ITEM 1: BUSINESS

Overview

        We are a specialty pharmaceutical company that acquires, develops and markets prescription and over-the-counter products in niche therapeutic markets, including dermatology, podiatry, gastroenterology and women’s health. Our business strategy contemplates our

        We have two primary business segments, our Doak Dermatologics subsidiary (which includes the products we acquired from Bioglan Pharmaceuticals in 2004), specializing in therapies for dermatology and podiatry, and our Kenwood Therapeutics division, providing gastroenterology, women’s health, respiratory and other internal medicine brands. To a lesser extent, Kenwood Therapeutics also markets nutritional supplements and respiratory products. At February 28, 2007, Doak Dermatologics had a dedicated sales force of 129 professional sales representatives, while Kenwood Therapeutics had a dedicated sales force of 46 professional sales representatives. During 2006, we launched our A. Aarons subsidiary, which markets authorized generic versions of Doak’s and Kenwood’s products.

        During 2006, we generated net sales of $144,806,640, representing an increase of $105,137,667, or 265%, from our net sales during 2002. Doak Dermatologics, led by its core branded products of ADOXA ^® , KERALAC ^® / KEROL™, SOLARAZE ^® , ZODERM ^® , LIDAMANTLE ^® , and ROSULA ^® , accounted for 79% of our net sales for 2006, while Kenwood Therapeutics, and its core branded products of PAMINE ^® , ANAMANTLE ^® HC and FLORA-Q ^® , accounted for the remaining 21% of our net sales for 2006. We did not recognize revenue for A. Aarons during 2006 because we did not have sufficient historical data (A. Aarons first began selling products during the Third Quarter of 2006) to make the assumptions necessary to record revenue.

        In August 2004, we purchased certain assets of Bioglan Pharmaceuticals. As part of this transaction, we acquired certain intellectual property, regulatory filings and other assets relating to SOLARAZE ^® , a topical treatment indicated for the treatment of actinic keratosis, ADOXA ^® , an oral antibiotic indicated for the treatment of acne, ZONALON ^® , a topical treatment indicated for pruritus, TX SYSTEMS ^® , a line of advanced topical treatments used during in-office procedures, and certain other dermatologic products. We paid approximately $191 million, including acquisition costs, for the Bioglan assets.

        During 2006, we entered into agreements with MediGene AG and BioSante Pharmaceuticals, respectively, to commercialize VEREGEN™ and ELESTRIN™, products with significant intellectual property protection. Pursuant to our agreement for VEREGEN™, we have been granted the exclusive license, or sublicense in certain instances, to certain patents, trademarks and other intellectual property for our use in the commercialization in the United States as a prescription product of any ointment or other topical formulation containing green tea catechins, a novel active ingredient, for the treatment of dermatological diseases in humans, including, but not limited to, external genital warts, perianal warts and actinic keratosis. During the Fourth Quarter of 2006, the U.S. Food and Drug Administration (“FDA”) approved the marketing of VEREGEN™ as a new drug indicated for the treatment of external genital and perianal warts. During 2006, we paid MediGene $5.0 million in consideration for development and regulatory activities undertaken prior to the date of our agreement and a $14 million milestone payment that was

triggered by the FDA’s approval of VEREGEN™. VEREGEN™ is patented through 2017 (additional pending patent applications may extend its patent life),

        Pursuant to our agreement for ELESTRIN™, we have been granted the exclusive right to market ELESTRIN™ in the United States. ELESTRIN™, which was approved by the FDA in the Fourth Quarter of 2006, is an estradiol transdermal gel to be prescribed for the treatment of moderate-to-severe “hot flashes” in menopausal women and is available at several dosage levels. ELESTRIN™ is the lowest dose of estradiol approved by the FDA for the treatment of these moderate-to-severe vasomotor symptoms. In consideration for the grant of our right to market ELESTRIN™, we paid BioSante and its licensor for ELESTRIN™ an aggregate of $3.5 million during October 2006. Under our agreement with BioSante, the FDA approval of ELESTRIN™ triggered regulatory milestone payments of $10.5 million, $7.0 million of which is payable in March 2007, with the remaining $3.5 million payable in December 2007. ELESTRIN™ is patented through 2021 (additional pending patent applications may extend its patent life),

        We expect to launch VEREGEN™ and ELESTRIN™ during 2007. VEREGEN™ will be promoted to physicians by both our Doak Dermatologics and Kenwood Therapeutics sales forces. ELESTRIN™ will be promoted to physicians by our Kenwood Therapeutics sales force. In connection with the launch of these products, we anticipate hiring approximately 20 additional Kenwood Therapeutics sales representatives during 2007 and incurring a corresponding amount of additional sales, marketing and related expenses. Our net sales and profitability would be adversely affected if, for any reason, we were unable to launch VEREGEN™ and ELESTRIN™ on a timely basis.

        With the exception of SOLARAZE ^® , which is patented through at least 2014, VEREGEN™, which is patented through at least 2017, and ELESTRIN™, which is patented through at least 2021, there is no meaningful intellectual property or proprietary protection for our other material branded pharmaceutical products, including ADOXA ^® , and competing generic or therapeutically equivalent versions for most of these other products are sold by other pharmaceutical companies. Currently, only SOLARAZE ^® , KEROL™ and FLORA-Q ^® do not face competition from generic or therapeutically equivalent products, which has, and is expected to continue to, adversely affect our sales. In addition, governmental and other pressure to reduce pharmaceutical costs may result in physicians prescribing products for which there are generic or therapeutically equivalent products.

        We were originally incorporated in New Jersey in January 1985. In May 1998, we reincorporated in Delaware. For a discussion of our international operations and segment information, see Note M to our consolidated financial statements included elsewhere in this Annual Report on Form 10-K.

Our Industry

        We principally target segments of the dermatologic, podiatric, women’s health and gastrointestinal markets where we believe that our sales force can effectively reach the physicians who account for a majority of the prescriptions for conditions treated by our products.

        Many of the pharmaceutical products sold in these specialty markets were originally discovered, researched or developed by major pharmaceutical companies. Due largely to industry consolidation, the costs of marketing and regulatory compliance, or lack of strategic fit, these types of products often do not justify continued promotion by major pharmaceutical companies. Major pharmaceutical companies typically focus on so-called “blockbuster drugs,” which are often described as having the potential to generate annual sales in excess of $500 million. These companies frequently sell their smaller products to specialty pharmaceutical companies, like us.

        Since 2004, our net sales have been negatively impacted by the onset and increase in generic or therapeutically equivalent products competing on price with our brands. Increased competition from the sale of generic or therapeutically equivalent products may cause a further decrease in sales, which would have an adverse effect on our business, financial condition and results of operations. In addition, as a result of increased generic competition, the execution of Distribution Service Agreements (DSAs) with three of our wholesale customers, two of whom are our two largest customers, and a change in these customers’ market dynamics, we have experienced an increase in product returns. Our branded products for which there are no generic or therapeutically equivalent forms

may also face competition from different therapeutic treatments used for the same indications for which our branded products are used.

Dermatologic and Podiatric Markets

        Based on data from Wolters Kluwer (formerly known as NDCHealth Corporation), an independent provider of pharmaceutical prescription data, we estimate the United States market for prescription dermatologic and podiatric drugs accounted for approximately $7.7 billion in retail prescription sales for 2006. Within the dermatologic market we estimate, based in part on data from Wolters Kluwer, that approximately 12,000 dermatologists specialize in treating a variety of skin disorders, including acne, eczema, psoriasis and actinic keratosis. Our core dermatologic products, ADOXA ^® , KERALAC ^® / KEROL™, SOLARAZE ^® , ZODERM ^® , LIDAMANTLE ^® and ROSULA ^® , compete in areas such as acne, rosacea, actinic keratosis, topical anesthetics and xerosis, a segment of the market we estimate accounted for approximately $3.8 billion in retail prescription sales in 2006. Within the podiatric market we estimate, based in part on data from Wolters Kluwer, that approximately 13,000 podiatrists treat patients suffering from a range of foot disorders, including athlete’s foot and nail disorders that can be treated with prescription products.

        Within the dermatologic market we estimate, based in part on data from Wolters Kluwer, that approximately 4,000 dermatologists are experienced and skilled in the treatment of external genital and perianal warts caused by human papilloma virus (HPV). External genital and perianal warts caused by HPV are conditions that our new product, VEREGEN™, is indicated to treat. External genital warts are one of the most common and fastest spreading venereal diseases worldwide. It is estimated that approximately 14 million people in the United States are infected with strains of HPV that cause external genital warts, making the United States the largest market for this indication. According to Wolters Kluwer, the U.S. market for this condition is approximately $200 million per year. We believe that dermatologists will predominantly treat male patients infected with external genital or perianal warts caused by HPV.

Gastrointestinal Market

        Based on data from Wolters Kluwer, we estimate that the United States market for prescription gastrointestinal drugs accounted for approximately $20.6 billion in retail prescription sales for 2006. Within the gastrointestinal market we estimate, based in part on data from Wolters Kluwer, that approximately 11,000 gastroenterologists specialize in treating a variety of stomach and intestinal disorders. We estimate that the segment of this market that focuses on the lower gastrointestinal tract, excluding heartburn related disorders, accounted for approximately $2.4 billion in retail prescription sales for 2006. Many of the drugs in this segment treat conditions such as constipation, hemorrhoids and colitis. Our core gastrointestinal drugs, PAMINE ^® , ANAMANTLE ^® HC and FLORA-Q ^® address principally hemorrhoids and symptoms associated with irritable bowel syndrome, specifically gastrointestinal pain and cramping.

Women’s Health Market

        Based in part on data from Wolters Kluwer, we estimate that there are approximately 14,000 women’s health providers, particularly OB/GYNs, who account for the majority of prescriptions in the entire $1.3 billion annual U.S. estrogen therapy market, which consists of oral and topical products. We believe that ELESTRIN™, our new topical, transdermal gel that has been approved by the FDA as offering the lowest effective dose of estradiol in the marketplace for the treatment of moderate-to-severe hot flashes in menopausal women, will compete primarily in the transdermal segment of this market. The transdermal segment consists primarily of patch products, and is expected to grow to more than $300 million annually over the next several years. We believe that women’s health providers, particularly OB/GYNs, will treat female patients infected with external genital or perianal warts caused by HPV.

Our Strategy

        Our primary objective is to be a leading specialty pharmaceutical company focused on selected pharmaceutical needs within the dermatologic, podiatric, women’s health and gastrointestinal markets. Our business

        strategy contemplates our in-licensing phase II and phase III drugs and developing and bringing to market products with long-term intellectual property protection. Our recent licensing transactions with MediGene for VEREGEN™ and BioSante for ELESTRIN™ are examples of our implementing this strategy. Under the MediGene Agreement, we also have rights to additional products containing green tea catechins that may be developed by MediGene for other dermatological indications. VEREGEN™ is patented through 2017 and ELESTRIN™ is patented through 2021 (pending patent applications may extend the patent life of each product), and we anticipate commencing commercialization of each product during 2007.

        Our business strategy also includes our commercializing brands that fill unmet patient and physician needs. For example, our SOLARAZE ^® Gel product is the only topical treatment for actinic keratosis that is approved by the FDA for use on other parts of the body besides the face and scalp. Further, ELESTRIN™, our new estradiol transdermal gel indicated for the treatment of moderate-to-severe hot flashes in menopausal women, has been approved by the FDA as the lowest dose of estradiol currently available on the market, fully 50% lower than the nearest current competitor.

        We also seek to expand existing partnerships and joint venture relationships with biotechnology and specialty pharmaceutical companies and fostering new strategic alliances designed to deliver a stronger product portfolio. We are continually pursuing new business opportunities and reassessing existing relationships. In addition to the MediGene and BioSante Agreements, our agreement in 2006 with Polymer Science to develop delivery systems not currently utilized by us for our future products is an example of this. For a more detailed discussion of our agreement with Polymer Science, see “Business- Products In Development” included elsewhere in this Annual Report.

        We also plan to increase our focus on research and development activities and to continue to develop products organically with longer lifecycles and to extend indications for our current product portfolio. Our introduction of core product line extensions, such as ADOXA Pak ^® , KEROL™ and ANAMANTLE ^® HC GEL, following the launch of generic or therapeutically equivalent versions of these products, demonstrates our commitment to enhancing our product lifecycle management.

        Our core branded products that we actively promote in the dermatologic, podiatric, gastrointestinal and women’s health markets are described below. With the exception of SOLARAZE ^® , KEROL™, FLORA-Q ^® , VEREGEN™ and ELESTRIN™, all of our other core brands are currently subject to some form of competition from generic or therapeutically equivalent products offered by other pharmaceutical companies.

        ADOXA ^® , doxycycline monohydrate, is a member of the tetracycline family of antibiotics and is available in 150mg, 100mg, 75mg and 50mg tablets. ADOXA ^® is available in bottles of tablets and as ADOXA Pak ^® , a convenient package that may enhance patient compliance and encourage physician prescribing. We also introduced ADOXA ^® Pak in an effort to offset the effects of generic competition. The tetracycline family of antibiotics is useful adjunctive therapy for the treatment of severe acne. These medications work by suppressing the common bacteria, P. acnes (the causative agent for acne), on the skin. They are often used in conjunction with topical therapies as part of an overall acne treatment regimen. ADOXA ^® is one of several branded tetracycline products for acne treatment. ADOXA’s commercial success is based on factors such as its small, easy-to-swallow tablet form and doxycycline’s proven safety profile. We have granted Par Pharmaceutical the right to market authorized generic versions of our ADOXA ^® 50mg, 75mg and 100mg tablets in bottles. Based on data from Wolters Kluwer, we estimate that, as of December 31, 2006, ADOXA ^® had approximately 16%, or $60 million, of the annual market for the oral antibiotic treatment for acne.

        KEROL™ and KERALAC ^® are prescription urea-based topical moisturizing therapies with keratolytic properties (helps to remove the surface layer of dead cells). KEROL™ is currently available as a urea-medicated cloth in its own packaging. We launched KEROL™ in the Fourth Quarter of 2006 as a line extension to KERALAC ^® in an effort to offset KERALAC ^® generic competition. KERALAC ^® is currently available in five formulations - a lotion, cream, nail gel, ointment and a Nailstik™. KERALAC ^® LOTION is marketed for mild to moderate dry skin, KERALAC ^® CREAM is marketed for moderate to severe dry skin and KERALAC ^® GEL is marketed for site-specific dry skin, nail debridement and as a nail softener. KERALAC ^® NAILSTIK is a patient-friendly application to treat diseased and damaged nails. KERALAC ^® OINTMENT is a site-specific treatment for dry skin relief. We developed KERALAC ^® as an enhancement to our CARMOL ^® 40 products. Based on data from Wolters Kluwer, we estimate that, as of December 31, 2006, KEROL™, KERALAC ^® and CARMOL ^® 40 collectively had approximately 21%, or $30 million, of the annual urea-based prescription severe dry skin and damaged nails market.

        SOLARAZE ^® Gel is an FDA-approved dermatological product containing the nonsteroidal anti- inflammatory diclofenac sodium in a 3% topical formulation. SOLARAZE ^® Gel is used to treat actinic keratosis. Actinic keratoses are common, pre-cancerous skin lesions affecting a large proportion of fair-skinned individuals. Actinic keratosis skin lesions are caused by over-exposure to the sun. Prior to the introduction of SOLARAZE ^® Gel, dermatology treatment options typically included cryosurgery, 5-fluorouracil and aminolevulinic acid HCl. SOLARAZE ^® Gel’s commercial success is based on factors such as its efficacy, tolerability/side-effect profile and its convenient, easy-to-apply non-greasy gel form. SOLARAZE ^® Gel is also the only topical treatment for actinic keratosis that is approved for use on other parts of the body besides the face and scalp. Based on data from Wolters Kluwer, we estimate that, as of December 31, 2006, SOLARAZE ^® Gel had approximately 19%, or $34 million, of the annual market for the topical treatment for actinic keratosis. SOLARAZE ^® is patented through at least 2014.

        ZODERM ^® CLEANSER, ZODERM ^® CREAM, ZODERM ^® GEL and ZODERM ^® REDI-PADS™ are internally developed benzoyl peroxide topical prescription products that help treat acne. The active ingredient in all ZODERM ^® products is benzoyl peroxide, which has antibacterial properties that are effective in treating acne.

        LIDAMANTLE ^® and LIDAMANTLE ^® HC, available in cream and lotion formulations, are prescription products with a topical anesthetic (lidocaine) that help relieve pain, soreness, itching and irritation caused by insect bites, eczema and other skin conditions. LIDAMANTLE ^® and LIDAMANTLE ^® HC are formulated in a special base that mimics the pH of healthy skin, thus providing an environment that facilitates healing, protects against infections and alleviates irritation. LIDAMANTLE ^® HC also contains hydrocortisone, which helps to reduce inflammation.

        ROSULA ^® AQUEOUS CLEANSER, ROSULA ^® AQUEOUS GEL and ROSULA ^® NS PADS are internally developed topical prescription products that treat skin conditions, including acne and rosacea. The active ingredients in ROSULA ^® AQUEOUS GEL and ROSULA ^® AQUEOUS CLEANSER, sodium sulfacetamide and sulfur, have antibacterial properties that are effective against acne and reduce the redness (erythema) and lesions

associated with rosacea. The active ingredient in ROSULA ^® NS PADS, sodium sulfacetamide, also acts as an antibacterial that is effective for acne and rosacea.

        PAMINE ^® and PAMINE ^® FORTE are prescription lactose-free, antispasmodic oral therapies that are indicated for the adjunctive therapy of peptic ulcer. PAMINE ^® FORTE contains twice the amount of methscopolamine bromide, the active ingredient of PAMINE ^® , and may be taken less frequently than PAMINE ^® , which we believe may promote greater patient compliance. Because both PAMINE ^® and PAMINE ^® FORTE have limited ability to cross the blood-brain barrier (BBB), they cause fewer side effects, such as dizziness and blurred vision, than comparable drugs that cross the BBB.

        ANAMANTLE HC ^® is a prescription cream containing a topical anesthetic (lidocaine) and hydrocortisone (an anti-inflammatory), which treats hemorrhoids and anal fissures. Because ANAMANTLE HC ^® is formulated in a pH-balanced base, it can encourage a pH that facilitates healing, reduces swelling and soothes irritation. ANAMANTLE HC ^® cream is packaged as a kit containing 20 single-use units, each containing a single-use tube and applicator, as well as a soothing cleansing wipe. ANAMANTLE HC ^® FORTE delivers twice the anti-inflammatory medication of the original ANAMANTLE HC ^® and contains mucoadhesive properties that are designed to promote better adhesion to affected areas. During the Second Quarter of 2006, we launched ANAMANTLE HC ^® GEL, the only topical treatment for hemorrhoids and anal fissures containing 2.5% hydrocortisone and 3% lidocaine.

        FLORA-Q ^® is an over-the-counter nutritional supplement blend of bacterial strains designed to promote the proper balance of natural healthful bacteria in the intestines, often referred to as probiotics. FLORA-Q ^® contains four proprietary strains of probiotic bacteria in a novel delivery system that ensures safe passage of the probiotic strains through the stomach and high potency delivery to the intestinal tract, where its beneficial effect is realized. Additionally, FLORA-Q ^® requires no refrigeration and is available in a convenient capsule form.

        VEREGEN™ is an FDA-approved topical ointment indicated for the treatment of external genital and perianal warts. The active ingredient in VEREGEN™ is a defined mixture of catechins extracted from green tea, a novel active ingredient, that has been proven effective for the treatment of external genital and perianal warts caused by certain strains of HPV. External genital warts are one of the most common and fastest spreading venereal diseases worldwide. It is estimated that approximately 14 million people in the U.S. are infected with the strains of HPV that cause external genital warts. Current treatment for external genital or perianal warts primarily consists of cryosurgery and the topical therapy Aldara™. VEREGEN™ is the first new treatment for external genital and perianal warts since 1997. VEREGEN™ is patented through at least 2017. We intend to launch VEREGEN™ during 2007.

        ELESTRIN™ is an FDA-approved estradiol transdermal gel indicated for the treatment of moderate-to-severe vasomotor symptoms (hot flashes) in menopausal women. ELESTRIN™ has been approved by the FDA as the lowest dose of estradiol currently available on the market, fully 50% lower than the nearest current competitor. There has been a growing trend in medical literature and general media in support of low-dose estrogen replacement therapies and transdermal estradiol products. ELESTRIN™ will conform to the recommendations directed to physicians by the FDA and the American College of Obstetricians and Gynecologists to prescribe the lowest effective dose of estrogen to control menopausal symptoms such as hot flashes. ELESTRIN™ is patented through at least 2021. We intend to launch ELESTRIN™ during 2007.

        Our A. Aarons subsidiary, which commenced operations during the Third Quarter of 2006, currently sells authorized generic versions of our ZODERM ^® , ANAMANTLE HC ^® , PAMINE ^® , PAMINE ^® FORTE, CARMOL ^® 40 and KERALAC ^® brands. We anticipate that A. Aarons will commence distribution of authorized generic versions of our other branded products that are facing competition from generic or therapeutically equivalent products during 2007.

        Percentages of our net sales by category for 2004, 2005 and 2006 were as follows:

        Financial information for 2004, 2005 and 2006 is presented in our consolidated financial statements included as part of this Annual Report on Form 10-K.

Products In Development

        We have developed internally and obtained from others rights to pharmaceutical agents in various stages of development. We currently have two new products, VEREGEN™ and ELESTRIN™, that we intend to launch during 2007, and are also planning to launch product line extensions for existing brands and reformulations of currently marketed products.

        On January 30, 2006, we entered into a Collaboration and License Agreement with MediGene AG for VEREGEN™. Under the MediGene Agreement, MediGene has granted us the exclusive license, or sublicense in certain instances, to certain patents, trademarks and other intellectual property for our use in the commercialization in the United States as a prescription product of any ointment or other topical formulation containing green tea catechins developed pursuant to our agreement with MediGene for the treatment of dermatological diseases in humans, including, but not limited to, external genital warts, perianal warts and actinic keratosis. MediGene has also granted us the non-exclusive license, or sublicense in certain instances, to certain patents, trademarks and other intellectual property to manufacture those products outside of the United States.

        On October 31, 2006, we announced that MediGene had received approval from the FDA to market VEREGEN™ as a new drug indicated for the treatment of external genital and perianal warts. VEREGEN™ has patent protection through at least 2017. Under the MediGene Agreement, we agreed to purchase exclusively from MediGene the active product ingredient, a mixture of green tea catechins, required for our commercialization of the products in the United States and have agreed to certain minimum purchase amounts contingent upon regulatory approval. The MediGene Agreement further provides that MediGene and we may engage in development and regulatory activities relating to products covered by the MediGene Agreement for indications other than a treatment for external and perianal warts to be applied three times per day (the “EGW Indication”) or new developments that would extend the scope of the EGW Indication. If we decide to pursue these other activities, MediGene and we will share the costs of such activities in varying percentages, depending on the indication sought and other circumstances. MediGene retains the rights to data generated under such activities for use outside the United States. If certain criteria are not met at various points along the development timeline for particular products, or if certain products being developed cease to have economic viability, MediGene and we each have the right to cease our participation in, and funding of, the development and regulatory activities relating to that particular product.

        During 2006, we paid MediGene an aggregate of $19,000,000 in consideration for development and regulatory activities undertaken prior to the date of our agreement and as a result of the FDA approving VEREGEN™. The MediGene Agreement also contemplates additional milestone payments that, when added to the milestones already paid by us, could aggregate to a maximum of approximately $69,000,000. These milestones are dependent upon specific achievements in the product development and regulatory approval process of products under the Agreement for indications other than the EGW Indication and also based upon our net sales of all products under the Agreement, including sales relating to the EGW Indication (which could aggregate to a maximum of approximately $31,000,000 in milestones). In addition to these payments, we will also pay MediGene, with respect to each product, a product royalty based on a percentage (in the mid-teens) of net sales during the product royalty term, which percentage is subject to reduction under certain circumstances. Thereafter, MediGene is entitled to a trademark royalty based on a percentage (in the low single digits) of net sales.

        The MediGene Agreement expires on the last day of the Royalty Term (as defined in the Agreement) of the product whose Royalty Term is the last-to-expire of all products developed and marketed under the Agreement. Either party may terminate the Agreement in its entirety by notice in writing to the other party upon or after any material breach of the Agreement by the other party, if the other party has not cured the breach within 60 days after written notice to cure has been given by the non-breaching party to the breaching party; however, if any breach relates solely to one or more products, then the non-breaching party may terminate the Agreement only to the extent it applies to such product or products, with certain exceptions. Either party may also terminate the Agreement in certain other instances described in the Agreement.

        The VEREGEN™ license includes the use of a patent which expires during 2017 and several other patent pending applications have been filed with the U.S. Patent and Trademark Office, which may extend the patent life. However, VEREGEN™ should be difficult to substitute generically due to the natural configurations of the catechins, which are proprietary. As a result, we expect the useful life of VEREGEN™ will be beyond the expiration date of its patent(s). We have estimated the economic life of the VEREGEN™ license based upon the expected future cash flow contributions over the expected useful life to be 15 years.

        We are in the process of creating and implementing our launch and initial marketing strategies for VEREGEN™ and expect to launch VEREGEN™ during 2007 as soon as commercial quantities of VEREGEN™ become available to us.

        On November 7, 2006, we entered into an agreement with BioSante Pharmaceuticals to market its estradiol transdermal gel, ELESTRIN™, in the United States. ELESTRIN™ is to be prescribed for the treatment of moderate-to-severe hot flashes in menopausal women and is available at several dosage levels. On December 19, 2006, we announced that BioSante had received approval from the FDA to market ELESTRIN™. ELESTRIN™ is the lowest dose of estradiol approved by the FDA for the treatment of moderate-to-severe vasomotor symptoms (“hot flashes”). In consideration for the grant of our right to market ELESTRIN™, we paid BioSante and its licensor for ELESTRIN™ an aggregate of $3.5 million during October 2006. As a result of the FDA’s approval of ELESTRIN™, we are obligated to pay $10.5 million in regulatory milestones, $7.0 million of which is due in March 2007, with the remaining $3.5 million due in December 2007, a royalty on net sales (in the low teens), and sales-based milestones.

        The ELESTRIN™ license includes the use of a patent covering ELESTRIN™ until 2021 and several other pending patent applications have been filed with the U.S. Patent and Trademark Office, which may extend the patent life. The term of the license agreement is the later of the expiration of the patents or the 12th anniversary of the first sale of the product. However, we can continue to commercialize ELESTRIN™ after the patents expire or the 12th anniversary of the first sale of the product. After the term of the license agreement expires, we are not required to pay a royalty to BioSante. We have estimated the economic life of the ELESTRIN™ license based upon the expected future cash flow contributions over the expected useful life to be 12 years.

        We are in the process of creating and implementing our launch and initial marketing strategies for ELESTRIN™ and expect to launch ELESTRIN™ during 2007 as soon as commercial quantities of ELESTRIN™ become available to us.

        During 2006, we also agreed to development terms with Polymer Science, Inc. who will develop delivery systems not currently used by us for future products that we intend to commercialize. Polymer Science will manufacture the products that will incorporate these new delivery systems exclusively for us. These products are being designed to help fill physician and patient needs for the effective and convenient delivery of the active ingredients to be incorporated in them. Initial launches of these products are expected in 2007 and beyond.

Marketing and Sales

        We market and sell our products primarily through our full-time sales personnel and wholesalers. As of February 28, 2007, we employed a national sales force, including district managers, of 175 professional sales representatives. These representatives seek to cultivate relationships of trust and confidence with dermatologists, podiatrists, gastroenterologists and other specialists who write a high volume of prescriptions in our core market segments. Our marketing and sales promotions principally target these doctors through visits where our sales representatives provide information and product samples to encourage these physicians to prescribe our products. In

addition, we use a variety of marketing techniques to promote our products, including journal advertising, promotional materials, specialty publications, convention participation, focus groups, educational conferences, telemarketing and informational websites.

        As of February 28, 2007, Doak Dermatologics had 129 sales representatives and district managers who call on dermatologists and podiatrists throughout the United States. As of February 28, 2007, our Kenwood Therapeutics division had 46 sales representatives and district managers who call on gastroenterologists, colon and rectal surgeons and women’s health providers in the United States. We believe we have created an attractive incentive program for our professional sales force that is based upon goals in prescription growth and market share improvement. We also train our professional sales force on applicable pharmaceutical sales and marketing ethics and guidelines and periodically apprise them of new legal developments that may influence the methods by which they act. In accordance with a growing trend among many states, we have adopted, and our professional sales force is required to comply with, our Pharma Compliance Program. The policies included in our Pharma Compliance Program are designed to provide guidance to our employees, including our professional sales force, on the legal and ethical standards relating to the most common marketing and sales activities, as well as other usual financial arrangements with physicians, physician assistants and other healthcare practitioners.

        We expect to launch VEREGEN™ and ELESTRIN™ during 2007. VEREGEN™ will be promoted primarily to dermatologists and women’s health providers by both our Doak Dermatologics and Kenwood Therapeutics sales forces. ELESTRIN™ will be promoted to women’s health providers by our Kenwood Therapeutics sales force. In connection with the launch of these products, we anticipate hiring approximately 20 additional Kenwood Therapeutics sales representatives during 2007 and incurring a corresponding amount of additional sales, marketing and related expenses.

        To facilitate sales of our products internationally, we have, as of February 28, 2007, entered into agreements with approximately 24 international marketing and distribution partners to provide for distribution and promotion of our products in more than 37 countries. Net sales from our international operations accounted for $2,952,846 during 2006, or approximately 2%, of our overall net sales for each of 2006, 2005 and 2004.

        During June 2004, we acquired exclusive distribution and marketing rights in selected international markets to the prescription acne and rosacea products Benzamycin ^® , Klaron ^® and Noritate ^® , and three additional products, Hytone ^® , Sulfacet R ^® and Zetar ^® Shampoo. Pursuant to the terms of this acquisition, we have exclusive distribution and marketing rights to these products for eight years in Australia, Japan, the Commonwealth of Independent States (other than Armenia, Azerbaijan, Georgia and Moldova), Latvia, Lithuania, Estonia, Saudi Arabia, the United Arab Emirates, Kuwait and Egypt in the Middle East, and Vietnam, Thailand and Cambodia in Southeast Asia. We are responsible for securing the necessary approvals to market these products in these countries. Through February 2007, we have entered into distribution agreements with entities that will file regulatory applications and promote the products listed earlier in this paragraph in the Commonwealth of Independent States, Saudi Arabia and the United Arab Emirates. We are also currently in negotiations with a potential distribution partner that intends to promote these products in Australia. We anticipate commencing the distribution of certain of these products in Saudi Arabia, the United Arab Emirates, Estonia and Latvia during 2007.

        One of the novel marketing campaigns that we recently initiated and are continuing is our Skin Cancer Screening Awareness Tour. During 2006, we custom-designed a recreational vehicle into a Mobile Diagnosis Vehicle (MDv) from which Board-certified dermatologists could perform skin cancer screenings. We then partnered with The Skin Cancer Foundation in a cross-country tour to raise awareness about skin cancer and the importance of early detection and treatment. At each stop along the tour, dermatologists conducted skin cancer screenings and we educated the public about the dangers of actinic keratosis, squamous cell carcinoma, basal cell carcinoma and melanoma, all different forms of skin cancer. The main goal of the Tour is to encourage people to see their local dermatologists for testing and treatment.

        During 2006, the MDv visited 26 cities and screened 5,573 people, of which 33% were suspected to have some form of pre-cancerous or cancerous condition. Through our extensive promotional and public relations campaign, we spread the word that it is critical that people see their dermatologist to get screened. We also created and maintain a website with a dermatologist finder feature so that people can find a dermatologist in their area.

        We intend to seek new markets in which to promote our product lines and will continue to expand our sales force as product growth and/or product acquisitions warrant. We also continue to seek new international wholesalers and currently are in the process of obtaining market approvals in new countries. Although we anticipate receiving the necessary approvals to market our products in these countries, there can be no assurance that these approvals will be received.

Customers

        We sell our products primarily to wholesalers, who, in turn, supply the nation’s pharmacy retailers. Our customers include several of the nation’s leading wholesalers, such as AmerisourceBergen Corporation, Cardinal Health, Inc., McKesson Corporation, Quality King Distributors, Inc. and other major wholesalers and drug chains. Our four largest customers listed below accounted for an aggregate of approximately 97% of our gross trade accounts receivable at December 31, 2006 and 90% of our gross trade accounts receivable at December 31, 2005. The following table presents a summary of our gross sales to significant customers, all of whom are also wholesalers, as a percentage of our total gross sales:

        We have two principal types of arrangements with wholesalers of our products: (a) traditional arrangements with health benefit providers such as managed care contractors and pharmacy benefit managers (“Standard Arrangements”), and (b) Inventory Management or Distribution Service Agreements (collectively, “DSAs”). Pursuant to Standard Arrangements, we provide discounts to various health benefit providers nationwide for purchases of our products, although such providers have no obligation to order any products at any time and we are under no obligation to offer or provide the discounts. We have utilized Standard Arrangements for several years and expect to continue to do so in the future.

        DSAs are a result of pharmaceutical wholesalers recently shifting from the traditional “buy and hold” model (i.e., wholesalers purchasing in bulk in anticipation of price increases or in exchange for discounts) to the “fee-for-service” model (i.e., where pharmaceutical providers, such as us, pay wholesalers a fee for their distributing the pharmaceutical provider’s products and providing other inventory management and administrative services) in an effort to align wholesaler purchasing patterns with end-user demand. During 2005, we entered into DSAs with Cardinal and McKesson which had effective dates during 2004. We entered into a DSA with Kinray, Inc. during the Third Quarter of 2006. The terms of each DSA require us, generally, to pay fees to the applicable wholesaler, which fees are offset by any price appreciation of the inventory that such wholesaler has on-hand and also by any discounts that we give such wholesaler for new product promotions. In return, the wholesaler is obligated to maintain its inventory levels of our products at agreed upon months-on-hand and to provide us with monthly inventory and sales reports. Based upon these DSAs, we owe these wholesalers, as of December 31, 2006, an aggregate of $1,778,711. We believe that these DSAs, among other things, improve our knowledge of demand for our products, reduce the level of wholesale inventories of our products and improve channel transparency because under the terms of the DSAs, the wholesalers provide us with periodic reports of inventory and demand levels of our products.

Third Party Payors

        Our operating results and business success also depend on the availability of adequate third party payor reimbursement to patients for our branded prescription products. These third party payors include governmental entities, such as Medicaid, private health insurers and managed care organizations. A majority of the United States population now participates in some version of managed care. Because of the size of the patient population covered by managed care organizations, marketing of prescription drugs to them and the pharmacy benefit managers that

serve many of these organizations has become important to our business. Managed care organizations and other third party payors try to negotiate the pricing of medical services and products to control their costs. Managed care organizations and pharmacy benefit managers typically develop formularies to reduce their cost for medications. Formularies can be based on the prices and therapeutic benefits of the available products. Due to their lower costs, generic products are often favored. The breadth of the products covered by formularies varies considerably from one managed care organization to another, and many formularies include alternative and competitive products for treatment of particular medical conditions. Exclusion of a product from a formulary can lead to its sharply reduced usage in the managed care organization patient population. Payment or reimbursement of only a portion of the cost of our prescription products could make our products less attractive to patients, suppliers and prescribing physicians. Changes in the reimbursement policies of these entities could prevent our branded pharmaceutical products from competing on a price basis. If our products are not included within an adequate number of formularies or if adequate reimbursement levels are not provided, or if reimbursement policies increasingly favor generic products, our market share, our gross margins and our overall business and financial condition could be negatively affected. While we focus on the inclusion of our products in these formularies, this marketing channel is highly competitive and we cannot assure that a significant percentage of our core products will be covered by the formularies of the major managed care organizations and pharmacy benefit managers.

        Moreover, some of our products are not of a type generally eligible for reimbursement, primarily due to either the product’s market share being too low to be considered, cheaper generics being available, or because the product is available without a prescription. It is also possible that products manufactured by others could have the same effects as our products and be subject to reimbursement. If this were the case, some of our products might become too costly to patients.

        We engage in a regular marketing campaign to raise the awareness of our brands to third party payors. This campaign involves regularly scheduled targeted product mailings, private meetings and attendance at industry conferences. We intend to continue expanding our existing base of national and regional relationships with third party payors.

Manufacturers and Suppliers

        We do not own or operate any manufacturing or production facilities and all of our products are manufactured and supplied to us by independent companies. Many of these companies also manufacture and supply products for some of our competitors. We do not have licensing or other supply agreements with most of these manufacturers or suppliers for our products, and therefore, some of them could terminate their relationship with us at any time, thereby hampering our ability to deliver and sell the manufactured product to our customers and negatively affecting our operating margins.

        While we could seek alternative sources to manufacture our products, we generally only contract with one manufacturer with respect to each of our products, including our core products. Other than with respect to VEREGEN™, ELESTRIN™, PAMINE ^® and SOLARAZE ^® , our manufacturing contracts are currently in the form of purchase orders. Firm manufacturing agreements are either being negotiated or are in place with respect to our core products, VEREGEN™, ELESTRIN™, PAMINE ^® and SOLARAZE ^® . Further, we and the manufacturers of our products generally rely on suppliers of raw materials used in the production of our products. Some of these materials, including the active ingredients in VEREGEN™, ELESTRIN™, PAMINE ^® and SOLARAZE ^® , are available from only one or a limited number of sources.

        In addition, during 2006, we entered into a development agreement with Polymer Science whereby they agreed to develop and supply us with delivery systems not currently utilized by us for future products to be commercialized by us.

        All manufacturers of pharmaceutical products sold in the United States must comply with “current good manufacturing practices” (cGMP) as determined by the FDA and their manufacturing operations and processes are subject to FDA inspection. Failure to comply with cGMP requirements can lead to the shutdown of a facility, the seizure of product distributed by that the facility and other sanctions. If we wish or need to identify an alternate manufacturer, delays in obtaining FDA approval of the replacement manufacturing facility could cause an interruption in the supply of our products.

        At December 31, 2006, we had an aggregate of $2,212,260 of backlog orders, compared to an aggregate of $1,134,668 of backlog orders at December 31, 2005. Our backlog at December 31, 2006 was primarily the result of our being temporarily out of stock of certain products. All of our backlog orders at December 31, 2006 were filled during the First Quarter of 2007. Likewise, all of our backlog orders at December 31, 2005 were filled during the First Quarter of 2006.

Intellectual Property

        We have recently refocused our business strategy, which anticipates greater investment in products with intellectual property protections. However, other than the ownership or license of patents with respect to SOLARAZE ^® , which is patented through at least 2014, VEREGEN™, which is patented through at least 2017, and ELESTRIN™, which is patented through at least 2021, we do not have meaningful intellectual property or proprietary protection for our other material branded pharmaceutical products, including ADOXA ^® . To our knowledge, none of our patents infringes any patent owned or used by others.

        We rely principally on unpatented proprietary technologies in the development and commercialization of our products. We also depend upon the unpatentable skills, knowledge and experience of our scientific and technical personnel, as well as those of our advisors, consultants and other contractors. To help protect our proprietary know how that is not patentable, and for inventions for which patents may be difficult to enforce, we often use trade secret protection and confidentiality agreements to protect our interests. To this end, we typically require employees, consultants and advisors to enter into agreements that prohibit the disclosure of confidential information and, where applicable, require disclosure and assignment to us of the ideas, developments, discoveries and inventions that arise from their activities for us. Additionally, these confidentiality agreements require that our employees, consultants and advisors do not bring to us, or use without proper authorization, any third party’s proprietary technology.

        We own trademarks associated with our products, including several national and foreign trademark registrations, or common law rights, for each of our material products. We cannot provide any assurance as to the extent or scope of the trademarks or other proprietary protection secured by us on our products. To our knowledge, none of our trademarks infringes any trademark owned or used by others.

Competition

        The pharmaceutical industry is highly competitive. We currently compete primarily in the dermatologic, podiatric and gastrointestinal markets and are becoming more involved in the women’s health market. We believe that competition for product sales is based primarily on brand awareness, price, availability, product efficacy and customer service.

        Most of our currently marketed products do not have patent or other intellectual property protections. Generic or therapeutically equivalent products for most of our brands are sold by other pharmaceutical companies. In addition, governmental and other pressure to reduce pharmaceutical costs may result in physicians prescribing products for which there are generic or therapeutically equivalent products. Further, our branded products for which there are no generic or therapeutically equivalent forms available may face competition from different therapeutic treatments used for the same indications for which our branded products are used.

        Over the past several years, generic or competitive and less expensive versions of many of our products have been introduced, including for different strengths of ADOXA ^® , ZODERM ^® , PAMINE ^® , ROSULA ^® , ANAMANTLE ^® HC and different formulations of KERALAC ^® , which has resulted in reduced demand and significant decreases in our net sales of the affected products. In order to maintain our sales, we may enter into agreements for authorized generic versions of our products and we implement life cycle management techniques such as creating new formulations and delivery methods.

        Many of our competitors are large, well-established companies in the pharmaceutical, chemical, cosmetic and health care fields and may have greater resources than we do to devote to manufacturing, marketing, sales, research and development and acquisitions. Our competitors include Axcan Pharma, Barrier Therapeutics,

CollaGenex Pharmaceuticals, Graceway Pharmaceuticals, King Pharmaceuticals, Medicis, Salix Pharmaceuticals, Sciele Pharma, Stiefel Laboratories, Valeant Pharmaceuticals and Wyeth Pharmaceuticals.

Government Regulation

        Virtually all aspects of our activities are regulated by federal and state statutes and regulations, and by government agencies. The research, development, manufacturing, processing, packaging, labeling, distribution, sale, advertising and promotion of our products, and disposal of waste products arising from these activities, are subject to regulation by one or more federal agencies and their state equivalents, including the FDA, the Drug Enforcement Administration, the Federal Trade Commission, the Consumer Product Safety Commission, the U.S. Department of Agriculture, the U.S. Occupational Safety and Health Administration and the U.S. Environmental Protection Agency, as well as by comparable state agencies and governmental authorities in those foreign countries in which we distribute some of our products.

        Noncompliance with applicable regulatory policies or requirements of the FDA or other governmental authorities could subject us to enforcement actions, such as suspensions of product distribution, seizure of products, product recalls, civil monetary and other penalties, criminal prosecution and penalties, injunctions, “whistleblower “ lawsuits, failure to approve pending drug product applications or total or partial suspension of product marketing approvals. Similar civil or criminal penalties could be imposed by other government agencies or the agencies of the states and localities in which our products are manufactured, sold or distributed, and could have ramifications for our contracts with government agencies, such as our contract with the U.S. Department of Veterans Affairs and the Department of Defense. These enforcement actions would detract from management’s ability to focus on our daily business and would have an adverse effect on the way we conduct our daily business, which could severely impact future profitability.

Pharmaceutical Products

        In the United States, all manufacturers, marketers and distributors of human pharmaceutical products are subject to regulation by the FDA. For innovative, or non-generic, new drugs, an FDA-approved new drug application, or NDA, is required before the drugs may be marketed in the United States. The NDA must contain data to demonstrate that the drug is safe and effective for its labeled uses, and that it will be manufactured to appropriate quality standards. In order to demonstrate safety and effectiveness, an NDA typically must include or reference pre-clinical data from animal and laboratory testing and clinical data from controlled trials in humans. For a new chemical entity, this generally means that lengthy, uncertain and rigorous pre-clinical and clinical testing must be conducted. For compounds that have a record of prior or current use, it may be possible to utilize existing data or medical literature and limited new testing to support an NDA. Any pre-clinical laboratory and animal testing must comply with FDA’s good laboratory practice and other requirements. Clinical testing in human subjects must be conducted in accordance with FDA’s good clinical practice and other requirements. In order to initiate a clinical trial, the sponsor must submit an investigational new drug application, or IND, to the FDA or meet one of the narrow exemptions that exist from the IND requirement. Clinical research must also be reviewed and approved by independent institutional review boards, or IRBs, at the sites where the research will take place, and the study subjects must provide informed consent.

        The FDA can, and does, reject NDAs, require additional clinical trials, or grant approvals on only a restricted basis even when product candidates performed well in clinical trials. The FDA regulates and typically inspects manufacturing facilities, equipment and processes used in the manufacturing of pharmaceutical products before granting approval to market any drug. Each NDA submission requires a substantial user fee payment, unless a waiver or exemption applies. The FDA has committed generally to review and make a decision concerning approval of an NDA within 10 months, and on a new priority drug within six months. However, final FDA action on the NDA can take substantially longer, and where novel issues are presented, there may be review and recommendation by an independent FDA advisory committee. The FDA can also refuse to file and review an NDA it deems incomplete or not properly reviewable.

        Generic drugs are approved through an abbreviated process based on the submission to the FDA of an abbreviated new drug application, or ANDA. The ANDA must seek approval of a drug product that has the same active ingredient(s), dosage form, strength, route of administration, and labeling as a so-called “reference listed

drug” approved under an NDA, although some limited exceptions may be permitted. The ANDA also generally contains limited clinical data to demonstrate that the product covered by the ANDA is absorbed in the body at the same rate and to the same extent as the reference listed drug. This is known as bioequivalence. In addition, the ANDA must contain information regarding the manufacturing processes and facilities that will be used to ensure product quality, and must contain certifications to patents listed with the FDA for the reference listed drug. Special procedures apply when an ANDA contains certifications stating that a listed patent is invalid or not infringed, and if the owner of the patent or the NDA for the reference listed drug brings a patent infringement suit within a specified time, an automatic stay bars FDA approval of the ANDA for a specified period of time pending resolution of the suit or other action by the court. The amount of testing and effort that is required to prepare and submit an ANDA is generally substantially less than that required for an NDA.

        The FDA continues to review marketed products even after approval. If previously unknown problems are discovered or if there is a failure to comply with applicable regulatory requirements, the FDA may restrict the marketing of an approved product, cause the withdrawal of the product from the market, or under certain circumstances seek recalls, seizures, injunctions or criminal sanctions. For example, the FDA may require an approved marketing application or additional studies for any marketed drug product if new information reveals questions about a drug’s safety or effectiveness. In addition, changes to the product, the manufacturing methods or locations, or labeling are subject to additional FDA approval, which may not be received and that may be subject to a lengthy FDA review process.

        Over-the-counter, or OTC, drugs may be sold either under an approved NDA or ANDA, or under special regulations of the FDA known as OTC monographs. The FDA issues OTC monographs for particular product categories, such as cough-cold products. The monographs specify permissible active ingredients, labeling and indications, and a product may be marketed under a monograph without receiving a separate FDA approval. Once the FDA has determined that a drug should be sold on an OTC basis for a particular use, it is generally considered unlawful to continue marketing that drug on a prescription basis for that use. Therefore, once the FDA issues a final OTC monograph, a prescription product covered by the monograph must generally convert from prescription status to OTC status.

        Certain drugs that we and others market are not the subject of an approved NDA or ANDA, or an OTC monograph. FDA has recognized that there are numerous, perhaps thousands, of such drug products currently on the market without FDA approvals or authorizations. These include principally products that first came on the market without an NDA prior to changes in the food and drug laws in 1962, and new products that have come on the market since that time on the grounds that they are identical, similar, or related to pre-1962 products. The FDA has stated that these unapproved products are new drugs under the Federal Food, Drug, and Cosmetic Act and thus require an effective approval in order to be introduced into interstate commerce. However, the FDA also acknowledges that many of these products have been marketed and prescribed for years without raising any safety or effectiveness issues, and thus has established policies stating the circumstances under which it will exercise its enforcement discretion and not take action against an otherwise unapproved new drug. Under these policies, the FDA states that it will exercise its enforcement discretion with respect to drugs marketed without a required FDA approval and focus its enforcement resources on drugs that (1) present potential safety risks, (2) lack evidence of effectiveness, and/or (3) constitute “health fraud drugs.” The FDA also states in these policies that the agency considers drugs presenting a challenge to the drug approval or OTC monograph system as falling into one or all of these categories. This means, among other things, that the FDA will give higher enforcement priority where one company obtains approval of an NDA and other companies are marketing the product without approval, or where drugs are marketed in violation of a final OTC monograph. Recently, the FDA has stated its intention to increase its enforcement in this area and has taken action against certain products, none of which are ours, primarily on the basis of safety concerns. We market a number of our products under these FDA enforcement policies on the basis that they are equivalent to products first marketed prior to 1962. Any change in the FDA’s enforcement discretion and/or policies could alter the way we have to conduct our business and any such change could severely impact our future profitability.

        Whether or not approved under an NDA, all drugs must be manufactured in conformity with cGMPs and other FDA regulations and requirements, and drug products subject to an approved application must be manufactured, processed, packaged, labeled and promoted in accordance with the approved application. Certain of our products must also be packaged with child-resistant and senior friendly packaging under the Poison Prevention

Packaging Act and Consumer Product Safety Commission regulations. Products that do not comply with these requirements can be considered misbranded and subject to seizure, recall, monetary fines, and other penalties. Our third-party manufacturers must comply with cGMP requirements and product specific regulations enforced by the FDA, and are continually subject to inspection by the FDA and other governmental agencies. Manufacturing operations could be interrupted or halted in any of those facilities if a government or regulatory authority determines that our contract manufacturers do not comply with applicable regulations or as a result of an unsatisfactory inspection. Any interruptions of this type could stop or slow the delivery of our products to our customers and affect adversely our results of operations.

        The distribution of prescription pharmaceutical products is subject to the Prescription Drug Marketing Act, or PDMA, which regulates the distribution of drugs and drug samples at the federal level, and sets minimum standards for the registration and regulation of drug distributors by the states. States require the registration of manufacturers and distributors who provide pharmaceuticals, including in certain states even if these manufacturers or distributors have no place of business within the state but satisfy other nexus requirements, for example, the shipment of products into such state. Both the PDMA and state laws limit the distribution of prescription drug product samples to licensed practitioners and impose other requirements to ensure accountability in the distribution of samples.

        Other reporting and recordkeeping requirements also apply for marketed drugs, including for most products requirements to review and report cases of adverse events. Product advertising and promotion are subject to FDA and state regulation, including requirements that promotional claims conform to any applicable FDA approval, and be appropriately balanced and substantiated. OTC drug advertising is also regulated by the Federal Trade Commission. Our sales, marketing and scientific/educational programs must comply with applicable requirements of the anti-kickback provisions of the Social Security Act, the False Claims Act, the Veterans Healthcare Act, and the implementing regulations and policies of the United States Health and Human Services Office of Inspector General and United States Department of Justice, as well as similar state laws. Our pricing and rebate programs must comply with applicable pricing and reimbursement rules, including the Medicaid drug rebate requirements of the Omnibus Budget Reconciliation Act of 1990. If products are made available to authorized users of the Federal Supply Schedule of the General Services Administration, additional laws and requirements apply. All of our activities are potentially subject to federal and state consumer protection and unfair competition laws.

Nutritional Supplements

        The FDA regulates nutritional supplements, including vitamins, minerals and herbs, principally under the Dietary Supplement Health and Education Act of 1994, or DSHEA. DSHEA defines dietary supplements as vitamins, minerals, herbs, other botanicals, amino acids and other dietary substances for human use to supplement the diet, as well as concentrates, metabolites, constituents, extracts or combinations of such dietary ingredients. Generally, under DSHEA, dietary ingredients that were on the market before October 15, 1994 may be used in dietary supplements without notifying the FDA. However, a dietary ingredient that was not marketed in the United States before October 15, 1994 must be the subject of a notification submitted to the FDA unless the ingredient has been present in the food supply as an article used for food without the food being chemically altered. A new dietary ingredient notification must provide the FDA evidence of a history of use or other evidence of safety, and must be submitted to FDA at least 75 days before the initial marketing of the new dietary ingredient.

        DSHEA permits statements of nutritional support to be included in labeling for dietary supplements without FDA pre-approval. Such statements may describe how a particular dietary ingredient affects the structure, function or well-being, but may not state that a dietary supplement will diagnose, cure, mitigate, treat, or prevent a disease unless such claim has been reviewed and approved by the FDA. A company that uses a statement of nutritional support in labeling must possess evidence substantiating that the statement is truthful and not misleading. In some circumstances it is necessary to disclose on the label that the FDA has not evaluated the statement, to disclose the product is not intended to diagnose, treat, cure or prevent a disease, and to notify the FDA about the use of the statement within 30 days of marketing the product.

        Dietary supplements are subject to the cGMP requirements that apply to ordinary foods. In addition, as authorized by DSHEA, the FDA proposed cGMP requirements specifically for dietary supplements. If these regulations are finalized, they will be more detailed than the requirements that currently apply.

        The FDA’s regulation of marketed nutritional supplements includes monitoring safety, through measures such as voluntary dietary supplement adverse event reporting, and product information, such as labeling, claims, package inserts, and accompanying literature. The Federal Trade Commission regulates dietary supplement advertising.

Product Liability Insurance

        We maintain product liability insurance on our products that provides coverage of up to $20,000,000 in the aggregate per year. This insurance is in addition to required product liability insurance maintained by the manufacturers of our products. We cannot assure you that product liability claims against us will not exceed that coverage. To date, no product liability claim has been made against us and we are not aware of any pending or threatened claim.

Employees

        As of February 28, 2007, we had approximately 300 employees. We also maintain active independent contractor relationships with various individuals with whom we have consulting agreements. We believe that our relationships with our employees are good. None of our employees are subject to a collective bargaining agreement.

Web Site Access to Filings with the Securities and Exchange Commission

        All of our electronic filings with the Securities and Exchange Commission, including our Annual Report on Form 10-K, Quarterly Reports on Form 10-Q, Current Reports on Form 8-K and amendments to these reports filed or furnished pursuant to Sections 13(a) or 15(d) of the Securities Exchange Act of 1934, are made available at no cost through our web site, www.bradpharm.com, as soon as reasonably practicable after we file such material with, or furnish it to, the SEC. Our SEC filings are also available through the SEC’s web site at www.sec.gov.

ITEM 1A: RISK FACTORS

        We provide the following discussion of risks and uncertainties relevant to our business. These are factors that we think could cause our actual results to differ materially from expected and historical results. We could also be adversely affected by other factors in addition to those listed here.

RISKS RELATED TO OUR BUSINESS

We derive a majority of our net sales from our core branded products, and any factor that hurts our sales of these products could reduce our revenues and profitability.

        We derive a majority of our net sales from our core branded products, particularly ADOXA ^® , KERALAC ^® / KEROL™, and SOLARAZE ^® . Ten of our core branded products accounted for a total of approximately 87%, 81% and 73% of our net sales for 2006, 2005 and 2004, respectively. We believe that the net sales of these core products, and line extensions, if any, of such products, will constitute the majority of our overall net sales for the foreseeable future unless and until we can develop sales of VEREGEN™, ELESTRIN™ or other new products. Accordingly, any factor that hurts the sales of our core products, individually or collectively, could reduce our revenues and profitability. Net sales of our core branded products could be adversely affected by the following factors, among others:

Our revenues and profitability would be adversely affected if we cannot launch VEREGEN™ or ELESTRIN™ on a timely basis or if these products are not commercially accepted.

        We plan on launching VEREGEN™ and ELESTRIN™ for commercial distribution during 2007. If, for any reason, our launch of either of these products is delayed, our revenues and profitability will be adversely affected, which will have a corresponding negative impact on our business, and would likely negatively affect the market price of our stock. Factors out of our control that could delay the launch of VEREGEN™ or ELESTRIN™ include manufacturing delays or problems, shortages of active product ingredients and shipping delays. In addition, our sales of VEREGEN™ and ELESTRIN™ will be adversely affected, and our revenues and profitability will be correspondingly impacted, if physicians do not accept VEREGEN™ or ELESTRIN™ as acceptable treatment alternatives for patients and do not write prescriptions for these products, our sales and marketing efforts are ineffective or if the safety or efficacy of VEREGEN™ or ELESTRIN™, on a commercial scale, is not sustained.

ADOXA ^® net sales make up a substantial portion of our revenues and profitability and failure to maintain its sales would reduce our revenues and profitability.

        Since August 2004, we have sold ADOXA ^® , an oral antibiotic indicated for the treatment of acne that is not patent protected. ADOXA ^® accounted for approximately 32%, 34% and 13% of our net sales for 2006, 2005 and 2004, respectively. The concentration of our net sales in a single product line makes us particularly dependent on that line. If demand for ADOXA ^® decreases and we fail to replace those sales, our revenues and profitability would decrease.

Our sales suffer from competition by generic or therapeutically equivalent products because we do not have proprietary protection for most of our existing branded pharmaceutical products.

        Most of our currently marketed products do not have patent or other intellectual property protections. Therapeutically equivalent products for most of our brands are sold by other pharmaceutical companies. In addition, governmental and other pressure to reduce pharmaceutical costs may result in physicians prescribing products for which there are generic or therapeutically equivalent products. In addition, our branded products for which there are no generic or therapeutically equivalent forms available may face competition from different therapeutic treatments used for the same indications for which our branded products are used. Over the past several years, generic or competitive and less expensive versions of many of our products have been introduced, including for different strengths of ADOXA ^® , ZODERM ^® , PAMINE ^® , ANAMANTLE ^® HC and different formulations of KERALAC ^® , which has resulted in reduced demand and significant decreases in our net sales of the affected products. In order to maintain our sales, we may enter into agreements for authorized generic versions of our products and we implement life cycle management techniques such as creating new formulations and delivery methods. For example, we authorized generic versions of certain strengths of ADOXA ^® and we also launched ADOXA PAKS ^® , designed to enhance patient compliance and physician prescribing. These strategies may not be successful with respect to individual products or in the aggregate. It is unlikely that once a generic or therapeutically equivalent product is introduced, we will be able to maintain significant sales of the affected product. If aggregate demand for ADOXA ^® , KERALAC ^® , ZODERM ^® , ANAMANTLE ^® HC or any other material product line decreases and we fail to replace

those sales, our revenues and profitability will decrease, which will have an adverse effect on our business, financial condition and results of operations and would likely negatively affect the market price of our stock.

If we cannot purchase or develop new products and bring them to market, our business could suffer.

        In 2006, we refocused our business strategy primarily on in-licensing, developing and bringing-to-market phase II and phase III drugs with long-term intellectual property protection. We also intend to grow by expanding our existing, and entering into new, joint venture relationships and strategic alliances with biotechnology companies. Although we expect to launch VEREGEN™ and ELESTRIN™ in 2007, we cannot assure you that we will continue to implement our refocused business strategy effectively. Factors that could limit or restrict our ability to implement our strategy include:

        While we anticipate making future acquisitions and entering into development agreements in accordance with our strategic plan, we might be unable to consummate any such transactions. Further, we may not achieve anticipated sales levels for newly acquired or licensed products or internally developed products or line extensions or those sales may not be profitable. Our failure to do any of these things would have a negative effect on the growth of our sales and profitability, and on our operations.

We may not be successful in establishing additional, or expanding existing, joint venture partnerships or strategic alliances, which could adversely affect our ability to develop and commercialize products.

        An important element of our business strategy is entering into collaborations for the development and commercialization of products. If we are unable to reach agreements with suitable collaborators, we may fail to meet our business objectives. We face significant competition in seeking appropriate collaborators. We cannot be sure that we will be able to locate adequate research partners or that supplemental research will be available on terms acceptable to us. Moreover, these collaboration arrangements are complex, costly to negotiate and time consuming to document. Further, we may, upon entering into such agreements, be required to make significant up-front payments to fund the projects. Even if we are able to enter into collaborations, we cannot assure you that these arrangements will result in successful product development or commercialization.

Delays in the research and development or testing processes will cause a corresponding delay in revenue generation from potential new products developed for or acquired by us, which could adversely affect our business and our income.

        We expect to rely on our collaborators for the research and development of any Phase II and Phase III drugs that we may in-license or acquire. For example, under our agreement with MediGene AG, in addition to VEREGEN™, we have acquired rights to additional potential ointments or other topical formulations containing

green tea catechins for the treatment of dermatological diseases in humans. We cannot assure you that we will be able to develop line extensions to our existing brands or any other products or technology, including any products or line extensions to be developed under the MediGene and BioSante agreements, in a timely manner, or at all. We evaluate our own and our collaborators’ research and development efforts regularly to assess whether our efforts to develop a particular product or technology are progressing at a rate that justifies our continued expenditures. On the basis of these evaluations, we have abandoned in the past, and may abandon in the future, our efforts on a particular product or technology. If we fail to take a product or technology from the development stage to market on a timely basis or at all, we may incur significant expenses without any financial return.

If we are not able to obtain required regulatory approvals, we will not be able to commercialize additional new product candidates, and our ability to generate revenue will be materially impaired.

        Our agreements with MediGene and BioSante involve the development of new pharmaceutical products, which are subject to FDA approval and regulation. As part of our strategy, we intend to enter into additional agreements to in-license or acquire additional new pharmaceutical products that will also be subject to FDA approval and regulation. We cannot assure you that the FDA will approve any products or applicable line extensions we develop in a timely fashion, or at all. Failure to obtain regulatory approval for any of our product candidates will prevent us from commercializing it.

        We have limited experience in filing and prosecuting the applications necessary to gain regulatory approvals. We will also be relying at least in part on our strategic collaborators and partners, and contract research organizations, to file and prosecute the appropriate applications. Securing FDA approval requires the submission of extensive preclinical and clinical data, information about product manufacturing processes and inspection of facilities and supporting information to the FDA for each therapeutic indication to establish the product candidate’s safety and efficacy. Our future products may not be efficacious, may be only moderately efficacious or may prove to have undesirable or unintended side effects, toxicities or other characteristics that may preclude our obtaining regulatory approval or prevent or limit commercial use.

        The process of obtaining regulatory approvals is expensive, often takes many years, if approval is obtained at all, and can vary substantially based upon, among other things, the type, complexity and novelty of the product candidates involved. Changes in the regulatory approval policy during the development period, changes in, or the enactment of additional, statutes or regulations, or changes in regulatory review for each submitted product application, may cause delays in the approval or rejection of an application.

        The FDA, and comparable authorities in other countries, have substantial discretion in the approval process and may refuse to accept any application or may decide that our data is insufficient for approval and require additional preclinical, clinical or other studies. In addition, varying interpretations of the data obtained from preclinical and clinical testing could influence how a product candidate is classified and delay, limit or prevent regulatory approval of a product candidate. Any regulatory approval we ultimately obtain may be limited or subject to restrictions or post-approval commitments that render the product not commercially viable.

        Even if regulatory approval of a product is granted, the approval may be subject to limitations on the indicated uses for which the product may be marketed or to the conditions of approval, or contain requirements for costly post-marketing testing and surveillance to monitor the safety or efficacy of the product.

The manufacture and packaging of pharmaceutical products are subject to the requirements of the FDA and similar foreign regulatory bodies. If our third party manufacturers fail to satisfy these requirements, our product development and commercialization efforts may be materially harmed.

        The manufacture and packaging of pharmaceutical products such as VEREGEN™, ELESTRIN™ and SOLARAZE ^® , as well as our other current and possible future products, are regulated by the FDA and similar foreign regulatory bodies and must be conducted in accordance with the FDA’s cGMPs and comparable requirements of foreign regulatory bodies. Independent companies manufacture and supply all of our products. Failure by our third party manufacturers to comply with applicable regulations, requirements or guidelines could result in sanctions being imposed on us, including fines, injunctions, civil penalties, failure of regulatory authorities to grant marketing approval of our products, delays, suspension or withdrawal of approvals, license revocation,

seizures or recalls of product, operating restrictions and criminal prosecutions, any of which could significantly and adversely affect our business.

        Changes in the manufacturing process or procedure, including a change in the location where the product is manufactured or a change of a third party manufacturer, require prior FDA review and/or approval of the manufacturing process and procedures in accordance with the FDA’s cGMP. This review may be costly and time consuming and could delay or prevent the launch of a product or the use of a facility to manufacture a product. Any such change in facility would be subject to a pre-approval inspection by the FDA and the FDA would again require demonstration of product comparability. Foreign regulatory agencies have similar requirements.

        The FDA and similar foreign regulatory bodies may also implement new standards, or change their interpretation and enforcement of existing standards and requirements, for manufacture, packaging or testing of products at any time. If we or the manufacturers of our products are unable to comply, we, and they, may be subject to regulatory enforcement, civil actions or penalties, which could significantly and adversely affect our business, and any such change may lead to an increase in cost of goods.

If VEREGEN™, ELESTRIN™ or other new product offerings fail to achieve market acceptance, the revenues that we generate from their sales will be limited and our profitability could be affected.

        Market acceptance of our products and any new products for which we obtain marketing approval from the FDA or other regulatory authorities will depend upon the acceptance of these products by physicians, patients and healthcare payors. Safety, efficacy, convenience and cost-effectiveness, particularly as compared to competitive products, are the primary factors that affect market acceptance. Physicians may elect to not recommend using our products for any number of other reasons, including whether our products best meet the particular needs of the individual patient. Even if a product displays a favorable efficacy and safety profile in clinical trials, market acceptance of the product will not be known until after it is launched.

        We have not yet begun to formally market VEREGEN™ or ELESTRIN™. Our efforts to educate the medical community and third-party healthcare payors on the benefits of these or any of our future products will require significant resources, including the hiring of additional sales representatives and training of the sales force about the benefits and risks of our products, and may never be successful. In the case of VEREGEN™, we will also need to educate the medical community and third-party healthcare payors about catechins extracted from green tea, a novel active ingredient, and there can be no assurance that this novel active ingredient will find market acceptance.

        If our products fail to achieve and maintain market acceptance, or if new products or technologies are introduced by others that are more favorably received than our products, or if we are otherwise unable to market and sell our products successfully, our business, financial condition, results of operations and future growth will suffer.

The introduction of line extensions of our existing products or of new products that compete with our existing products, or unanticipated generic competition, could result in unexpected changes in our estimates for future product returns and reserves for obsolete inventory, which would adversely affect our operating results.

        One of the principal strategies we employ to offset the impact of generic competition affecting our products is the introduction of line extensions of our existing products to create marketing advantages and extend the life cycles of our products. From time-to-time we may seek to introduce line extensions on an expedited basis before we are able to reduce the levels of inventories of product that may be rendered obsolete or otherwise adversely affected by the line extension. This may require us to increase our estimate for returns of product on hand at wholesalers, which is recorded as a reduction of our net sales, and increase our reserve for inventory in our warehouse, which is recorded as a cost of sales. Accordingly, generic competition and the introduction of line extensions may adversely affect our operating results.

We depend on a limited number of customers, and if we lose any of them, our business could be harmed. Further consolidation of wholesalers of pharmaceutical products can negatively affect our distribution terms and sales of our products.

        Our four largest customers, who are all wholesalers, accounted for an aggregate of approximately 97%, 90% and 91% of our gross trade accounts receivable at December 31, 2006, 2005 and 2004, respectively. The following table presents a summary of gross sales to our four largest customers as a percentage of our total gross sales:

The loss of any of these customers’ accounts or a reduction in their purchases could harm our business, financial condition or results of operations. In addition, we may face pricing pressures from these customers.

        In recent years, the distribution network for pharmaceutical products has been subject to increasing consolidation. As a result, a few large wholesalers control a significant share of the market. Consequently, there are fewer channels for wholesale and retail pharmaceutical distribution than were historically available. Accordingly, we depend on fewer wholesalers for our products and we are less able to negotiate price terms with wholesalers. Although we believe that this consolidation among wholesalers will ultimately reduce our distribution costs, our inability to aggressively negotiate price terms with them over the long term could inhibit our efforts to improve our profit margins or sales levels. Additional consolidation among pharmaceutical wholesalers could limit our ability to compete effectively.

We are subject to chargebacks and rebates when our products are resold to or reimbursed by governmental agencies and managed care buying groups, which may reduce our future profit margins.

        Chargebacks and rebates are the difference between the prices at which we sell our products to wholesalers and the price that third party payors, such as governmental agencies and managed care buying groups, ultimately pay pursuant to fixed price contracts. Medicare, Medicaid and reimbursement legislation or programs regulate drug coverage and reimbursement levels for most of the population in the United States. Federal law requires all pharmaceutical manufacturers to rebate a percentage of their revenue arising from Medicaid-reimbursed drug sales to individual states. Some of our products are subject to rebates of up to the greater of 15.1% of the average manufacturer price or the difference between the average manufacturer price and the lowest manufacturer price during a specified period. We record an estimate of the amount either to be charged back to us or rebated to the end-users at the time of sale to the wholesaler. Over recent years, the pharmaceutical industry in general has accepted the managed care system of chargebacks and rebates. Managed care organizations increasingly began using these chargebacks and rebates as a method to reduce overall costs in drug procurement. Levels of chargebacks and rebates have increased momentum and caused a greater need for more sophisticated tracking and data gathering to confirm sales at contract prices to third-party payors with respect to related sales to wholesalers. We record an accrual for chargebacks and rebates based upon factors including current contract prices, historical chargeback and rebate rates and actual chargebacks and rebates claimed. The amount of actual chargebacks claimed could, however, be higher than the amounts we accrue, and could reduce our profit margins during the period in which claims are made.

If our estimates for returned products are incorrect, there may be a materially adverse impact on our net sales as well as an impact on our operating results.

        In the pharmaceutical industry, customers are normally granted the right to return product for a refund if the product has not been used by its expiration date, which is typically two to three years from the date of manufacture. Our return policy typically allows product returns for products within an eighteen-month window from six months prior to the expiration date to up to twelve months after the expiration date. Our return policy conforms to industry standard practices. Management is required to estimate the level of sales that will ultimately be returned pursuant to our return policy and to record a related reserve at the time of sale. These amounts are deducted from our gross sales to determine our net sales. We believe that we have sufficient data to estimate future returns at the time of sale. Management periodically reviews the allowances for returns and adjusts them based on actual experience. In order to reasonably estimate future returns, we analyze both quantitative and qualitative information including, but not limited to, actual return rates by product, the level of product in the distribution channel, expected shelf life of the product, product demand, the introduction of competitive or generic products that may erode current demand, our new product launches and general economic and industry wide indicators. If we over or under estimate the level of sales that will ultimately be returned, there may be a material impact to our operating results.

Distribution Service Agreements (DSAs) with our wholesalers have affected our sales and product returns and may result in us paying an additional service fee to the wholesalers in the future.

        We have entered into DSAs with three wholesale customers, two of whom are our largest two customers, McKesson and Cardinal. The third wholesaler is Kinray. Our DSAs with McKesson, Cardinal and Kinray became effective during 2004, 2004, and 2006, respectively. The terms of these DSAs require us to pay fees for product distribution, inventory management and administrative services that are offset by any price appreciation of the inventory that these wholesalers have on hand and also by any discounts that we give them for new product promotions. In return for these fees, these wholesalers are generally obligated to maintain their inventory levels to an agreed upon months-on-hand and to provide us with monthly inventory and sales reports. The increased visibility afforded by these DSAs provides us with greater sales and inventory predictability and the improved ability to match sales with underlying demand. The initial effects of our executing DSAs were that each wholesaler initially reduced its inventory of our products and our sales to them decreased and product returns increased. During 2006, we continued to experience substantial product returns from McKesson and Cardinal that we believe are partially attributable to the DSAs. As a result of the DSAs, we expensed an aggregate of $2,042,838 in service fees during 2006.

Because we rely on independent manufacturers for our products, any production or regulatory problems these third parties experience could be disruptive to our inventory supply.

        We do not own or operate any manufacturing or production facilities and all of our products are manufactured and supplied to us by independent companies. Many of these companies also manufacture and supply products for some of our competitors. We do not have licensing or other supply agreements with some of these manufacturers or suppliers for our products, and therefore, some of them could terminate their relationship with us at any time, thereby hampering our ability to deliver and sell the manufactured product to our customers and negatively affecting our operating margins. From time to time, we have experienced delays in shipments from some of our vendors due to production management or supply problems. Although we believe we can obtain replacement manufacturers, if necessary, the absence of agreements with some of our present suppliers may interrupt our ability to sell our products and adversely affect our present and future sales. Any delays in manufacturing or shipping products, including any customs or related issues, may affect our product supply and ultimately have a negative impact on our sales and profitability.

        All manufacturers of pharmaceutical products sold in the United States must comply with cGMP requirements and manufacturing operations and processes are subject to FDA inspection. Failure to comply with cGMP requirements can lead to the shutdown of a facility, the seizure of product distributed by that the facility and other sanctions. If we wish or need to identify an alternate manufacturer, delays in obtaining FDA approval of the replacement manufacturing facility could cause an interruption in the supply of our products. Although we have business interruption insurance covering the loss of income for up to $4,060,000, this insurance may not be sufficient to compensate us for any interruption of this kind. As a result, the loss of a manufacturer could cause a reduction in our sales, margins and market share, as well as harm our overall business.

Any disruption in the supply of raw materials for our products or an increase in the cost of raw materials to our manufacturers could have a significant effect on their ability to supply us with our products and could adversely affect our sales.

        We, and the manufacturers of our products, rely on suppliers of raw materials used in the production of our products. Some of these materials, including the active ingredient in VEREGEN™, ELESTRIN™, PAMINE ^® and SOLARAZE ^® , are available from only one source or a limited number of sources. We try to maintain inventory levels that are no greater than necessary to meet our current projections. Any interruption in the supply of finished products could hinder our ability to timely distribute finished products. If we are unable to obtain adequate product supplies to satisfy our customers’ orders, we may lose those orders and our customers may cancel other orders and stock and sell competing products. This, in turn, could cause a loss of our market share and reduce our revenues.

        We cannot be certain that supply interruptions will not occur or that our inventories of products will always be adequate. Numerous factors could cause interruptions in the supply of our finished products including:

If we cannot sell our products in amounts greater than our minimum purchase requirements under some of our supply agreements or sell our products in accordance with our forecasts, our results of operations and cash flows may be adversely affected.

        Some of our supply agreements require us to purchase certain minimum levels of active ingredients or finished goods. If we are unable to maintain market exclusivity for our products, if our product life-cycle management is not successful, if we fail to sell our products in accordance with the forecasts we develop as required by our supply agreements or if we do not terminate supply agreements at optimal times for us, we may incur losses in connection with the purchase commitments under the supply agreements or purchase orders. In the event we incur losses in connection with the purchase commitments under the supply agreements or purchase orders, there may be a material adverse effect upon our results of operations and cash flows.

We selectively outsource some of our non-sales and non-marketing services, and cannot assure you that we will be able to obtain these services on acceptable terms.

        To enable us to focus on our core marketing and sales activities, we selectively outsource non-sales and non-marketing functions, such as product and clinical research, manufacturing and warehousing. As we expand our activities in these areas, we expect to use additional financial resources. Typically, we do not enter into long-term contracts for our non-sales and non-marketing functions. Whether or not long-term contracts exist, we cannot assure you that we will be able to obtain these services or products in a timely fashion, on acceptable terms, or at all.

We may need additional financing to implement our business strategy, which may not be available on terms acceptable to us.

        In order to implement our business strategy, and to grow through in-licensing of products and other acquisitions and product enhancement, we may need additional financing. Our ability to grow is dependent upon,

and may be limited by, among other things, the availability of satisfactory financing arrangements. Our existing credit facility restricts our ability to incur indebtedness and our ability to grant liens upon, and security interests in, our assets, including our intellectual property. As a result, we may not be able to obtain the additional capital necessary to pursue our business strategy. In addition, even if we can obtain additional financing, that financing may not be on terms that are satisfactory to us. We intend to finance any new licensing or acquisitions from one or more of the following:

        If we raise additional funds by issuing equity securities, our then-existing stockholders could experience dilution and the terms of any new equity securities may have preferences over our common stock.

We have outstanding indebtedness, which could adversely affect our financial condition.

        Our total consolidated long term debt, including current maturities, arising solely from the term loan portion of our $110 million credit facility, was approximately $69 million as of December 31, 2006. For a discussion of our financial condition at December 31, 2006, see “Management’s Discussion and Analysis of Financial Condition and Results of Operations- Liquidity and Capital Resources” included elsewhere in this Annual Report. Under this facility, we have granted to the lenders a lien on substantially all of our current and future property, including our intellectual property.

        The degree to which we are indebted could have important consequences to you because, among other things:

        We cannot assure you that our business will generate sufficient cash flow from operations or that future borrowings will be available in an amount sufficient to enable us to pay our debt or to fund our other liquidity needs. Our ability to make payments on and, if necessary, to refinance our debt will also be influenced by general economic, business, financial, competitive, legislative, regulatory and other factors beyond our control. We may need to refinance all or a portion of our debt as a result of a default, or otherwise, on or before maturity. We cannot assure you that we would be able to refinance any of our debt, including the debt under our credit facility, on commercially reasonable terms or at all.

        Further, based upon our current projections, we expect to be in default under the fixed coverage charge ratio set forth in our current syndicated credit facility beginning in the Third Quarter of 2007. As a result of the projected default, the desire to reduce the interest rates charged under the facility and to provide us increased

flexibility to potentially enter into future licensing, acquisition or other similar transactions, we currently expect to enter into a new credit facility prior to the Third Quarter of 2007.

We may be subject to product liability claims, and if we do not have adequate insurance coverage, we could face substantial losses and legal costs, and our reputation could suffer.

        Pharmaceutical and health related products, such as those we market, may carry health risks. In the case of new products, such as VEREGEN™ and ELESTRIN™, those risks may not become fully known until the product has been commercially available in the market for a period of time. Consequently, consumers may bring product liability claims against us. We maintain product liability insurance on our products that provides coverage of up to $20,000,000 in the aggregate per year. This insurance is in addition to the required product liability insurance maintained by the manufacturers of our products. We cannot assure you that product liability claims will not exceed that coverage or that our reputation will not suffer as a result of any claims. If insurance does not fully fund any product liability claim, or if we are unable to recover damages from the manufacturer of a product that may have caused such injury, we must pay such claims from our own funds. We may also incur substantial litigation costs to defend such claims, even if the claims are without merit. Any such payment or costs could have a detrimental effect on our financial condition. In addition, we may not be able to maintain our product liability insurance at reasonable premium rates, if at all.

If we suffer negative publicity concerning the safety of our products, our sales may be harmed and we may be forced to withdraw products.

        Physicians and potential patients may have a number of concerns about the safety of our products, whether or not such concerns have a basis in generally accepted science or peer-reviewed scientific research. Negative publicity, whether accurate or inaccurate, concerning our products could reduce market or governmental acceptance of our products and could result in decreased product demand or product withdrawal. In addition, significant negative publicity could result in an increased number of product liability claims.

Rising insurance costs could negatively impact profitability.

        The cost of insurance, including workers compensation, product liability and general liability insurance, has risen significantly in recent years and may increase in the future. In addition, as a result of the SEC inquiry, the restatement of our financial results for the quarter ended September 30, 2004, the federal securities class action lawsuit and federal and state derivative shareholder lawsuits, the cost of our directors and officers insurance has increased and could continue to increase. In response to increased premiums, we may increase deductibles and/or decrease certain coverages to mitigate these costs. These increases, and our increased risk due to increased deductibles and reduced coverages, could have a negative impact on our results of operations, financial condition and cash flows.

The loss of our key personnel could limit our ability to operate our business successfully.

        We are highly dependent on the principal members of our management staff, the loss of whose services we believe would impede the achievement of our business strategy and objectives. We may not be able to attract and retain key personnel on acceptable terms. Many of our key managerial, operational and scientific personnel would be difficult to replace. The loss of such personnel’s services could delay the acquisition or development of products, the achievement of our business objectives and limit our ability to operate our business successfully.

RISKS RELATED TO INTELLECTUAL PROPERTY

Our intellectual property rights might not afford us with meaningful protection.

        We have recently refocused our business strategy, which anticipates greater investment in products with intellectual property protections. However, other than patents with respect to SOLARAZE ^® , VEREGEN™ and ELESTRIN™, we do not have meaningful patents or patent applications pending with respect to any other material products currently sold by us, including ADOXA ^® . We mainly rely on unpatented proprietary technologies in the

development and commercialization of our products. We also depend upon the unpatentable skills, knowledge and experience of our scientific and technical personnel, as well as those of our advisors, consultants and other contractors. To help protect our proprietary know-how that is not patentable, and for inventions for which patents may be difficult to enforce, we often use trade secret protection and confidentiality agreements to protect our interests. These agreements may not effectively prevent disclosure of confidential information or result in the effective assignment to us of intellectual property, and may not provide an adequate remedy to us in the event of unauthorized disclosure of confidential information or other breaches of the agreements. In addition, others may independently develop similar or equivalent trade secrets or know-how.

        The ownership of a patent or an interest in a patent does not always provide significant protection and the patents and applications in which we have an interest may be challenged as to their validity or enforceability. Other market participants may independently develop similar technologies or design around the patented aspects of our technology. Challenges to the patents for SOLARAZE ^® , VEREGEN™ or ELESTRIN™ or other products for which we may obtain rights may result in significant harm to our business. The cost of responding to these challenges and the inherent costs to defend the validity of our patents, including the prosecution of infringements and the related litigation, could be substantial. Such litigation also could require a substantial commitment of management’s time, which would detract from the time available to be spent maintaining and developing our business. Because marketing patent protected products represents a new business strategy for us, the cost of analyzing and responding to intellectual property related challenges may be amplified by our lack of experience with this business model.

We could be sued regarding the intellectual and proprietary rights of others, which could seriously harm our business and cost us a significant amount of time and money.

        Historically, we have only conducted patent searches on a limited basis due to the maturity of our existing products. As a result, the products and technologies we currently market, and those we may market in the future may infringe on patents and other rights owned by others. We also conduct trademark searches. However, the products we currently market, and those we may market in the future, may infringe on trademarks and other rights owned by others. If we are unsuccessful in any challenge to the marketing and sale of our products, technologies or brands, we may be required to license the disputed rights, if the holder of those rights is willing, or to cease marketing the challenged product, or to modify our products or brand names to avoid infringing upon those rights.

        Although we believe that our product lines and brand names do not infringe on the intellectual property rights of others, infringement claims may be asserted against us in the future, and if asserted, an infringement claim might not be successfully defended. The costs of responding to infringement claims could be substantial and could require a substantial commitment of management’s time and resources.

RISKS RELATED TO OUR INDUSTRY

We face significant competition within our industry.

        The specialty pharmaceutical industry is highly competitive. Many of our competitors are larger and more well-established. Our competitors include Axcan Pharma, Barrier Therapeutics, CollaGenex Pharmaceuticals, Graceway Pharmaceuticals, King Pharmaceuticals, Medicis, Salix Pharmaceuticals, Sciele Pharma, Stiefel Laboratories, Valeant Pharmaceuticals and Wyeth Pharmaceuticals. Many of these companies have greater resources than we do to devote to marketing, sales, research and development and acquisitions. As a result, they have a greater ability than us to undertake more extensive research and development, marketing and pricing policy programs. In addition, many of these competitors have greater name-recognition than we do among purchasers of pharmaceutical products, and in some cases, they have a reputation for producing highly-effective products.

        In addition to competition from existing products, it is also possible that our competitors may develop and bring new products to market before us, or may develop new technologies that improve existing products, new products that provide the same benefits as existing products at less cost, or new products that provide benefits superior to those of existing products. These competitors also may develop products that make our current or future products obsolete. Our competitors may also make technological advances reducing their cost of production so that

they may engage in price competition through aggressive pricing policies to secure a greater market share to our detriment. Any of these events could have a significant negative impact on our business and financial results, including reductions in our market share.

Failure to comply with government regulations could affect our ability to operate our business.

        Virtually all aspects of our activities are regulated by federal and state statutes and government agencies. The research, manufacturing, processing, formulation, packaging, labeling, distribution, advertising and marketing of our products, and disposal of waste products arising from these activities, are subject to regulation by one or more federal agencies, including the FDA, the Federal Trade Commission, the Consumer Product Safety Commission, the United States Department of Agriculture, the Occupational Safety and Health Administration, and the Environmental Protection Agency, as well as by foreign governments in countries where we distribute some of our products.

        Noncompliance with applicable FDA or other government policies or requirements could subject us to enforcement actions, such as suspensions of distribution, seizure of products, product recalls, fines, “whistleblower” lawsuits, criminal penalties, injunctions, failure to approve pending drug product applications or withdrawal of product marketing approvals. Similar civil or criminal penalties could be imposed by other government agencies or various agencies of the states and localities in which our products are manufactured, sold or distributed and could have ramifications for our contracts with government agencies. These enforcement actions would detract from management’s ability to focus on our daily business and would have an adverse effect on the way we conduct our daily business, which could severely impact future profitability.

If we market products in a manner that violates health care fraud and abuse laws, we may be subject to civil or criminal penalties.

        Federal health care program anti-kickback statutes prohibit, among other things, knowingly and willfully offering, paying, soliciting or receiving remuneration to induce, or in return for purchasing, leasing, ordering or arranging for the purchase, lease or order of any health care item or service reimbursable under Medicare, Medicaid, or other federally financed health care programs. This statute has been interpreted to apply to arrangements between pharmaceutical manufacturers on one hand and prescribers, patients, purchasers and formulary managers on the other. Although there are a number of statutory exemptions and regulatory safe harbors protecting certain common activities from prosecution, the exemptions and safe harbors are drawn narrowly, and practices that involve remuneration intended to induce prescribing, purchasing, or recommending may be subject to scrutiny if they do not qualify for an exemption or safe harbor.

        Federal false claims laws prohibit any person from knowingly presenting, or causing to be presented, a false claim for payment to the federal government, or knowingly making, or causing to be made, a false statement to get a false claim paid. Pharmaceutical companies have been prosecuted under these laws for a variety of alleged promotional and marketing activities, such as allegedly providing free product to customers with the expectation that the customers would bill federal programs for the product; reporting to pricing services inflated average wholesale prices that were then used by federal programs to set reimbursement rates; engaging in promotion for uses that the FDA has not approved, or off-label uses, that caused claims to be submitted to Medicaid for non-covered off-label uses; and submitting inflated best price information to the Medicaid Rebate Program.

        The majority of states also have statutes or regulations similar to the federal anti-kickback law and false claims laws, which apply to items and services reimbursed under Medicaid and other state programs, or, in several states, apply regardless of the payor. Sanctions under these federal and state laws may include civil monetary penalties, exclusion of a manufacturer’s products from reimbursement under government programs, criminal fines, and imprisonment. Even if we are not determined to have violated these laws, government investigations into these issues typically require the expenditure of significant resources and generate negative publicity, which would also harm our financial condition. Because of the breadth of these laws and the narrowness of the safe harbors, it is possible that some of our business activities could be subject to challenge under one or more of such laws.

The FDA may change its enforcement policies and take action against products marketed without an approved application such as some of our products.

        New prescription drugs must be the subject of an FDA-approved application before they may be marketed in the United States. Certain other drugs may be marketed over the counter, or OTC, under special regulations issued by the FDA known as OTC monographs. Certain of our current drugs that we and others market are not the subject of an approved application or an OTC monograph.

        The FDA has recognized that there are numerous, perhaps thousands, of such drug products currently on the market without FDA approvals or authorizations. These include principally products that first came on the market without an NDA prior to changes in the food and drug laws in 1962, and new products that have come on the market since that time on the grounds that they are identical, similar, or related to pre-1962 products. The FDA has stated that these unapproved products are new drugs under the Federal Food, Drug, and Cosmetic Act and thus require an effective approval in order to be introduced into interstate commerce. However, the FDA also acknowledges that many of these products have been marketed and prescribed for years without raising any safety or effectiveness issues, and thus has established policies stating the circumstances under which it will exercise its enforcement discretion and not take action against an otherwise unapproved new drug. The FDA has recently stated its intent to increase enforcement activities in this area and has taken action against certain drugs, none of which are ours, pursuant to its established enforcement policies primarily on the basis of safety concerns.

        Many of our brands, including KERALAC ^® , KEROL™, CARMOL ^® 40, ROSULA ^® , ZODERM ^® , SELSEB ^® , LIDAMANTLE ^® and ANAMANTLE ^® , are marketed in the United States without an FDA-approved marketing application under FDA’s established enforcement policies on the grounds that they are identical, related, or similar to products that existed on the market prior to 1962. Any change in the FDA’s enforcement discretion and/or policies could prevent us from continuing to market these products without incurring the expense and delay of obtaining an approval, alter the way we have to conduct our business, and severely affect our future profitability. In addition, if a competitor submits an NDA to the FDA for any of these drugs, the FDA may require us also to file an NDA or an ANDA for that same drug in order to continue marketing it in the United States. Similarly, if the FDA issues a final OTC monograph covering one of the products we currently market on a prescription basis, we may be required to sell the product under the monograph on an OTC basis, which could significantly affect our future profitability.

State pharmaceutical marketing compliance and reporting requirements may expose us to regulatory and legal action by state governments or other government authorities.

        In recent years, several states and localities, including California, the District of Columbia, Maine, Massachusetts, Michigan, Minnesota, New Mexico, Ohio, Rhode Island, Vermont, and West Virginia, have enacted legislation requiring pharmaceutical companies to establish marketing compliance programs, and file periodic reports with the state or make periodic public disclosures on sales, marketing, pricing, clinical trials, and other activities. Similar legislation is being considered in other states. Many of these requirements are new and uncertain, and the penalties for failure to comply with these requirements are unclear. We are not aware of any companies against which fines or penalties have been assessed under these special state reporting and disclosure laws to date. We are currently in the process of developing a formal compliance infrastructure and standard operating procedures to comply with such laws. Unless we are in full compliance with these laws, we could face enforcement action and fines and other penalties, and could receive adverse publicity.

New legislation or regulatory proposals may adversely affect our revenues.

        A number of legislative and regulatory proposals aimed at changing or amending the way in which health care services and products are provided and paid for in the United States, including the cost of prescription products, importation and reimportation of prescription products from countries outside the United States and changes in the amounts at which pharmaceutical companies are reimbursed for sales of their products, have been proposed. While we cannot predict when or whether any of these proposals will be adopted, or the effect these proposals may have on our business, the pending nature of these proposals, as well as the adoption of any amendment or change in existing applicable laws and regulations, may exacerbate industry-wide pricing pressures and could have a material adverse effect on our business, financial condition, results of operations and cash flows. For example, in 2000, Congress

directed the Department of Health and Human Services to issue regulations allowing the reimportation of approved drugs originally manufactured in the United States back into the United States from other countries where the drugs were sold at a lower price. Although the Secretary of Health and Human Services has not acted to implement this directive, the House of Representatives passed a similar bill in January 2003 that would have permitted reimportation to take effect without the action of the Secretary of the Department of Health and Human Services. This bill as well as other reimportation bills have not yet resulted in any new laws or regulations. Enactment of any of these proposed bills and other initiatives could decrease the reimbursement amount we receive for our products.

        Additionally, sales of our products in the United States could be adversely affected by the importation into the U.S. of foreign manufactured products that some may deem equivalent to our product and that are available outside the United States at lower prices than in the United States. Most of these foreign imports into the U.S. are illegal under current law. However, the volume of imports continues to rise due to the limited enforcement resources of the FDA and the U.S. Customs Service, and there is increased political pressure to permit the imports as a mechanism for expanding access to lower priced medicines. In addition, state and local governments have suggested that they may import or facilitate the import of drugs from Canada for employees covered by state health plans or others, and some already have put such plans in place.

Changes in Medicare, Medicaid or similar governmental programs or the amounts paid by those programs for our products may adversely affect our earnings.

        Medicare, Medicaid or similar governmental programs are highly regulated, and subject to frequent and substantial changes and cost containment measures. In recent years, changes in these programs have limited and reduced reimbursement to providers. The Medicare Prescription Drug, Improvement and Modernization Act of 2003 or MMA, created a new, voluntary prescription drug benefit under the Social Security Act, or Part D Medicare Drug Benefit. Beginning in 2006, Medicare beneficiaries entitled to Part A or enrolled in Part B, as well as certain other Medicare enrollees, became eligible and began enrolling for the Part D Medicare Drug Benefit. In addition, the MMA requires that the Federal Trade Commission conduct a study and make recommendations regarding additional legislation that may be needed concerning the Medicare Drug Benefit. We are unable at this time to predict or estimate the financial impact of this new legislation or these regulations.

Changes in the reimbursement policies of managed care organizations and other third party payors may reduce our gross margins.

        Our operating results and business success depend in large part on the availability of adequate third party payor reimbursement to patients for our prescription brand products. These third party payors include governmental entities, such as Medicaid, private health insurers and managed care organizations. A majority of the United States population now participates in some version of managed care. Because of the size of the patient population covered by managed care organizations, marketing of prescription drugs to them and the pharmacy benefit managers that serve many of these organizations has become important to our business. Managed care organizations and other third party payors try to negotiate the pricing of medical services and products to control their costs. Managed care organizations and pharmacy benefit managers typically develop formularies to reduce their cost for medications. Formularies can be based on the prices and therapeutic benefits of the available products. Due to their lower costs, generic products are often favored. The breadth of the products covered by formularies varies considerably from one managed care organization to another, and many formularies include alternative and competitive products for treatment of particular medical conditions. Exclusion of a product from a formulary can lead to its sharply reduced usage in the managed care organization patient population. Payment or reimbursement of only a portion of the cost of our prescription products could make our products less attractive to patients, suppliers and prescribing physicians. Changes in the reimbursement policies of these entities could prevent our branded pharmaceutical products from competing on a price basis. If our products are not included within an adequate number of formularies or if adequate reimbursement levels are not provided, or if reimbursement policies increasingly favor generic products, our market share, our gross margins and our overall business and financial condition could be negatively affected. While we focus on the inclusion of our products in these formularies, this marketing channel is highly competitive and we cannot assure that a significant percentage of our core products will be covered by the formularies of the major managed care organizations and pharmacy benefit managers.

        Moreover, some of our products are not of a type generally eligible for reimbursement, primarily due to either the product’s market share being too low to be considered, cheaper generics being available, or because the product is available without a prescription. It is also possible that products manufactured by others could have the same effects as our products and be subject to reimbursement. If this were the case, some of our products might become too costly to patients.

RISKS RELATED TO OUR COMMON STOCK

Shareholder lawsuits could have a material adverse effect on our results of operations and liquidity.

        We, along with certain of our officers and directors, were named defendants in thirteen federal securities lawsuits that were consolidated on May 5, 2005 in the United States District Court for the District of New Jersey. The plaintiffs allege violations of Sections 10(b) and 20(a) of the Securities Exchange Act of 1934 and Rule 10b-5 promulgated thereunder, arising out of disclosures made to the market that plaintiffs allege were materially false and misleading. Plaintiffs also allege that we and the individual defendants falsely recognized revenue. Additionally, two related New Jersey state court shareholder derivative actions were filed on April 29, 2005 and May 11, 2005 against certain of our officers and directors alleging breach of fiduciary duty and other claims arising out of substantially the same allegations made in the federal securities class action. Further, a federal shareholder derivative action was filed against us and certain of our officers and directors alleging breach of fiduciary duties arising out of the SEC inquiry and the restatement of our financial results for the quarter ended September 30, 2004 and violations of Delaware law regarding annual meetings. On July 14, 2006, the plaintiff filed an amended complaint alleging a sole count for breach of fiduciary duties arising out of substantially the same allegations made in the federal securities class action lawsuit. These proceedings have resulted, and are expected to continue to result, in a diversion of management’s attention and resources and in significant professional fees. These professional fees have substantially increased, and in the near term may continue to substantially increase, our cash needs.

        We have certain obligations to indemnify our officers and directors and to advance expenses to such officers and directors. Although we have purchased liability insurance for our directors and officers, if our insurance carriers should deny coverage, or if the indemnification costs exceed the insurance coverage, we may be forced to bear some or all of these indemnification costs directly, which could be substantial and may have an adverse effect on our business, financial condition, results of operations and cash flows. If the cost of our liability insurance increases significantly, or if this insurance becomes unavailable, we may not be able to maintain or increase our levels of insurance coverage for our directors and officers, which could make it difficult to attract or retain qualified directors and officers.

        We are not able to estimate the amount of any damages that may arise from these legal proceedings and the internal efforts associated with defending ourselves and our officers and directors. If we are unsuccessful in defending ourselves, these lawsuits could adversely affect our business, financial condition, results of operations and cash flows as a result of the damages that we would be required to pay. It is possible that our insurance policies either may not cover potential claims of this type or may not be adequate to indemnify us for all liability that may be imposed. While we believe that the allegations and claims made in these lawsuits are wholly without merit and intend to defend these actions vigorously, we cannot be certain that we will be successful in any or all of these actions.

        Concerns with respect to the circumstances surrounding our pending litigations may have created uncertainty regarding our ability to focus on our business operations and remain competitive with other companies in our industry. Because of this uncertainty, we may have difficulty retaining critical personnel or replacing personnel who leave us.

Securities class action and shareholder derivative lawsuits due to stock price volatility or other factors could cause us to incur substantial costs and divert management’s attention and resources.

        Securities class action and shareholder derivative lawsuits have often been brought against companies following periods of volatility in the market price of their securities and we are currently the subject of such lawsuits. Due to the volatility of our stock price, we could be the target of further securities litigation in the future.

Securities class action and shareholder derivative lawsuits are often expensive and time consuming and their outcome may be uncertain. Any additional claims, whether successful or not, could require us to devote significant amounts of monetary or human resources to defend ourselves and could harm our reputation. We may need to spend significant amounts on our legal defense and senior management may be required to divert their attention from other portions of our business, which could materially and adversely affect our business, financial condition and results of operations. If, as a result of any proceeding, a judgment is rendered or a decree is entered against us, it may materially and adversely affect our business, financial condition and results of operations and harm our reputation.

We could be subject to fines, penalties, or other sanctions as a result of the inquiry by the SEC.

        In December 2004, we were advised by the staff of the SEC that it is conducting an informal inquiry relating to us to determine whether there have been violations of the federal securities laws. In connection with the inquiry, the SEC staff has requested that we provide it with certain information and documents, including with respect to revenue recognition and capitalization of certain payments. We are cooperating with this inquiry, however, we are unable at this point to predict the final scope or outcome of the inquiry, and it is possible it could result in civil injunctive or criminal proceedings, the imposition of fines and penalties, and/or other remedies and sanctions. The conduct of these proceedings could negatively impact our stock price. Since we cannot predict the outcome of this matter and its impact on us, we have made no provision relating to this matter in our financial statements. In addition, we expect to continue to incur expenses associated with the SEC inquiry and its repercussions, regardless of the outcome of the SEC inquiry, and it may divert the efforts and attention of our management team from normal business operations.

Because our Class B common stock has the right, as a class, to elect a majority of our Board of Directors and has disparate voting rights with respect to all other matters on which our stockholders vote, your voting rights will be limited and the market price of our common stock may be affected adversely.

        Holders of our common stock are entitled to one vote per share on matters on which our stockholders vote generally. As long as there are at least 325,000 shares of our Class B common stock outstanding, holders of our Class B common stock vote, as a class, to elect a majority of our board of directors. In addition, shares of our Class B common stock are entitled to five votes per share on all other matters to be voted on by stockholders in general. The ability of the holders of our Class B common stock to elect a majority of our directors and the differential in the voting rights between the common stock and the Class B common stock could affect adversely the market price of our common stock. All of the outstanding shares of our Class B common stock are currently held by Daniel Glassman, our founder and President and Chief Executive Officer, and his wife, and Bradley Glassman, Senior Vice President, Sales & Marketing.

        The Board of Directors has agreed to review our dual-class equity structure in the first half of 2007.

Our founder and President and Chief Executive Officer could exercise substantial control over our affairs.

        At February 28, 2007, Daniel Glassman, our founder and President and Chief Executive Officer, and members of his immediate family (including his wife, Iris Glassman, and son, Bradley Glassman), were the beneficial owners of approximately 13%, or 2,144,389 shares of our outstanding common stock, including the possible beneficial conversion of all outstanding shares of Class B common stock. The Class B common stock currently votes, as a class, to elect a majority of our board of directors, and has five votes per share, or approximately 18% of the total voting power, with respect to all other matters on which our stockholders are entitled to vote other than the election of the board of directors. As a result, Mr. Glassman exercises voting control over the election of our board of directors and could influence our corporate actions. The interests of Mr. Glassman and his family may differ from yours and they may be able to take actions that advance their respective interests to your detriment. Mr. Glassman’s ability to exercise control over the election of the board of directors may discourage, delay or prevent a merger or acquisition and could discourage any bids for our common stock at a premium over the market price.

Our certificate of incorporation and Delaware law may delay or prevent our change of control, even if beneficial to investors.

        Our charter authorizes us to issue up to 2,000,000 shares of preferred stock with such designations, rights and preferences as the board of directors may determine from time to time. This authority empowers the board of directors, without further stockholder approval, to issue preferred shares with dividend, liquidation, conversion, voting or other rights that could decrease the voting power or other rights of the holders of our common stock. The issuance of such preferred stock could, under some circumstances, discourage, delay or prevent a change of control. To date, we have not issued any shares of preferred stock. In addition, we are and will continue to be subject to the anti-takeover provisions of the Delaware General Corporation Law, which could delay or prevent a change of control.

Our operating results and financial condition may fluctuate which could negatively affect the price of our stock. Our stock price has fluctuated considerably and could decline.

        Our operating results and financial condition may fluctuate from quarter to quarter and year to year depending upon the relative timing of events or uncertainties that may arise. The following events or occurrences, among others, could cause fluctuations in our financial performance from period to period, which could negatively affect the price of our stock:

        Stock prices of emerging growth pharmaceutical and small-cap companies such as ours fluctuate significantly. In particular, our stock price per share since January 1, 2004 has fluctuated from a low of $7.61 to a high of $25.00. A variety of factors in addition to the foregoing that could cause the price of our common stock to fluctuate, perhaps substantially, include:

        We will not be able to control many of these factors, and we believe that period-to-period comparisons of our financial results will not necessarily be indicative of our future performance. If our revenues in any particular period do not meet expectations, we may not be able to adjust our expenditures in that period, which could cause our operating results to suffer further. If our operating results in any future period fall below the expectations of securities analysts or investors, our stock price may fall by a significant amount. In addition, fluctuations in the stock market in general and the market for shares for emerging growth and specialty pharmaceutical companies in particular can be unrelated to our operating performance or the operating performance of other companies. Any such fluctuations in the future could reduce the market price of our common stock.

The exercise of outstanding options or the issuance of other shares could reduce the market price of our stock.

        We currently have outstanding a substantial number of options to purchase shares of our common stock. If the holders of all outstanding options exercised them, we would have an additional 1,651,617 shares of common stock issued and outstanding as of December 31, 2006. The sale, or availability for sale, of such substantial amounts

of additional shares of common stock in the public marketplace could reduce the prevailing market price of our securities and otherwise impair our ability to raise additional capital through the sale of equity securities.

We may sell equity securities in the future, which would cause dilution.

        We may sell equity securities in the future to obtain funds for general corporate or other purposes. We may sell these securities at a discount to the market price. Any future sales of equity will dilute the holdings of existing stockholders, possibly reducing the value of their investment.

ITEM 1B: UNRESOLVED STAFF COMMENTS

        None.