in development. We cannot assure you that we will be able to obtain or maintain adequate product liability insurance on acceptable terms, if at all, or that such insurance will provide adequate coverage against our potential liabilities. Furthermore, our current and potential partners with whom we have collaborative agreements with or our future licensees may not be willing to indemnify us against these types of liabilities and may not themselves be sufficiently insured or have sufficient liquidity to satisfy any product liability claims. Claims or losses in excess of any product liability insurance coverage that may be obtained by us could have a material adverse effect on our business, financial condition and results of operations.

Acceptance of our formulations or products in the marketplace is uncertain and failure to achieve market acceptance will prevent or delay our ability to generate revenues.

Our future financial performance will depend, at least in part, upon the introduction and customer acceptance of our proposed pharmaceutical formulations or products. Even if approved for marketing by the necessary regulatory authorities, our formulations or products may not achieve market acceptance. The degree of market acceptance will depend upon a number of factors, including:

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Physicians, patients, payors or the medical community in general may be unwilling to accept, utilize or recommend any of our proposed formulations or products. If we are unable to obtain regulatory approval, commercialize and market our proposed formulations or products when planned, we may not achieve any market acceptance or generate revenue.

We may be sued by third parties who claim that our drug formulations or products infringe on their intellectual property rights, particularly because there is substantial uncertainty about the validity and breadth of medical patents.

We may be exposed to future litigation by third parties based on claims that our technologies, formulations, products or activities infringe the intellectual property rights of others or that we have misappropriated the trade secrets of others. This risk is exacerbated by the fact that the validity and breadth of claims covered in medical technology patents and the breadth and scope of trade secret protection involve complex legal and factual questions for which important legal principles are unresolved. Any litigation or claims against us, whether or not valid, could result in substantial costs, could place a significant strain on our financial resources and could harm our reputation. Most of our license agreements require that we pay the costs associated with defending this type of litigation. In addition, intellectual property litigation or claims could force us to do one or more of the following:

Other parties could have patent rights which may block our products. We are aware of two issued United States patents dealing with lipid formulations of Amphotericin B products. The first of these patents, United States Patent No. 4,978,654, claims an Amphotericin B liposome product. We do not believe that our patent or technology are in conflict with this existing patent, although there can be no assurance that a court of law in the United States’ patent authorities might determine otherwise. Our belief is based upon the fact that our cochleate product does not contain liposomes, which is required by the issued claims of this patent. The second of these patents, United States Patent No. 5,616,334, claims a composition of a lipid complex containing Amphotericin B defined during prosecution as a ribbon structure. Our Bioral ^® nano-encapsulation technology uses cochleates which are not ribbon structures. Accordingly, we do not believe that we require a license under this patent.

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We are also aware of United States Patent No. 6,585,997, related to mucoadhesive erodible drug delivery devices. We do not believe that our BEMA™ Fentanyl product is in conflict with the existing patent, at least because there are limitations recited in the issued claims that are not met by our product. Accordingly, we do not believe that we require a license under this patent for BEMA ^® Fentanyl. We have not, however, conducted any patent searches with respect to our other proposed BEMA ^® -based products. We are further aware of U.S. Patents Nos. 5,948,430, 6,177,096 and 6,284,264, and European Patent No. 949 925, which are owned by LTS Lohmann and which also relate to mucoadhesive erodible drug delivery devices.

If a court were to determine that we infringe any of these or other patents and that such patents are valid, we might be required to seek one or more licenses to commercialize our Bioral ^® formulation of Amphotericin B and/or our BEMA ^® products. There can be no assurance that we would be able to obtain such licenses from the patent holders. In addition, if we were unable to obtain a license, or if the terms of the license were onerous, we might be precluded from developing or commercializing these products, which would likely have a material adverse effect on our results of operations and business plans.

Most of the inventions claimed in our Bioral ^® patents were made with the United States government support. Therefore, the United States government has certain rights in the technology, and we have certain obligations to the U.S. government, which could be inconsistent with our plans for commercial development of products and/or processes. We believe to the extent the United States government would have rights in our licensed Bioral ^® technology due to their funding, we have to either obtain a waiver from the United States government relating to the United States government’s rights in the technology, or have agreements with the United States government which would grant us exclusive rights.

If we are unable to adequately protect or enforce our rights to intellectual property or secure rights to third-party patents, we may lose valuable rights, experience reduced market share, assuming any, or incur costly litigation to protect such rights.

Our ability to obtain license to patents, maintain trade secret protection and operate without infringing the proprietary rights of others will be important to our commercializing any formulations or products under development. The current and future development of our drug delivery technologies is contingent upon whether we are able to maintain licenses to access the patents. Without these licenses, the technologies would be protected from our use and we would not be able to even conduct research without prior permission from the patent holder. Therefore, any disruption in access to the technologies could substantially delay the development of our technologies.

The patent positions of biotechnology and pharmaceutical companies, including ours which involves licensing agreements, are frequently uncertain and involve complex legal and factual questions. In addition, the coverage claimed in a patent application can be significantly reduced before the patent is issued. Consequently, our patent applications and any issued and licensed patents may not provide protection against competitive technologies or may be held invalid if challenged or circumvented. Our competitors may also independently develop drug delivery technologies or products similar to ours or design around or otherwise circumvent patents issued to us or licensed by us. In addition, the laws of some foreign countries may not protect our proprietary rights to the same extent as U.S. law.

We also rely upon trade secrets, technical know-how and continuing technological innovation to develop and maintain our competitive position. We require our employees, consultants, advisors and collaborators to execute appropriate confidentiality and assignment-of-inventions agreements with us. These agreements provide that all materials and confidential information developed or made known to the

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individual during the course of the individual’s relationship with us is to be kept confidential and not disclosed to third parties except in specific circumstances, and that all inventions arising out of the individual’s relationship with us shall be our exclusive property. These agreements may be breached, and in some instances, we may not have an appropriate remedy available for breach of the agreements. Furthermore, our competitors may independently develop substantially equivalent proprietary information and techniques, reverse engineer our information and techniques, or otherwise gain access to our proprietary technology. We may be unable to meaningfully protect our rights in trade secrets, technical know-how and other non-patented technology.

Although our trade secrets and technical know-how are important, our continued access to the patents is a significant factor in the development and commercialization of our drug delivery technologies. Aside from the general body of scientific knowledge from other drug delivery processes and lipid technology, these patents, to the best of our knowledge and based upon our current scientific data, are the only intellectual property necessary to develop and apply our Bioral ^® and BEMA ^® drug delivery systems to the drugs to which we are attempting to apply them.

We may have to resort to litigation to protect our rights for certain intellectual property, or to determine their scope, validity or enforceability. Enforcing or defending our rights is expensive, could cause diversion of our resources and may not prove successful. Any failure to enforce or protect our rights could cause us to lose the ability to exclude others from using our technologies to develop or sell competing products.

Key components of our drug delivery technologies may be provided by sole or limited numbers of suppliers, and supply shortages or loss of these suppliers could result in interruptions in supply or increased costs.

Certain components used in our research and development activities, such as lipids, are currently purchased from a single or a limited number of outside sources. The reliance on a sole or limited number of suppliers could result in:

Except for our agreement with Aveva, we do not have long-term agreements with any of our suppliers and, therefore, the supply of a particular component could be terminated without penalty to the supplier. Any interruption in the supply of components could cause us to seek alternative sources of supply or manufacture these components internally. If the supply of any components is interrupted, components from alternative suppliers may not be available in sufficient volumes within required time frames, if at all, to meet our needs. This could delay our ability to complete clinical trials, obtain approval for commercialization or commence marketing; or cause us to lose sales, incur additional costs, delay new product introductions or harm our reputation. Furthermore, components from a new supplier may not be identical to those provided by the original supplier. Such differences if they exist could affect product formulations or the safety and effectiveness of our products that are being developed.

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We have limited manufacturing experience, and once our drug formulations or products are approved, we may not be able to manufacture sufficient quantities at an acceptable cost.

We remain in the research and development and clinical and pre-clinical trial phase of product commercialization. Accordingly, once our proposed formulations or products are approved for commercial sale, we will need to establish, most likely through third parties, the capability to commercially manufacture our formulations or products in accordance with FDA and other regulatory requirements. We have limited experience in establishing, supervising and conducting commercial manufacturing. If we fail to adequately establish, supervise and conduct all aspects of the manufacturing processes, we may not be able to commercialize our formulations or products. We do not presently own manufacturing facilities necessary to provide clinical or commercial quantities of our proposed formulations or products. We presently plan to rely on third party contractors to manufacture part or all of our proposed formulations or products. This may expose us to the risk of not being able to directly oversee the production and quality of the manufacturing process. Furthermore, these contractors, whether foreign or domestic, may experience regulatory compliance difficulty, mechanic shut downs, employee strikes, or any other unforeseeable acts that may delay production.

Due to the fact that we must build our marketing, sales, managed care, and distribution infrastructure and channels, we may be unsuccessful in our efforts to sell our formulations or products.

Except for our non-exclusive distribution agreement with BioTech Specialty Partners, Inc., a development-stage company affiliated with Dr. Francis E. O’Donnell, a member of our management and significant beneficial owner of our securities, and the agreement between us and TEAMM Pharmaceuticals, also an affiliate of Dr. O’Donnell, relating to Emezine ^® , we have yet to establish marketing, sales or distribution capabilities for our proposed formulations or products. Even though our proposed formulations or products have not been approved by the regulatory authorities, we devote meaningful time and resources in this regard. At the appropriate time, we intend to enter into agreements with third parties to sell our proposed formulations or products, or we may (in the future, resources permitting) develop our own sales and marketing force. We may be unable to establish or maintain third-party relationships on a commercially reasonable basis, if at all. In addition, these third parties may have similar or more established relationships with our competitors. In particular, our inability to secure a commercial partner for our lead product, BEMA ^® Fentanyl, would seriously compromise our ability to bring this product to market.

If we do not enter into relationships with third parties for the sales and marketing of our proposed formulations or products, especially our lead product BEMA ^® Fentanyl, we will need to develop our own sales and marketing capabilities. Given the late stage of the clinical development of BEMA ^® Fentanyl, it is highly unlikely that we will have the time or resources to develop such capabilities with respect to such product and will have to rely on securing a commercial partner. Moreover, even if we were to develop our own sales and marketing capability, our experience in developing a fully integrated commercial organization is very limited. If we choose to establish a fully integrated commercial organization, we may incur substantial additional expenses in developing, training and managing such an organization. We may be unable to build a fully integrated commercial organization on a cost effective basis or at all. Any such direct marketing and sales efforts may prove to be unsuccessful. In addition, we will compete with many other companies that currently have extensive and well-funded marketing and sales operations. Our marketing and sales efforts may be unable to compete against these other companies. We may be unable to establish a sufficient sales and marketing organization on a timely basis, if at all.

We may be unable to engage qualified distributors. Even if engaged, these distributors may:

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If we fail to develop sales, managed care, marketing and distribution channels, we would experience delays in generating sales and incur increased costs, which would harm our financial results.

If we are unable to convince physicians as to the benefits of our proposed formulations or products, we may incur delays or additional expense in our attempt to establish market acceptance.

Broad use of our proposed formulations and products and related drug delivery technologies may require physicians to be informed regarding our proposed pharmaceutical formulations or products and the intended benefits. The time and cost of such an educational process may be substantial. Inability to successfully carry out this physician education process may adversely affect market acceptance of our proposed formulations or products. We may be unable to timely educate physicians regarding our intended pharmaceutical formulations or products in sufficient numbers to achieve our marketing plans or to achieve product acceptance. Any delay in physician education may materially delay or reduce demand for our formulations or products. In addition, we may expend significant funds toward physician education before any acceptance or demand for our formulations or products is created, if at all.

Risks Related to Our Products in Development and Regulation

Our failure to obtain costly government approvals, including required FDA approvals, or to comply with ongoing governmental regulations relating to our technologies and proposed products and formulations could delay or limit introduction of our proposed formulations and products and result in failure to achieve revenues or maintain our ongoing business.

Our research and development activities and the manufacture and marketing of our proposed formulations and products are subject to extensive regulation for safety, efficacy and quality by numerous government authorities in the United States and abroad. Before receiving FDA clearance to market our proposed formulations and products, we will have to demonstrate that our formulations and products are safe and effective on the patient population and for the diseases that are to be treated. Clinical trials, manufacturing and marketing of drugs are subject to the rigorous testing and approval process of the FDA and equivalent foreign regulatory authorities. The Federal Food, Drug and Cosmetic Act and other federal, state and foreign statutes and regulations govern and influence the testing, manufacture, labeling, advertising, distribution and promotion of drugs and medical devices. As a result, regulatory approvals can take a number of years or longer to accomplish and require the expenditure of substantial financial, managerial and other resources.

Moreover, we may never receive regulatory approval of our proposed products and formulations. No assurances can be given that we will be able to obtain all required regulatory approvals, and our failure to do so would materially and adversely affect our business, results of operations and viability.

For example, on February 28, 2006, we received a non-approvable letter from the FDA regarding our Emezine ^® NDA. We subsequently have had interactions with the FDA regarding Emezine ^® , and at the present time, given our level of resources and our focus on other initiatives, it is not likely that we will proceed with Emezine ^® in the foreseeable future.

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Our failure to complete or meet key milestones relating to the development of our technologies and proposed products and formulations would significantly impair the viability of our company.

In order to be commercially viable, we must research, develop, obtain regulatory approval for, manufacture, introduce, market and distribute formulations or products incorporating our technologies. For each drug that we formulate with our drug delivery technologies, we must meet a number of critical developmental milestones, including:

The required capital and time-frame necessary to achieve these developmental milestones is uncertain, and we may not able to achieve these milestones for any of our proposed formulations or products in development. Our failure to meet these or other critical milestones would adversely affect the viability of our company.

Conducting and completing the clinical trials necessary for FDA approval is costly and subject to intense regulatory scrutiny. We will not be able to commercialize and sell our proposed products and formulations without completing such trials.

In order to conduct clinical trials that are necessary to obtain approval by the FDA to market a formulation or product, it is necessary to receive clearance from the FDA to conduct such clinical trials. The FDA can halt clinical trials at any time for safety reasons or because we or our clinical investigators do not follow the FDA’s requirements for conducting clinical trials. If we are unable to receive clearance to conduct clinical trials or the trials are halted by the FDA, we would not be able to achieve any revenue from such product as it is illegal to sell any drug or medical device for human consumption without FDA approval.

Moreover, it is our stated intention to attempt to avail ourselves of the FDA’s 505(b)(2) approval procedure, which we believe is less costly and time consuming. If this approval pathway is not available to us with respect to a particular formulation or product or at all, the time and cost associated with developing and commercialize such formulations or products may be prohibitive and our business strategy would be materially and adversely affected.

Data obtained from clinical trials are susceptible to varying interpretations, which could delay, limit or prevent regulatory clearances.

Data already obtained, or in the future obtained, from pre-clinical studies and clinical trials do not necessarily predict the results that will be obtained from later pre-clinical studies and clinical trials. Moreover, pre-clinical and clinical data is susceptible to varying interpretations, which could delay, limit or prevent regulatory approval. A number of companies in the pharmaceutical industry, including those involved in competing drug delivery technologies, have suffered significant setbacks in advanced clinical trials, even after promising results in earlier trials. The failure to adequately demonstrate the safety and effectiveness of a proposed formulation or product under development could delay or prevent regulatory clearance of the potential drug, resulting in delays to commercialization, and could materially harm our business. Our clinical trials may not demonstrate sufficient levels of safety and efficacy necessary to obtain the requisite regulatory approvals for our drugs, and thus our proposed drugs may not be approved for marketing.

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We depend on technology licensed to us by third parties, and the loss of access to this technology would terminate or delay the further development of our products, injure our reputation or force us to pay higher royalties.

We rely, in large part, on drug delivery technologies that we license from third parties such as the Universities, QLT and Reckitt. The loss of these licenses would seriously impair our business and future viability. After the expiration of these licenses, this technology may not continue to be available on commercially reasonable terms, if at all, and may be difficult to replace. The loss of any of these technology licenses could result in delays in developing, introducing or maintaining our products and formulations until equivalent technology, if available, is identified, licensed and integrated. In addition, any defects in the technology we may license in the future could prevent the implementation or impair the functionality of our products or formulation, delay new product or formulation introductions or injure our reputation. If we are required to enter into license agreements with third parties for replacement technology, we could be subject to higher royalty payments.

Competitors in the drug development or specialty pharmaceutical industries may develop competing technology.

Drug companies and/or other technology companies may seek to develop and market nanoencapsulation, mucosal adhesive or other technologies which may compete with our technologies. While we believe that our technologies have certain advantages over potential competitors, competitors may develop similar or different technologies which may become more accepted by the marketplace. In addition, these competitors may be larger and better financed than we are, thus giving them a significant advantage over us.

Our lead product candidates contain narcotic ingredients. The development, manufacturing and sale of such products are subject strict regulation, including the necessity of risk management programs, which may prove difficult or expensive to comply with.

Our lead product candidates, most notably BEMA ^® Fentanyl and BEMA ^® LA, contain narcotic ingredients. Misuse or abuse of such drugs can lead to physical or other harm. The FDA or the U.S. Drug Enforcement Administration, or DEA, currently impose and may impose additional regulations concerning the development manufacture and sale of prescription narcotics. Such regulations include labeling requirements, the development and implementation of risk management programs, restrictions on prescription and sale of these products and mandatory reformulation of our products in order to make abuse more difficult. In addition, state health departments and boards of pharmacy have authority to regulate distribution and may modify their regulations with respect to prescription narcotics in an attempt to curb abuse. In either case, any such current or new regulations may be difficult and expensive for us to comply with, may delay the introduction of our products, may adversely affect our net sales, if any, and may have a material adverse effect on our results of operations.

The DEA limits the availability of the active ingredients used in our products in development and, as a result, our procurement quota may not be sufficient to meet commercial demand or complete clinical trials.

The DEA regulates chemical compounds as Schedule I, II, III, IV or V substances, with Schedule I substances considered to present the highest risk of substance abuse and Schedule V

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substances the lowest risk. The active ingredients in our lead products in development, including fentanyl and the active ingredient in BEMA ^® LA, are listed by the DEA as Schedule II or III substances under the Controlled Substances Act of 1970. Consequently, their manufacture, shipment, storage, sale and use are subject to a high degree of regulation. For example, all Schedule II drug prescriptions must be signed by a physician, physically presented to a pharmacist and may not be refilled without a new prescription.

Furthermore, the DEA limits the availability of the active ingredients used in our products in development and, as a result, our procurement quota of these active ingredients may not be sufficient to complete clinical trials or meet commercial demand. We must annually apply to the DEA for procurement quota in order to obtain these substances. The DEA may not establish procurement quota following FDA approval of an NDA for a controlled substance until after DEA reviews and provides public comment on the labeling, promotion, risk management plan and other documents associated with such product. No assurance can be given that the DEA review of such materials may not result in delays in obtaining procurement quota for controlled substances, a reduction in the quota issued to us or an elimination of our quota entirely. Any delay or refusal by the DEA in establishing our procurement quota for controlled substances could delay or stop our clinical trials or product launches which could have a material adverse effect on our business and results of operations.

Risks Related to Our Industry

The market for our proposed formulations and products is rapidly changing and competitive, and new drug delivery mechanisms, drug delivery technologies, new drugs and new treatments which may be developed by others could impair our ability to maintain and grow our business and remain competitive.

The pharmaceutical and biotechnology industries are subject to rapid and substantial technological change. Developments by others may render our technologies and proposed formulations or products noncompetitive or obsolete, or we may be unable to keep pace with technological developments or other market factors. Technological competition from pharmaceutical and biotechnology companies, universities, governmental entities and others diversifying into the field is intense and is expected to increase. Many of these entities have significantly greater research and development capabilities and budgets than we do, as well as substantially more marketing, manufacturing, financial and managerial resources. These entities represent significant competition for us. Acquisitions of, or investments in, competing pharmaceutical or biotechnology companies by large corporations could increase such competitors’ financial, marketing, manufacturing and other resources.

We are engaged in the development of drug delivery technologies. As a result, our resources are limited and we may experience technical challenges inherent in such technologies. Competitors have developed or are in the process of developing technologies that are, or in the future may be, the basis for competition. Some of these technologies may have an entirely different approach or means of accomplishing similar therapeutic effects compared to our technology. Our competitors may develop drug delivery technologies and drugs that are safer, more effective or less costly than our proposed formulations or products and, therefore, present a serious competitive threat to us.

The potential widespread acceptance of therapies that are alternatives to ours may limit market acceptance of our formulations or products, even if commercialized. Many of our targeted diseases and conditions can also be treated by other medication or drug delivery technologies. These treatments may be widely accepted in medical communities and have a longer history of use. The established use of these competitive drugs may limit the potential for our technologies, formulations and products to receive widespread acceptance if commercialized.

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If users of our proposed formulations or products are unable to obtain adequate reimbursement from third-party payors, or if new restrictive legislation is adopted, market acceptance of our proposed formulations or products may be limited and we may not achieve revenues.

The continuing efforts of government and insurance companies, health maintenance organizations and other payors of healthcare costs to contain or reduce costs of health care may affect our future revenues and profitability, and the future revenues and profitability of our potential customers, suppliers and collaborative partners and the availability of capital. For example, in certain foreign markets, pricing or profitability of prescription pharmaceuticals is subject to government control. In the United States, given recent federal and state government initiatives directed at lowering the total cost of health care, the U.S. Congress and state legislatures will likely continue to focus on health care reform, the cost of prescription pharmaceuticals and on the reform of the Medicare and Medicaid systems. While we cannot predict whether any such legislative or regulatory proposals will be adopted, the announcement or adoption of such proposals could materially harm our business, financial condition and results of operations.

Our ability to commercialize our proposed formulations or products will depend in part on the extent to which appropriate reimbursement levels for the cost of our proposed formulations and products and related treatments are obtained by governmental authorities, private health insurers and other organizations, such as HMOs. Third-party payors are increasingly challenging the prices charged for medical drugs and services. Also, the trend toward managed health care in the United States and the concurrent growth of organizations such as HMOs, which could control or significantly influence the purchase of health care services and drugs, as well as legislative proposals to reform health care or reduce government insurance programs, may all result in lower prices for or rejection of our drugs.

We could be exposed to significant drug liability claims which could be time consuming and costly to defend, divert management attention and adversely impact our ability to obtain and maintain insurance coverage.

The testing, manufacture, marketing and sale of our proposed drug formulations involve an inherent risk that product liability claims will be asserted against us. We currently have a general liability policy with an annual aggregate limit of $2 million with a $1 million limit per occurrence which does not provide coverage for product liability for commercial products. All of our pre-clinical trials have been and all of our proposed clinical and pre-clinical trials are anticipated to be conducted by collaborators and third party contractors. We currently have insurance relating to product liability or insurance related to clinical or pre-clinical trials only with respect to our developmental product portfolio, for which we have a clinical trial liability policy providing for a $2 million aggregate limit. We intend to seek additional insurance against such risks before our product sales are commenced, although there can be no assurance that such insurance can be obtained at such time, or even if it is available, that the cost will be affordable. Even if we obtain insurance, it may prove inadequate to cover claims and/or litigation costs. The cost and availability of such insurance are unknown. Product liability claims or other claims related to our proposed formulations and products, regardless of their outcome, could require us to spend significant time and money in litigation or to pay significant settlement amounts or judgments. Any successful product liability or other claim may prevent us from obtaining adequate liability insurance in the future on commercially desirable or reasonable terms. In addition, product liability coverage may cease to be available in sufficient amounts or at an acceptable cost. An inability to obtain sufficient insurance coverage at an acceptable cost or otherwise to protect against potential product liability claims could prevent or inhibit the commercialization of our drug delivery technology. A product liability claim could also significantly harm our reputation and delay market acceptance of our proposed formulations and products.

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Our business involves environmental risks related to handling regulated substances which could severely affect our ability to conduct research and development of our drug delivery technology.

In connection with our research and development activities and our manufacture of materials and drugs, we are subject to federal, state and local laws, rules, regulations and policies governing the use, generation, manufacture, storage, air emission, effluent discharge, handling and disposal of certain materials, biological specimens and wastes. Although we believe that we have complied with the applicable laws, regulations and policies in all material respects and have not been required to correct any material noncompliance, we may be required to incur significant costs to comply with environmental and health and safety regulations in the future. Our research and development may in the future involve the controlled use of hazardous materials, including but not limited to certain hazardous chemicals and narcotics. The current hazardous chemicals that we currently use, which may change as our research progresses, are chloroform and methanol. We are authorized to use these and other hazardous chemicals in our facilities through our affiliation with the UMDNJ. UMDNJ also disposes these chemicals from our premises as part of our agreement to use the facilities and carries general liability insurance in this regard.

Although we believe that our safety procedures for storing, handling and disposing of such materials will comply with the standards prescribed by state and federal regulations, we cannot completely eliminate the risk of accidental contamination or injury from these materials. In the event of such an occurrence, we could be held liable for any damages that result and any such liability could exceed our resources.

Risks Related to Our Management and Key Employees

We depend upon key personnel who may terminate their employment with us at any time, and we will need to hire additional qualified personnel.

Our success will depend to a significant degree upon the continued services of key management, technical, and scientific personnel, including Drs. Francis O’Donnell, Mark Sirgo, Andrew Finn, Raphael Mannino and Mr. James McNulty. Our management and other employees may voluntarily terminate their employment with us at any time. The loss of the services of these or other key personnel, or the inability to attract and retain additional qualified personnel, could result in delays to development or approval, loss of sales and diversion of management resources. In addition, our success will depend on our ability to attract and retain other highly skilled personnel, including research scientists. Competition for qualified personnel is intense, and the process of hiring and integrating such qualified personnel is often lengthy. We may be unable to recruit such personnel on a timely basis, if at all, which would negatively impact our development and commercialization programs.

Additionally, we do not currently maintain “key person” life insurance on the lives of our Chairman of the Board, Dr. Frank O’Donnell, our President and Chief Executive Officer, Dr. Mark Sirgo, or any of our other executive officers. This lack of insurance means that we may not have adequate compensation for the loss of the services of these individuals.

Executive officers, directors and entities affiliated with them have substantial control over us, which could delay or prevent a change in our corporate control favored by our other stockholders.

As of the date of this Report, our directors, executive officers and affiliated principal stockholders, together with their affiliates, beneficially own, in the aggregate, approximately 30.5% of our outstanding common stock. These figures do not reflect any conversion or exercise of our outstanding shares of Series A Preferred, the vast majority of which is held by Drs. Sirgo and Finn, or our convertible

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notes with Laurus. Additionally, these figures do not reflect any future potential exercise of our Class A warrants or other outstanding warrants (including those issued to Laurus, CDC and others) into shares of common stock or the increased percentages that our officers and directors may have in the event that they exercise any of the options granted to them under our Amended and Restated 2001 Stock Incentive Plan or if they otherwise acquire additional shares of common stock generally.

The interests of our current officer and director stockholders may differ from the interests of other stockholders. As a result, these current officer and director stockholders would have the ability to exercise significant control over all corporate actions requiring stockholder approval, irrespective of how our other stockholders may vote, including the following actions:

Certain of our management team have relationships which may potentially result in conflicts of interests.

Dr. O’Donnell, who is the Chairman of our board of directors and also is a substantial beneficial owner of our securities, has a financial interest in a number of other companies which have business relationships with us. These companies include Accentia, RetinaPharma Technologies, Inc., Biotechnology Specialty Partners, Inc, and American Prescription Providers, Inc. We have entered into license agreements with Accentia and RetinaPharma International, Inc. with regard to proposed products incorporating our Bioral ^® technology. We have entered into a non-exclusive distribution with Biotechnology Specialty Partners, Inc. Each of these business arrangements was approved (with Dr. O’Donnell abstaining) by our board of directors and our predecessor’s board of directors. In addition, Dr. Mannino is a member of the board of directors of Biovest International, Inc. (OTC BB:BVTI), a subsidiary of Accentia, and Mr. McNulty is employed by Accentia. These relationships and agreements or any future agreements may involve conflicting interests between our interests, the interests of the other entities and such members of our management.

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Risks Related to Our Publicly-Traded Securities

Our stock price is subject to market factors, and your investment in our securities could decline in value.

Since our initial public offering in June 2002, there has only been a limited public market for our securities and there can be no assurance that an active trading market in our securities will be maintained. In addition, the overall market for securities in recent years has experienced extreme price and volume fluctuations that have particularly affected the market prices of many smaller companies. In particular, the market prices of securities of biotechnology and pharmaceutical companies have been extremely volatile, and have experienced fluctuations that often have been unrelated or disproportionate to operating performance of these companies. These broad market fluctuations could result in extreme fluctuations in the price of our securities, which could cause a decline in the value of your securities. These fluctuations, as well as general economic and market conditions, may have a material or adverse effect on the market price of our common stock.

If we cannot meet the Nasdaq Capital Market’s continuing listing requirements and Nasdaq rules, Nasdaq may delist our securities, which could negatively affect our company, the price of our securities and your ability to sell our securities.

In 2004, according to rules of the Nasdaq Capital Market (then known as the Nasdaq SmallCap Market), our shares of common stock were subject to potential delisting from such market because we did not meet certain requirements. Also, on September 15, 2005, the Nasdaq Stock Market informed us of its view that we did not meet continuing listing requirements as a result of the non-independent status of Donald L. Ferguson, a former director of our company. These issues have been resolved and we believe that we are currently in compliance with Nasdaq listing requirements. Although, as of the date of this Report, our shares are still listed on the Nasdaq Capital Market, in the future, we may not be able to meet the listing maintenance requirements of the Nasdaq Capital Market and Nasdaq rules, which require, among other things, minimum stockholders equity of $2.5 million or a minimum market capitalization of $35 million and a majority of “independent” directors on our board of directors.

If we are unable to satisfy the Nasdaq criteria for maintaining listing, our securities could again be subject to delisting. Trading, if any, of our securities would thereafter be conducted in the over-the-counter market, in the so-called “pink sheets” or on the National Association of Securities Dealers, Inc.’s “electronic bulletin board.” As a consequence of any such delisting, an event of default may be called under our Laurus notes and, regardless of whether such an event of default is called, a stockholder would likely find it more difficult to dispose of, or to obtain accurate quotations as to the prices of our securities.

Additional authorized shares of our common stock and preferred stock available for issuance may adversely affect the market for our common stock.

We are authorized to issue 45 million shares of our common stock. As of April 13, 2007, there were 16,682,268 shares of common stock issued and 16,666,777 shares of common stock outstanding. However, the total number of shares of our common stock issued and outstanding does not include shares reserved in anticipation of the exercise of options or warrants. We will likely, subject to the approval of our stockholders, increase the size of our option plan at our next annual meeting of stockholders. To the extent such options (including options under our larger, amended option plan) or warrants are exercised, the holders of our common stock may experience further dilution.

In addition, as in the case of our February and May 2005 financings with Laurus, in the event that

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any future financing should be in the form of, be convertible into or exchangeable for, equity securities, and upon the exercise of options and warrants, investors may experience additional dilution. This same principle applies to potential conversions of shares of our Series C Stock.

Moreover, in addition to the above referenced shares of common stock which may be issued without stockholder approval, we have 5,000,000 shares of authorized preferred stock, the terms of which may be fixed by our board of directors. We have issued preferred stock in the past, and our board of directors has the authority, without stockholder approval, to create and issue one or more additional series of such preferred stock and to determine the voting, dividend and other rights of holders of such preferred stock. The issuance of any of such series of preferred stock may have an adverse effect on the holders of common stock.

Shares eligible for future sale may adversely affect the market for our common stock.

We presently have a significant number of convertible securities outstanding, including: (i) 1,647,059 shares of common stock, issuable upon full conversion of shares of our Series C Stock, (ii) 2,732,787 shares of common stock issuable upon exercise of outstanding stock options at a weighted average exercise price of $2.96 per share, and (iii) 7,594,129 shares of common stock issuable upon exercise of our outstanding warrants at a weighted average exercise price of $4.27 per share and (iv) 2,085,000 shares underlying our publicly-traded warrants, which expire on June 24, 2007 currently have an exercise price at $6.11 per share (originally $6.30 per share, but adjusted downward because of issuances of our securities at below the market price on the date of the issuance). If and when these securities are converted or exercised into shares of our common stock, our shares outstanding will increase. Such increase in our outstanding securities, and any sales of such shares, could have a material adverse effect on the market for our common stock and the market price of our common stock.

In addition, from time to time, certain of our stockholders may be eligible to sell all or some of their shares of common stock by means of ordinary brokerage transactions in the open market pursuant to Rule 144, promulgated under the Securities Act of 1933, as amended, which we refer to herein as the Securities Act, subject to certain limitations. In general, pursuant to Rule 144, a stockholder (or stockholders whose shares are aggregated) who has satisfied a one year holding period may, under certain circumstances, sell within any three month period a number of securities which does not exceed the greater of 1% of the then outstanding shares of common stock or the average weekly trading volume of the class during the four calendar weeks prior to such sale. Rule 144 also permits, under certain circumstances, the sale of securities, without any limitation, by our stockholders that are non-affiliates that have satisfied a two year holding period. Any substantial sale of our common stock pursuant to Rule 144 or pursuant to any resale prospectus may have a material adverse effect on the market price of our securities.

Our certificate of incorporation, our bylaws and Delaware law contain provisions that preserve our current management.

Our certificate of incorporation and by-laws may discourage, delay or prevent a change in our management team that stockholders may consider favorable. These provisions include:

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These provisions could allow our board of directors to affect your rights as a stockholder since our board of directors can make it more difficult for common stockholders to replace members of the board. Because our board of directors is responsible for appointing the members of our management team, these provisions could in turn affect any attempt to replace our current management team.