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The following is an excerpt from a 10KSB SEC Filing, filed by TRANSDERM LABORATORIES CORP on 4/18/2007.
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TRANSDERM LABORATORIES CORP - 10KSB - 20070418 - BUSINESS
ITEM 1.   DESCRIPTION OF BUSINESS

Overview .

Transderm Laboratories Corporation (“Transderm”, the “Company”, “we”, “us”, or like terms) is a Delaware corporation that conducts its business primarily through its subsidiary, Hercon Laboratories Corporation ("Hercon"). Unless the context otherwise requires, the terms “we”, “us”, the “Company” or similar terminology, includes Transderm Laboratories Corporation and Hercon, of which Transderm owns 98.5%. Transderm is a 90%-owned subsidiary of Health-Chem Corporation ("Health-Chem" which, together with Transderm, Hercon and Health-Chem’s other subsidiaries, may be referred to as the “Group”).

We develop, manufacture and market transdermal drug delivery systems. A transdermal drug delivery system is an adhesive patch containing medication which is released through the skin into the bloodstream at a controlled rate over an extended period of time. Transdermal delivery can significantly enhance the therapeutic benefit of certain drugs, through improved efficacy, safety and patient compliance, when compared to conventional methods of drug administration, such as oral or parenteral (drugs that are delivered other than by the digestive tract, such as subcutaneous or intramuscular injection, or intravenous ly) delivery. Over the last several years, our sole product and continuing source of revenue has been a transdermal nitroglycerin patch for the relief of the vascular and cardiovascular symptoms related to angina pectoris (chest pain). We manufacture our nitroglycerin patch both on a contract basis for specific clients and for sale to distributors and wholesalers for distribution in the United States. We manufacture our products in accordance with Good Manufacturing Practices, or GMP’s, prescribed by the United States Food and Drug Administration, or FDA, at our facility in Emigsville, Pennsylvania.

Transderm has developed a base of technology in the design of transdermal systems by applying its expertise in the area of skin biology, pharmaceutical and polymer chemistry, drug diffusion, adhesive technology, pharmacokinetics and clinical protocol design. We believe that the integration of our technology and manufacturing experience gives us a competitive advantage by providing us with the capability to custom design and produce individual, cost-effective transdermal delivery systems for specific drugs. As a result, over the last several years, we have been engaged by third parties to conduct feasibility studies and development and related activities with respect to new pharmaceutical products that may be amenable to transdermal delivery and, in some cases, to manufacture such products for them on a commercial basis if they reach the market.  
 
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Current Financial Condition of Transderm.

Transderm continues its efforts to recover from the operational and financial adversity it has experienced since 1997, the basis for which is more fully described in the 2004 Annual Report. While net sales had increased during the period 2001 through 2004 (the financial information for the years 2001 and 2002 is unaudited), net revenues decreased significantly during each of 2005 and 2006 as a result of a decline in orders in each such year by one of our principal customers, as described elsewhere in this Report. Transderm has posted significant operating losses in each year since 1997, and as of December 31, 2006 had an accumulated deficit of $35.6 million and a working capital deficiency of approximately $26 million.

At December 31, 2006, the Company had total liabilities of $41.3 million, which included approximately (i) $7.3 million due under the terms of a license acquired from Key Pharmaceuticals, Inc. to utilize certain technology in its current generation transdermal patch (the “Key License”), which represents royalty payments owed over the last seven years (the “Key Royalty”), and (ii) $30.5 million owed to Health Chem, including $14.1 million related to redeemable preferred stock under which Transderm is currently in default, $7.2 million related to a subordinated promissory note under which Transderm is currently in default, and $9.2 million related to a long-term payable (each of which items is more fully described under the heading “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and in the notes to the Financial Statements, and which are herein collectively referred to as the “Intercompany Obligations”).

Transderm’s current financial condition negatively impacts its day-to-day operations and undermines its ability to grow its business. In addition, at December 31, 2006, Health-Chem, Transderm’s parent corporation, had total outstanding liabilities of approximately $22.4 million, including $11.5 million of principal and interest due under certain debentures under which it has been in default since April 1999, and had a working capital deficiency of approximately $16.2 million, which conditions also bear on Transderm’s current and future prospects. Transderm’s ability to return to profitability from the precarious financial condition which it has experienced over the last several years is predicated on a number of factors, including the Group’s ability to reach agreements with its largest creditors, its ability to reduce operating expenses as a percentage of revenues, its ability to obtain financing and its ability to identify and bring new products to market.

Transderm’s and the Group’s fragile financial condition leaves them vulnerable because:

 
·
existing creditors of either company could seek the immediate collection of amounts due them which could cause either company to seek protection under federal bankruptcy laws;

 
·
their obligations and liabilities, as well as their respective stockholders’ deficiencies, do not allow them to obtain financing for operations;

 
·
their working capital deficiencies prevent the Group from diversifying operations by developing new products and reducing reliance on revenues generated from sales of a single product;
 
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·
the extraordinary conditions make it difficult to endure business cycles resulting from general economic conditions or the effects of competition, among other things, as they occur;

 
·
the condition prevents them from taking advantage of business opportunities as they may arise; and

 
·
the condition does not allow them to retain senior management who have experience in the pharmaceutical industry or in any business in which they may become involved in the future.

Transdermal Delivery Systems .

A transdermal drug delivery system, known as a transdermal patch or skin patch, is a medicated adhesive patch that is placed on the skin to deliver a time released dose of medication through the skin and into the bloodstream . These systems utilize a special membrane to control the rate at which the liquid drug contained in the patch can pass through the skin and into the bloodstream. Transdermal drug delivery involves the inherent challenge of overcoming the skin barrier. Skin protects the body from the environment very effectively and generally is only permeable to small molecule, lipophilic (oil soluble) drugs which require only limited dose sizes. Transdermal delivery systems, therefore, not only have to provide drug to the skin under stable conditions in controlled dosages and in a format convenient to the patient, but also serve to locally increase the permeability of skin to larger, charged, or hydrophilic (easily dissolved in water) drug molecules while minimizing irritation.

The first transdermal patch was approved by the FDA in 1979. It contained the drug scopolamine used to prevent the nausea and vomiting associated with motion sickness. In 1981, the FDA approved a patch for nitroglycerin and as of 2003 patches have been approved to deliver 15 molecules spanning 35 different drugs, including combination patches utilized for, among other purposes, contraception and hormone replacement.

The first transdermal systems consisted of plastic dipped into a drug that was dissolved in alcohol. The plastic had an adhesive around the edges. These patches created a significant number of skin reactions and frequently became dislodged from the skin. Second, third and fourth generation patches have been developed which have significantly advanced adhesion properties, delivery control and skin permeability. There are four major types of transdermal drug delivery systems in use today : single layer drug-in-adhesive systems, multi-layer drug-in-adhesive systems, reservoir transdermal systems and matrix systems. The basic components of current transdermal delivery systems include the drug(s) either incorporated directly into the adhesive or dissolved or dispersed in a reservoir or inert polymer matrix; an outer backing film of paper, plastic, or foil; and a pressure-sensitive adhesive that anchors the patch to the skin. Developments and improvements to transdermal systems are being made rapidly.

Transdermal drug delivery has numerous advantages over conventional drug delivery methods. In contrast to orally delivered drugs, compounds entering the body through the skin escape first-pass metabolism in the liver (which may destroy the drug) , often resulting in higher bioavailability of the drug. Transdermal delivery is effective for use in patients who experience nausea from the medication because there are few or no gastrointestinal effects from the drug itself and is useful for those drugs that have poor oral uptake, need frequent administration or that interact with stomach acid and allows effective use of drugs with short half-lives that otherwise require large initial doses (bolus dosing) to achieve desired drug levels, such as nitroglycerin. As a result, the side effects, or variability in therapeutic effect due to peaks and troughs in plasma concentration, that are seen with bolus administration are minimized. In contrast to intravenous drug delivery, transdermal administration is noninvasive and poses little risk of infection. It is also relatively easy for patients to apply and remove a transdermal system.
 
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Our Nitroglycerin Transdermal Patch.

In 1986, we introduced the first FDA-approved generic transdermal nitroglycerin patch into the United States market. Nitroglycerin, also known as glycerin trinitrate, provides relief from vascular and cardiovascular symptoms related to angina pectoris or angina. Angina pectoris, or "heart pain," is the chest discomfort that occurs when the blood oxygen supply to an area of the heart muscle does not meet the demand. Nitroglycerin corrects the imbalance between the flow of blood and oxygen to the heart and relieves the work that the heart must do by dilating the arteries and veins in the body. Dilation of the veins reduces the amount of blood that returns to the heart that must be pumped. Dilation of the arteries lowers the pressure in the arteries against which the heart must pump. As a consequence, the heart works less and requires less blood and oxygen. Additionally, nitroglycerin preferentially dilates blood vessels that supply the areas of the heart where there is not enough oxygen, thereby delivering oxygen to the heart tissue that needs it most.

Since no one holds a valid patent covering nitroglycerin, which would grant to the patent holder the exclusive right to sell the drug while the patent is in effect and which is intended to protect the holder’s development investment, others can seek to obtain FDA approval to sell nitroglycerin-based products, assuming the proposed product meets certain specific criteria, by submitting an Abbreviated New Drug Application, or ANDA. The ANDA approval process can be substantially quicker and significantly less expensive than the new drug approval process because the applicant can rely on results collected from clinical trials conducted by the original drug developer.

Our nitroglycerin transdermal patch comprises a multi-layer drug-in-adhesive system wherein the medication and all the excipients (the inert substances used as a diluents or vehicles for a drug) are incorporated into a membrane between two distinct drug-in-adhesive layers under a single backing film. Our patch is comprised of three layers; a transparent outer backing layer composed of a composition plastic film and printed with the name of the drug and strength; nitroglycerin in a acrylic-based polymer adhesive with a cross-linking agent; and a protective, translucent peelable liner which covers the second layer and must be removed prior to use. Our nitroglycerin transdermal patch is AB2 rated, which means it is considered bioequivalent to Novartis’ NitroDerm™ product based on clinical trial data. Our patch is a one-day use patch and is sold in shelf cartons, with each shelf carton containing thirty patches. Our patch is produced in three different dosage sizes, with each size delivering different milligrams per hour (mg/hr) amounts of nitroglycerin to the patient. The three sizes are: 0.2mg/hr, 0.4mg/hr and 0.6mg/hr.

Our second generation transdermal patch technology developed during the mid 1990’s incorporates certain technology which, unbeknownst to us at the time of development, was the subject of a patent held by Key Pharmaceuticals, Inc., or Key, a subsidiary of Schering-Plough Corporation. In December 1997, Key obtained a court order enjoining us from manufacturing or selling transdermal nitroglycerin patches that have been found to infringe Key's patent before the expiration of Key's patent on February 16, 2010. In March 2000, we acquired a non-exclusive license from Key to manufacture, use, import, sell and offer for sale any drug-in-adhesive transdermal nitroglycerin patch product developed by the Company either before or during the term of the license which provided for the payment of a royalty per unit sold in amounts ranging from $2 to $3, based upon the dosage delivered. The license extends to February 16, 2010, the expiration of Key’s patents. We are in breach of the Key License for not having made royalty payments under the Key License since its execution and as of December 31, 2006 we owed aggregate royalties to Key of approximately $7,321,000. We recently entered into discussions with Key with respect to payment of past due royalties. If we are unable to negotiate an agreement with Key with respect to the royalties due and are prevented from utilizing the Key technology, we would have to discontinue selling our transdermal patches unless we could develop our own technology to replace that covered by the Key License or otherwise locate and obtain a license for similar technology which can be incorporated into our manufacturing process, of which we can give no assurance. Moreover, our failure to negotiate a repayment agreement with Key on terms favorable to us could have a material negative impact on our Company. See “BUSINESS-Risk Factors” and “Management’s Discussion and Analysis of Financial Statements and Results of Operations.”

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Research and Development .

Our research and development efforts are severely constrained by our lack of cash, as described elsewhere in this Annual Report, and other than activities currently being undertaken for third parties as described below, we are not engaging in any research and development on our own behalf.

If and when we possess the financial resources to resume proprietary research and development activities, we expect that our primary strategy will be to identify generic drugs which can be delivered transdermally, which correspond with our technical and manufacturing capabilities and which we believe have substantial market potential or for which a product niche may exist. We may also explore developing transdermal products that use FDA-approved drugs that currently are being delivered to patients through means other than transdermal delivery. In addition, we may seek to supplement our research and development efforts by entering into research and development agreements, joint ventures and other collaborative arrangements with other companies.
 
By focusing on bringing new products to market based upon unprotected, generic drugs that are then being delivered transdermally , we will not have to bear the same level of research and development costs and other expenses associated with bringing a new drug formulation to market. Thus, we believe that we would be able to charge significantly less for a product, a decided competitive advantage in our industry, given that managed care organizations typically favor generic products over brand name drugs, and governments encourage, or under some circumstances, mandate generic drugs.

We currently are developing transdermal products for two companies, one of which has engaged us to assist in the development of two drug formulations to be delivered transdermally. In all cases, we act as an independent contractor for the party that engaged us and said party owns all intellectual property which may emanate from the projects we are retained to complete or the services which we render.

In February 2001, Hercon entered into a series of agreements with Ranbaxy Pharmaceuticals Inc. under which we:

 
·
granted a worldwide, non-exclusive, royalty-free license to Ranbaxy to use certain intellectual property we developed relating to the transdermal delivery of a certain generic pharmaceutical compound;

 
·
acquired a license from Ranbaxy to use certain intellectual property it had developed in connection with the pharmaceutical compound and were retained by Ranbaxy to assist in the development of commercial products to deliver the pharmaceutical compound transdermally; and
 
 
·
agreed to supply the products which may be developed and approved by the FDA exclusively to Ranbaxy which agreed to purchase from us all of its requirements for such products from us on an exclusive basis.
 
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We recently completed certain milestones under these agreements, including producing a supply of the pharmaceutical compound which permitted Ranbaxy to complete pilot bioequivalence study results which were filed by Ranbaxy with the FDA as part of the ANDA filed in connection with this compound.

We have undertaken to provide certain services, including, completing the development of the initial formulation of the pharmaceutical compound for transdermal delivery, demonstrating that our production techniques can be scaled-up to meet anticipated production runs of the transdermal patch, providing all laboratory data relating to the utilization of our patch technology for this pharmaceutical compound, completing documentation necessary for GMP production of the product, providing dosage forms for the pilot and bioequivalence studies, conducting the pilot and other studies and providing underlying documentation required for Ranbaxy to gain regulatory approval for the product and support Ranbaxy’s ANDA filing. We are performing under this agreement as requested by Ranbaxy.

Ranbaxy granted us a license to utilize certain intellectual property we will require for the manufacture of the products which are the subject of the agreement and we have agreed to supply Ranbaxy with such product in the strengths and amounts as Ranbaxy may require for its bioequivalence studies. Thereafter, assuming Ranbaxy’s ANDA for this product is approved by the FDA, of which neither we nor Ranbaxy can be certain, we will manufacture and supply Ranbaxy with all of its commercial requirements of the product, subject to its right to acquire the product elsewhere if we are unable to furnish the supplies it requires, under the circumstances provided in the agreement. We have agreed to sell the product exclusively to Ranbaxy. We also have agreed to conform to GMP’s in connection with the manufacture of the product and otherwise supply product in conformity with Ranbaxy’s specifications as enumerated in the agreement which relate to quality control, packaging and labeling, among other things. Ranbaxy will pay us fixed prices for the products of various dosages and a royalty in excess of the per product price in the event it achieves certain net sales milestones. The agreement has a ten-year term from the date of the first commercial sale of the products. We have agreed to indemnify Ranbaxy for damages resulting from, among other things, our formulation or manufacturing of the product and Ranbaxy has agreed to indemnify us for damages relating to regulatory improprieties.

In June 2004, we entered into a Development, Manufacturing and Supply Agreement with Ranbaxy relating to a generic pharmaceutical compound subject to transdermal delivery. Under the agreement, we have been engaged to manufacture and supply products for use both in connection with Ranbaxy’s regulatory approval requirements and ANDA application and thereafter, if FDA approval is granted for the product, of which neither we nor Ranbaxy can be certain, on an ongoing basis to meet its requirements. In furtherance of our efforts, Ranbaxy extended a loan to us in the amount of $166,664 to purchase certain equipment required in connection with our obligations under the agreement which is repayable by offsetting amounts payable for product which may eventually be purchased from us, agreed to pay for the active pharmaceutical ingredient incorporated into the product during the trial phases and to pay for a contract research organization to conduct bioequivalence studies of the proposed product. Our obligations under this agreement are similar to those in our agreement with Ranbaxy described above. For example, we have agreed to conform to GMP’s in connection with the manufacture of the product and otherwise supply product in conformity with Ranbaxy’s specifications as enumerated in the agreement which relate to quality control, packaging and labeling, among other things, and in accordance with all applicable laws. The successful completion of the development portion of the agreement could yield us an aggregate of $678,800 of gross revenues, payable in tranches upon achieving certain milestones. Ranbaxy will purchase products from us at prices calculated in relation to the price we pay for the underlying active pharmaceutical ingredient and in the event that the price for said ingredient exceeds the maximum amount set forth in the agreement, Ranbaxy may terminate the agreement as to that specific product. We have agreed to indemnify Ranbaxy for damages resulting from, among other things, our development and related obligations under the agreement and Ranbaxy has agreed to indemnify us for damages relating to regulatory improprieties.
 
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In April 2006, we entered into a Development, Manufacturing and Supply Agreement with Cure Therapeutics, Inc., or CTI, relating to the development of a transdermal patch which delivers a generic pharmaceutical compound which will be utilized for new indications (that is, the treatment of conditions not covered by the original FDA approval) for such drugs. Under the agreement, CTI engaged us to undertake all processing of the pharmaceutical compound for the purpose of filing a new drug application, or NDA, with the FDA and to manufacture and supply sufficient quantities of the compound required for obtaining approval of the NDA. Our engagement is divided into three stages: technology transfer, formulation optimization, and scale-up; FDA phase 2 clinical trial batch manufacturing; and FDA phase 3 clinical trial batch manufacturing. Our obligations under the agreement include all manner of analyzing, testing, optimizing the formulation of our process by which clinical trial products are made, creation of dedicated tooling, scaling-up our manufacturing facility to produce commercial quantities of product, finishing, packaging, inspecting, labeling and preparing product for shipment, all as required under applicable law. In addition, we are required to maintain data and records with respect to all aspects of the foregoing for the specific purpose of filing same with the FDA with respect to the NDA and to report to CTI with respect to each phase of the process. CTI pays us fees upon our successful completion of milestones enumerated in the agreement. We are currently working on the second stage under the agreement. CTI has agreed, at its own cost and expense, to engage a contract research organization to conduct safety and efficacy studies of the clinical trial products we manufacture and, in the event that such studies fail to demonstrate the safety or efficacy of such products, CTI may terminate the agreement. We have agreed to conform to GMP’s in connection with the manufacture of the product and otherwise supply product in conformity with CTI’s specifications as enumerated in the agreement which relate to quality control, packaging and labeling, among other things, and in accordance with all applicable laws. We have agreed to indemnify CTI for damages resulting from, among other things, our performance of or failure to perform our obligations under the agreement and CTI has agreed to indemnify us for damages relating to regulatory improprieties. Each party has agreed to maintain the confidentiality of the other’s confidential information. The agreement has a term of two years but is subject to prior termination by either party in the event of a material breach by the other party and by CTI for any reason at any time upon written notice. The parties recognize the possibility that no commercial product may arise from their efforts.

We are also conducting a number of feasibility studies on transdermal products on behalf of client companies and are pursuing additional contract manufacturing opportunities. We do not undertake clinical studies. As a contract manufacturer for developing products, it would be the responsibility of our client to undertake and bear the cost of these clinical studies, including preparing and filing all documents required by the FDA. We would, however, perform routine chemical analysis of these products to determine if they meet proposed product specifications.

For the years ended December 31, 2006 and 2005, we spent $491,000 and $438,000, respectively, for research and development activities. Our research and development expense may vary significantly from quarter to quarter and year to year depending on, among other things, product development cycles and whether we or a third party are funding development. These variations in research and development spending may not be accurately anticipated and may have a material effect on our results of operations. Currently, research and development personnel engage in assisting with technical transfers of existing formulation and test methodology to our production facility. In addition, our personnel perform small scale development work on behalf of clients, including producing hand-cut transdermal patches on a research laminator for analytical testing or performing permeation studies to demonstrate how drug formulations penetrate a skin layer. Our personnel also work on improving test methods that may impact day to day testing requirements for commercial products. We periodically outsource analytical testing either because we do not possess the appropriate equipment or outsourcing such testing is more economically efficient.
 
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The time necessary to complete clinical trials and the regulatory process to obtain marketing approval varies significantly. We cannot be certain that we will have the financial resources necessary to complete products which we propose to develop, that those projects to which we dedicate resources will be successfully completed, that we will be able to obtain regulatory approval for any such product, or that any approved product may be produced in commercial quantities, at reasonable costs, and be successfully marketed. Similarly, we cannot assure that our competitors, most of which have greater resources than we do, will not develop and introduce products that will adversely affect our business and results of operations.

Manufacturing .

We conduct our manufacturing operations in a single facility comprised of an approximately 61,000 square foot building located on approximately 3.5 acres in Emigsville, Pennsylvania. Our products are manufactured in accordance with GMPs prescribed by the FDA. The FDA visited our facilities in November 2003 and June 2006 and issued establishment inspection reports. The reports indicated that there were no objectionable conditions or practices noted during their reviews. The FDA did not issue a Form FDA 483 (Inspectional Observations) report to us during either of these two visits. The FDA uses the Form FDA 483 report to communicate all observations of objectionable conditions noted during their inspection process. This facility has also been licensed by the United States Drug Enforcement Administration (“DEA”) to conduct research and manufacture products containing Schedule II controlled substances. To bring new products to market as quickly as possible, we will seek to have the manufacturing capacity to produce the new product prior to obtaining FDA approval.

Our products are manufactured according to current GMPs as specified by federal regulations which require us to maintain and update procedures and specifications as provided under federal law. We must maintain records that demonstrate the application of raw materials from receipt to use in a finished product. In addition, any complaints received must be documented and investigated. We are obligated to submit to the FDA reports covering our marketed products that include both chemistry information and adverse event information on an annual basis. If we do not adhere to current GMPs, the FDA could seek an injunction barring commercial distribution of our products.

The manufacture of advanced transdermal drug delivery systems requires specialized skills in several areas, as well as specialized manufacturing equipment. Our process development and design engineers work closely with the research and development department starting early in the product design stage, which renders the manufacturing development process more efficient. All scale-up work (spanning the gamut of initial research on a potential product to large-scale manufacturing for clinical and stability work), commencing with initial product development trials, is conducted on full-size, completely functional manufacturing equipment, reducing delays in the development and approval process and smoothing the transition to commercial production. Some of this equipment is manufactured in-house; the balance is fabricated by outside manufacturers to our specifications. We believe that this equipment provides a decided advantage in the manufacture of the complex multi-layer systems necessary for successful transdermal drug delivery. We currently have assembly packaging equipment in place having a single shift capacity of over 24 million patches annually. We believe that our current manufacturing facility is adequate for our intended purposes and will be sufficient for product expansion for the foreseeable future.
 
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As part of the manufacturing process, we have developed and perform appropriate quality control procedures including testing of all raw materials and finished product. Quality control procedures are specific checks and balances performed on raw materials and finished product to ensure materials adhere to the predetermined specifications.

Several raw materials used in the manufacture of our products are only available from single sources, all of which are domestic companies. These materials have generally been available to us and the pharmaceutical industry on commercially reasonable terms. To date, we have not experienced difficulty acquiring necessary materials. We will seek to negotiate supply agreements, as appropriate, for certain components.

Any curtailment in the availability of such raw materials could result in production or other delays, and, in the case of products for which only one raw material supplier exists, could result in a material loss of sales, with consequent adverse effects on our business and results of operations. In addition, because most raw material sources for transdermal patches must generally be approved by regulatory authorities, changes in raw material suppliers may result in production delays, higher raw material costs and loss of sales, customers and market share.

We do not believe that compliance with federal, state or local laws and regulations which have been enacted or adopted regulating the discharge of materials into the environment or otherwise relating to the protection of the environment has had or will have any material effect upon our capital expenditures, earnings or competitive position. There can be no assurance, however, (i) that changes in federal, state or local laws or regulations, changes in regulatory policy or the discovery of unknown problems or conditions will not in the future require substantial expenditures, or (ii) as to the extent of the Company's liabilities, if any, for past failures, if any, to comply with laws, regulations and permits applicable to its operations.

Marketing and Sales .

We have contracted with a full-service sales and marketing outsourcing company that focuses on generic and branded pharmaceutical companies to handle the majority of the sales and marketing efforts for our transdermal nitroglycerin product. This company monitors client sales, as well as examines our competition in order to anticipate and recommend changes to our sales, marketing and promotional strategy. This company also assists in providing the industry contacts to reach all distribution channels.

We have engaged Cardinal Health, Inc. as a non-exclusive distributor of our transdermal patches pursuant to an agreement dated October 1, 2001. We sell product to Cardinal at our list price and Cardinal is entitled to receive certain discounts and rebates as stipulated in the agreement. During the years ended December 31, 2005 and 2006, Cardinal purchased products representing in excess of 10% of our total sales.

We market our products directly to wholesalers, distributors, retail pharmacy chains, mail order pharmacies and group purchasing organizations. We also market our products indirectly to independent pharmacies, managed care organizations, hospitals, nursing homes and pharmacy benefit management companies, collectively referred to as “indirect customers.” We may enter into agreements with our indirect customers to establish contract pricing for certain products. The indirect customers then independently select a wholesaler from which they actually purchase the products at these contracted prices. Alternatively, certain wholesalers may enter into agreements with indirect customers which establish contract pricing for certain products which the wholesalers provide.
 
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Competition .

The market for our nitroglycerin transdermal patches is highly competitive. Because nitroglycerin is a generic drug, companies willing and able to comply with FDA and other applicable regulations can produce nitroglycerin-based products. Moreover, nitroglycerin can be administered utilizing a wide array of conventional and alternate forms of drug delivery. Accordingly, our product faces intense competition from a diverse group of domestic and multinational companies most of which possess significantly greater financial and personnel resources than we do and that includes:

 
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large conglomerates of which pharmaceutical formulations , including nitroglycerin-based products, represent only a portion of the products they offer;

 
·
pharmaceutical companies of all sizes which focus on the development of advanced transdermal systems which deliver nitroglycerin;

 
·
pharmaceutical companies which offer nitroglycerin based products delivered other than transdermally or other formulations which relieve angina; and

 
·
companies that offer alternate non-drug therapies.

In addition, medical science is constantly evolving and the entities against which we currently compete may change in the future . As developments in medicine are made, drugs and delivery methods may become obsolete or fall out of favor with physicians.

Most of our competitors have substantially greater financial resources and larger research and development staffs than we do and may have substantially greater experience in developing products, in obtaining regulatory approvals and in manufacturing and marketing pharmaceutical products. Many other pharmaceutical companies have the financial resources to acquire the skills necessary to develop transdermal systems.

Advances in transdermal patch technology have intensified over the last several years. As new materials have been developed which allow for more efficient delivery of drugs through the patch membrane and adhesive, manufacturers have been able to develop smaller patches which are more comfortable for the user. New adhesive technologies have recently been incorporated into patches which have selective adhesive properties once in contact with the skin, exhibit substantial strength of initial adhesion and duration of adhesion and are compatible with skin and various drug molecules. Other advances in patch technology include the development of chemical penetration enhancers, substances that make the skin more permeable and allow drug molecules to cross the skin at a faster rate, and the development of micro-needles to enlarge the skin pores through which drugs flow. In addition, active transdermal patches which use energy, such as electricity and ultrasound, to enhance the extent and rate at which pharmaceutical compounds cross the skin and which will allow for larger drug molecules to be delivered transdermally, are being developed at a rapid rate. All of these new transdermal technologies could supplant our technology and render our product obsolete.

Since we manufacture a generic drug product and are not subject to the myriad of factors which impact drug developers, such as high development costs and establishing name and brand recognition, we believe that the principal factors that bear upon our competitive position are price, consistency and quality of product, our ability to deliver product on a timely basis, reliability and patient convenience. We have been manufacturing nitroglycerin patches for nearly twenty years and believe that we have gained significant experience that contributes to our ability to compete effectively in the market. Our competitive position will also depend on our ability to attract and retain qualified scientific and other personnel, develop effective proprietary products, implement production and marketing plans, effect distribution of our products, obtain patent protection and secure adequate capital resources.
 
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Patents and Proprietary Rights .

We seek to obtain patent protection on our delivery systems and manufacturing processes whenever possible. We have obtained eleven United States and foreign patents and trademarks relating to our transdermal delivery systems and manufacturing processes. While we view our patents and trademarks as a valuable asset, we do not consider any single patent or trademark to be of material importance to our business as a whole.

As a result of changes in United States patent law under the General Agreement on Tariffs and Trade and the accompanying agreement on Trade-Related Aspects of Intellectual Property Law, which took effect in their entirety on January 1, 1996, the terms of some of our existing patents have been extended beyond the original term of seventeen years from the date of grant. Our patents filed after June 7, 1995 will have a term of twenty years computed from the effective filing date.

We are unaware of any challenge to the validity of our patents or of any third party claim of patent infringement with respect to any of our products, in either case that could have a material adverse effect on our business or prospects.

Although there is a statutory presumption as to a patent’s validity, the issuance of a patent is not conclusive as to such validity, or as to the enforceable scope of the claims of the patent. We cannot assure that our patents or any future patents will prevent other companies from developing similar or functionally equivalent products. We cannot assure that we would have the resources to prosecute an action to enforce our patent rights against an alleged infringer or that we would be successful in any infringement action that we elect to bring. Likewise, we cannot assure that we would have the resources to defend an infringement action or that we would be successful in any such defense. Furthermore, we cannot assure that any of our future processes or products will be patentable, that any additional patents will be issued in any or all appropriate jurisdictions or that our processes or products will not infringe upon the patents of third parties. In addition, since our patents typically cover our product formulation rather than the compound being delivered, competitors may seek to create functionally equivalent products (i.e., patches delivering the same compound over the same time period to treat the same indication) that avoid our patents. In those cases, we may face competition from functionally equivalent products even before our patents expire.

We also attempt to protect our proprietary information under trade secret and confidentiality agreements. Generally, our agreements with each employee, client, consultant and agent contain provisions designed to protect the confidentiality of our proprietary information. There can be no assurance that these agreements will not be breached, that we will have adequate legal remedies as a result thereof, or that our trade secrets will not otherwise become known or be independently developed by others.
 
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Government Regulation .

Our operations are subject to extensive regulation by governmental authorities in the United States and in other countries in which we or our distributors may sell products which we manufacture with respect to the testing, approval, manufacture, labeling, marketing and sale of pharmaceutical products and the possession and use of controlled substances. We devote significant time, effort and expense to address the extensive government regulations applicable to our business.

The marketing of pharmaceutical products requires the approval of the FDA in the United States. The process for obtaining such approval varies depending upon the nature of the product we are seeking to manufacture and sell. The FDA has established regulations, guidelines and safety standards, which apply to the pre-clinical evaluation, clinical testing, manufacturing and marketing of pharmaceutical products. New drugs or drugs to be delivered by a new route of administration are subject to a more lengthy approval process. Typically, drugs that, among other factors, have been previously approved by the FDA are subject to a less stringent, less time consuming and less expensive approval process.

The process of obtaining FDA approval for a new product may take several years or more and is likely to involve the expenditure of substantial resources. The steps required before a product can be produced and marketed for human use typically include: (i) pre-clinical studies; (ii) submission to the FDA of an Investigational New Drug Exemption (“IND”), which must become effective before human clinical trials may commence in the United States; (iii) adequate and well controlled human clinical trials; (iv) submission to the FDA of a New Drug Application (“NDA”); and (v) review and approval of the NDA by the FDA. Approval of a product by the FDA does not serve as a guaranty of the product’s safety or efficacy.

Generally, products with new active ingredients, new indications, new routes of administration, new dosage forms or new strengths require an NDA to be filed with the FDA. An NDA requires that complete clinical studies of a product’s safety and efficacy be submitted to the FDA, the cost of which is substantial. These costs can be reduced, however, for delivery systems that utilize approved drugs. In these cases, the company seeking approval may refer to safety and toxicity data reviewed by the FDA in its approval process for the innovator product. In addition, a supplemental NDA may be filed to add an indication to an already approved product.

Since we expect that any new products we may bring to market will contain drugs previously approved by the FDA for transdermal delivery, an abbreviated approval process may be available. Such products must have, among other requirements, the same active ingredient(s), indication, route of administration, dosage form and dosage strength as an existing FDA-approved product covered by an NDA, if clinical studies have demonstrated bio-equivalence of the new product to the FDA-approved product covered by an NDA. For this abbreviated process, we would submit an ANDA to the FDA instead of an NDA. Under FDA ANDA regulations, companies that seek to introduce an ANDA product must also certify that the product does not infringe on any approved product’s patent listed with the FDA or that such patent has expired. If the applicant certifies that its product does not infringe on the approved product’s patent or that such patent is invalid, the patent holder may institute legal action to determine the relative rights of the parties and the application of the patent. Under the Drug Price Competition and Patent Term Restoration Act of 1984 (the “Hatch-Waxman Act”), the FDA may not finally approve the ANDA until the later of thirty months from the date of the legal action or a final determination by a court that the applicable patent is invalid or would not be infringed by the applicant’s product.

With respect to any new products we or our clients may seek to develop, the results of product development and pre-clinical and clinical studies (if necessary) will be submitted to the FDA as an NDA or ANDA for approval. If an application is submitted, there can be no assurance that the FDA will review and approve the NDA or ANDA in a timely manner. The FDA may deny an NDA or ANDA if applicable regulatory criteria are not satisfied or it may require additional clinical testing. Even if such data is submitted, the FDA may ultimately deny approval of the product. Further, if there are modifications to the drug, including changes in indication, manufacturing process, labeling, or a change in manufacturing facility, an NDA or ANDA notification may be required to be submitted to the FDA and FDA approval required prior to implementation of the change. Product approvals may be withdrawn after the product reaches the market if compliance with regulatory standards is not maintained or if problems occur regarding the safety or efficacy of the product. The FDA may require testing and surveillance programs to monitor the effect of products that have been commercialized, and has the power to prevent or limit further marketing of these products based on the results of these post-marketing programs.
 
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Manufacturing facilities are subject to periodic inspections for compliance with the FDA’s good manufacturing practices (GMP’s) regulations and each domestic drug manufacturing facility must be registered with the FDA. In addition, our manufacturing operations must be registered with the Pennsylvania Department of Health. In complying with standards set forth in these regulations, we must expend significant time, money and effort in the area of quality assurance to ensure full technical compliance. Facilities handling controlled substances, such as ours, also must be licensed by the Drug Enforcement Administration, or DEA, and are subject to more extensive regulatory requirements than those facilities not licensed to handle controlled substances. We also require approval of the DEA to obtain and possess controlled substances. We produce transdermal drug delivery products in accordance with United States regulations for manufacturing process validation studies and commercial sale. FDA approval to manufacture a drug product is site specific. In the event our approved manufacturing facility becomes inoperable, obtaining the required FDA approval to manufacture such drug at a different manufacturing site could result in production delays, which could adversely affect our business and results of operations.

Failure to comply with governmental regulations may result in fines, warning letters, unanticipated compliance expenditures, interruptions or suspension of production and resulting loss of sales, product seizures or recalls, injunctions prohibiting further sales, withdrawal of previously approved marketing applications and criminal prosecution.

Our activities are subject to various federal, state and local laws and regulations regarding occupational safety, sales practices, laboratory practices, environmental protection and hazardous substance control, and may be subject to other present and possible future local, state, federal and foreign regulations. Under certain of these laws, we could be liable for substantial costs and penalties in the event that waste is disposed of improperly. While it is impossible to accurately predict the future costs associated with environmental compliance and potential remediation activities, compliance with environmental laws is not expected to require significant capital expenditures and has not had, and is not presently expected to have, a material adverse effect on our earnings or competitive position.

Employees .

We employ approximately fifty five employees, of whom seventeen are covered by a collective bargaining agreement with a local unit of the Retail Wholesale and Department Store Union, AFL-CIO (“R.W.D.S.U.”). The R.W.D.S.U. agreement is for a three year period ending December 10, 2007. The contract is subject to annual renewal thereafter and acknowledges that the R.W.D.S.U. is the exclusive bargaining agent for the Company’s regular production employees, excluding all other employees including but not limited to supervisors, foremen, clerical employees, time-keepers, watchmen, guards, maintenance personnel and part-time employees. We believe our employee relations are good.
 
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Risk Factors .

The following is a summary of certain risk factors that may cause our results to differ from the “forward-looking statements” made in this Annual Report. The risks and uncertainties described below are not listed in order of priority and are not the only ones we face. Additional risks not presently known to us or other factors not perceived by us to present significant risks to our business at this time also may impair our business operations. If any of these risks actually occur, our business, financial condition, and/or results of operations would likely suffer significantly. We do not undertake to update any of these forward-looking statements or to announce the results of any revisions to these forward-looking statements except as required by law.

Risks Relating to Our Financial Condition.

We believe that our financial condition as of December 31, 2006 gives rise to several risks and uncertainties. In addition, because of our status as a majority owned subsidiary of Health-Chem, that company’s financial condition and future operating results may directly impact Transderm. We believe that the financial information and other factors set forth below are relevant in this regard.

As of December 31, 2006:

·
Transderm had aggregate liabilities of approximately $41.3 million comprised of $10.8 million to unrelated parties, including $7.3 million of royalties due under the Key License of which we are in breach (the “Key Royalty”), and $30.5 million owed to Health-Chem in respect of intercompany accounts (the “Intercompany Obligations” and collectively with Transderm’s other liabilities, the “Transderm Liabilities”);

·
Transderm had a working capital deficiency of approximately $26 million; and

·
the Group had aggregate debts and liabilities of approximately $22.4 million (the “Group Liabilities”), including $11.5 million under the Debentures under which Health-Chem currently is in default.

In view of the foregoing, investors should consider the following risks:

Risks relating to our financial condition include the following:

Our financial condition and continuing breach under the Key License create substantial doubt as to whether we can continue to operate as a going concern. If we can not continue to operate as a going concern, we may have to cease operations and investors will lose their entire investment in our company.

Transderm’s audited consolidated financial statements for the year ended December 31, 2006 have been prepared assuming that we will continue as a going concern. However, Note 3 of the Notes to Consolidated Financial Statements and the auditor’s report on our financial statements cite certain financial conditions and other factors that raise substantial doubt about our ability to continue to operate as a going concern, including that:

·
Transderm has significant outstanding liabilities at December 31, 2006, particularly the amounts due to Health-Chem and Key, which it is unable to satisfy;
 
·
our breach of the Key License for failing to make royalty payments thereunder entitles Key to terminate the license and curtail our use of technology incorporated into our transdermal patches, which, unless we were able to develop our own technology to replace that covered by the Key License or otherwise obtain a license for similar technology, neither of which are likely, would require us to discontinue selling our transdermal patch and we would have no source of continuing meaningful revenues;

·
our financial condition has prevented us from securing financing or obtaining loans from third parties from which we could repay all or a portion of the amounts due; and

·
if our creditors were to initiate legal action against us for the amounts due to them, we would not be able to continue to operate as a going concern unless there was an increase in profitability and/or an infusion of additional funds in order to meet the our obligations to Health Chem and Key for both the past amounts due and ongoing amounts as they became due.

We have experienced net losses from operations in every year since 1995 and have an accumulated deficit of approximately $35.6 million at December 31, 2006 . In addition, we had a working capital deficit of approximately $26.0 million at December 31, 2006.

We have been able to continue operating over the last several years because we have not paid Health-Chem or Key. We do not have the means to satisfy the amounts due to Health-Chem or pay the Key Royalty but we have been paying our debts and liabilities not related to Health-Chem or the Key License on a current basis from cash flow generated from operations. Our financial condition has prevented us from securing financing or obtaining loans from which we could repay all or a portion of the amounts due. We are further constrained from obtaining financing because of Health-Chem’s financial condition, as more fully described in the ensuing risk factor. We have entered into discussions with Key in an effort to develop payment arrangements for the amount owed to it, though we cannot be certain we will be successful in our efforts in reaching an agreement that allows us to continue our operations.

While management has formulated a plan to address these conditions as described under the heading “Management’s Discussion and Analysis of Financial Condition and Results of Operation” and in Note 3 of the Notes to Consolidated Financial Statements, we cannot be certain that we will be successful in executing this plan or that if we are successful that we will achieve profitability. The financial statements do not include any adjustments that might result from the outcome of this uncertainty.

If we are unable to address successfully the conditions that raise doubt about our ability to continue to operate as a going concern, particularly our efforts to negotiate favorable payment terms of the amounts due to Key and Health-Chem, we may have to discontinue our operations and possibly seek protection under bankruptcy laws, which likely would result in the loss of all value which our stock now or at such time may have and result in investors losing the entire amount of their investment.  

Health-Chem’s ability to achieve financial stability will bear on Transderm’s financial condition and its ability to continue to operate as a going concern and to achieve profitability in the future. If Health-Chem does not effectively address its financial concerns, it may be required to take steps to wind-up the Group’s, including Transderm’s, operations, in which case holders of Transderm’s stock could lose the entire amount of their investment.
 
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As stated in the footnotes to the audited consolidated financial statement included in Health-Chem’s annual report for the year ended December 31, 2006 and the auditor’s report on such financial statements, Health-Chem’s financial condition casts doubt upon its ability to continue operating as a going concern. Health-Chem’s principal liability (excluding liabilities and obligations attributable exclusively to Transderm) consists of approximately $11.5 million of principal and interest due under the Debentures.

Health-Chem is in default under several provisions of the Debentures as a result of its failure to have paid principal and interest when they became due in April 1999. A default allows the Trustee or the holders of at least 25% in aggregate principal amount of all Debentures to declare the outstanding principal of the Debentures plus all accrued and unpaid interest immediately due and payable. Health-Chem has been able to continue operating because neither the Trustee nor the Debenture holders have pursued legal redress to obtain the payment due. Health-Chem has approached the Trustee to negotiate a payment plan with the Debenture holders but no assurance can be given that Health-Chem will be successful in negotiating a payment plan that does not unduly burden or otherwise prohibit normal operations, if at all. If Health-Chem is unable to negotiate payment terms with the Debenture holders, they could initiate legal action against Health-Chem for the entire amount due under the Debentures. In such case, Health-Chem may have to liquidate its assets and dissolve or wind-up the companies comprising the Group, including Transderm, or seek protection from creditors under the federal bankruptcy laws which likely would result in the loss of all value which our stock now or at such time may have and result in investors losing the entire amount of their investment.

Even if payment terms for the Group’s debts and liabilities are negotiated, the Group’s cash flow and ability to operate may be adversely affected.

If the Group were to successfully negotiate payment plans with respect to the Key Royalties and the amount due under the Debentures, it is likely that a significant portion of the Group’s revenues will be allocated to making payments under such agreements and there will be little capital to fund other business opportunities, including new product development and marketing. In addition, the Group’s substantial indebtedness could have other important consequences to both Transderm and Health-Chem, including, with respect to each company:
 
·
negatively impacting its ability to remain current in the payment of other liabilities and current accounts payable;

·
limiting its ability to obtain financing for working capital, capital expenditures, acquisitions and general corporate or other purposes;

·
increasing its vulnerability to general economic and industry conditions; and

·
placing it at a disadvantage compared to its competitors who have less debt.
 
Even if the Group concludes favorable agreements to satisfy its obligations, it may not be able to generate sufficient cash from operations to abide by the terms of these agreements.
 
Even if the Group successfully negotiates agreements to pay the Key Royalty and the amount due under the Debentures, its ability to make scheduled payments on these obligations and remain current with respect to its other financial obligations will depend on its operating performance, which is subject to prevailing economic and competitive conditions and to certain financial, business and other factors beyond its control. We cannot assure you that the Group will maintain a level of cash flows from operating activities sufficient to permit it to pay Key and the Debenture holders under any agreements they reach with these creditors and remain current with respect to other outstanding liabilities.
 
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Transderm’s Intercompany Obligations to Health-Chem at December 31, 2006 are approximately $30.5 million. Health-Chem has not sought to collect on these obligations since they began to accrue in 1995. If Health-Chem were to seek collection of such Intercompany Obligations, Transderm would not be able to pay them and may be forced to seek protection under bankruptcy laws.

Transderm owes Health-Chem approximately $30.5 million in intercompany obligations at December 31, 2006 as reported in its financial statements, some of which extend back to 1995. To date, Health-Chem has not sought to collect the amounts due from Transderm. Transderm does not currently have and does not expect to have in the near future, sufficient funds to repay such obligations. If Health-Chem were to seek collection of the amounts due, Transderm may have to seek protection under bankruptcy laws and investors could lose the amount of their investment in Transderm.

Risks Relating to Our Failure to File Reports under Federal Securities Laws.

Our failure to abide by our reporting requirements under federal securities laws could subject us to enforcement proceedings by the SEC, including the de-registration of our securities, which could materially adversely affect our business and your ability to obtain information about our company and could also subject Transderm’s management to civil liabilities from private shareholder actions.

Prior to filing an Annual Report on Form 10-KSB for the years ended December 31, 2003 and 2004 (the “2004 Annual Report”) in January 2007, we had not filed any annual or quarterly reports with the SEC since we filed an annual report for the year ended December 31, 1998 and quarterly reports for the first three quarters of 1999 in November 1999. We have not filed and do not expect to file annual or quarterly reports for the years 1999 through 2002 because we do not have the financial information necessary to prepare such reports, as detailed in the 2004 Annual Report. Additionally, we have not filed and do not expect to file any quarterly reports for the years 2003 through 2006 both because we do not believe such information would be useful to stockholders and because of the costs we would have to incur in connection with the preparation of such reports. Our failure to file any of the reports we were required to file under federal securities laws could give rise to action by the SEC or private litigation by our current and former stockholders. The SEC’s action against us could take the form of penalties, fines, sanctions, enforcement or other actions or proceedings, including revocation of registration of our common stock under the Securities Exchange Act which could result in less public information available to our stockholders and negatively impact any opportunity which we might otherwise have to raise capital in the future. Moreover, private suits by our current and former security holders for failing to make available current information about our company could subject us as well as our officers and directors to civil liabilities. We cannot predict what, if any, actions the SEC may impose upon or take against our company or suits stockholders may bring against us for our failure to file required reports; however, any such actions could cause us to incur significant additional compliance expenditures and divert management’s attention from our core business activities.

Health-Chem is delinquent in its reporting requirements as well and could be subject to similar action by the SEC or stockholders which, if taken or initiated, would have a negative impact on our operation.
 
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Risks Relating to Our Business.

We are dependent on the Key License which allows us to use certain technology incorporated into our transdermal patch under which we are seven years in arrears in royalty payments and, consequently, are in breach. If we are unable to negotiate a plan with Key that allows us to pay the past due royalties and Key revokes the license or if we otherwise lose our right to utilize the technology subject to such license we will have to discontinue manufacturing our sole product.

We rely on the Key License to permit us to incorporate certain transdermal patch technology owned by Key into our second generation transdermal patch developed during the mid 1990’s. If we are unsuccessful in negotiating a plan with Key to pay past due royalties which does not impede our ability to operate and does not materially impact our cash, we may be forced to discontinue selling transdermal patches, unless we could develop our own technology to replace that covered by the Key License or otherwise locate and obtain a license for similar technology which can be incorporated into our manufacturing process, neither of which is unlikely, and will have no source of revenue from product sales. Given our current financial condition, it is unlikely we would be able to continue operating under such circumstances and investors could lose the entire amount of their investment in Transderm.

We are subject to all of the risks associated with being a single product company, including special risks relating to the fact that we manufacture and sell such product pursuant to a license. If we are unable to develop and bring to market other products, our current and future operations and financial condition may be adversely affected.

We manufacture and sell only one product, our nitroglycerin transdermal patch. We are subject to all of the risks associated with being a single product company, including

·
the inordinate effect of competition on our business which could cause us to reduce the price we charge for the product or erode total sales, and the corresponding reduction in earnings we generate from such product as result of competition;

·
the loss of the Key License; and

·
our inability to obtain critical raw materials from which we manufacture the product.

If we experience any of the foregoing or other difficulties or impediments with respect to sales of such product, our business, financial condition and results of operations would be materially adversely affected.

We are seeking to develop and bring to market other products to broaden our revenue base and reduce reliance on revenues generated from sales of our nitroglycerin patch. We cannot be certain that we will have sufficient resources to bring any new products to market and if we do, that our efforts to develop and market other products will be successful. To the extent that we are unable to expand our product offerings, our business and results of operation could be negatively impacted and stockholders in our company may lose all or part of their investment.

The development and manufacturing agreements to which we currently are a party allow our clients to terminate these agreements at will. The termination of these agreements for any reason would have a negative impact on our operations.

We are party to contracts with two clients under which we have agreed to develop and manufacture three potential pharmaceutical compounds for transdermal delivery. We currently generate revenues from these agreements in connection with our product development efforts and may generate revenues under these agreements in the future from the manufacture of products which ultimately are approved by the FDA for sale in the United States, of which we can offer no assurance. In some cases, our clients are permitted to terminate these agreements at will for any reason. If our clients elect to terminate these agreements our current and future operations would be adversely impacted.
 
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We are subject to extensive regulation by the FDA and other federal and state agencies. If we fail to maintain satisfactory compliance with FDA regulations and other governmental agencies, we may be forced to suspend or terminate our operations and we could be subject to civil or criminal penalties.

Our operations are subject to extensive regulation by governmental authorities in the United States with respect to the testing, approval, manufacture, labeling, marketing and sale of pharmaceutical products. These regulations are wide-ranging and govern, among other things: adverse drug experience reporting, product promotion, product pricing and discounting, drug sample accountability, drug product stability, product manufacturing, including good manufacturing practices, and product changes or modifications. Our facilities handle controlled substances, resulting in additional extensive regulatory requirements and oversight. Compliance with the extensive government regulations applicable to our business requires the allocation of significant time, effort and expense. Even if a product is approved by a regulatory authority, product approvals may be withdrawn after the product reaches the market if compliance with regulatory standards is not maintained or if problems occur regarding the safety or efficacy of the product. If we fail to comply with the regulatory requirements of the FDA and other applicable U.S. regulatory authorities or previously unknown problems with our products or manufacturing processes are discovered, we could be subject to administrative or judicially imposed sanctions, including: restrictions on the products, manufacturers or manufacturing processes; warning letters; civil or criminal penalties; fines; injunctions; product seizures or detentions; voluntary or mandatory product recalls and publicity requirements; unanticipated compliance expenditures; suspension or withdrawal of previously approved marketing applications; total or partial suspension of production; and criminal prosecution.

Our product sales are concentrated among a few customers and a substantial decrease in revenues generated from sales to these customers would have an adverse effect on our business unless we were able to identify other customers.

During each of fiscal years ended December 31, 2006 and 2005, a significant portion of our revenues were derived from a small number of customers. In 2006, two customers accounted for approximately 43% of our revenues and these customers accounted for approximately 55% of our revenues during fiscal 2005. During 2006, orders from one of our principal customers decreased by 53% and our revenues for the year declined commensurately. If we are unable to identify other customers to replace the revenues lost from the decline in sales to this customer or this customer does not place order for products from us at its prior levels, our business, financial condition and results of operations will continue to be negatively impacted.
 
Because our sales tend to be concentrated among a small number of customers during any period, our operating results may be subject to substantial fluctuations. Moreover, we tend to receive relatively large orders for products from a relatively small number of customers. Consequently, a single order from one customer may represent a substantial portion of our sales in any one period and significant orders by any customer during one period may not be followed by further orders from the same customer in subsequent periods. These and other factors may cause our sales and operating results to be subject to very substantial periodic variations. Since quarterly performance is likely to vary significantly, our results of operations for any quarter are not necessarily indicative of the results that we might achieve for any subsequent period. Accordingly, quarter-to-quarter comparisons of our operating results may not be meaningful.
 
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We rely on a single supplier or a limited number of suppliers for certain raw materials used in our products.

Certain raw materials and components used in the manufacture of our products are available from limited sources, and, in some cases, a single source. Generally, regulatory authorities must approve raw material sources for transdermal products, and in the case of controlled substances, the DEA sets quotas for controlled substances and we must receive authorization from the DEA to purchase and handle these substances. We cannot be certain that we will be granted sufficient DEA quota to meet production requirements for controlled substances. Without adequate approved supplies of raw materials or packaging supplies, our manufacturing operations could be interrupted until another supplier is identified, our products approved and trading terms with it negotiated. We may not be able to identify an alternative supplier and any supplier that we do identify may not be able to obtain the requisite regulatory approvals in a timely manner, or at all. Furthermore, we may not be able to negotiate favorable terms with an alternative supplier. Any disruptions in our manufacturing operations from the loss of an approved supplier may cause us to incur increased costs and lose revenues and may have an adverse effect on our relationships with our customers, any of which could have adverse effects on our business and results of operations. Our business also faces the risk that third party suppliers may supply us with raw materials that do not meet required specifications, which, if undetected by us, could cause our products to test out of specification and require us to recall the affected product.

We rely on the services of a single agent to market our product and if we were to lose the services of such entity or it is not as successful in its sales efforts, our business and results of operations would be adversely affected.

We market our products through a single marketing representative. If we were to lose the services of such marketing agent for any reason or said entity does not maintain a steady demand for our product, and we are unable to identify an adequate replacement, our business, results of operations and financial condition would be materially adversely affected.

We may expend significant cash and personnel resources in the development of any new products and if we do not generate the anticipated level of revenues from sales of such products, our business will be negatively and adversely affected.

Our efforts to commercialize new products will require significant expenditures of resources, including cash, which we do not currently possess, and time, in the research, development, testing, preparation and execution of applications with governmental authorities to manufacture and sell such product. If we do not generate revenues from sales of any new product at levels anticipated prior to embarking on such development, our business, financial condition and results of operations would be materially adversely affected.

We may lose out to larger and better-established competitors.

The drug delivery industry is intensely competitive. We face competition from a number of companies that develop, market and sell transdermal patches that deliver nitroglycerin, and competition is expected to intensify as more companies enter the field. Most of our competitors have significantly greater financial, technical, manufacturing, marketing and distribution resources as well as greater experience in the drug delivery industry than we have. The particular medical conditions our product addresses can also be addressed by other drugs and other delivery modalities. Many of these alternatives are widely accepted by physicians and have a long history of use. Physicians may use our competitors' products and/or our products may not be competitive with other technologies. If these things happen, our sales and revenues will decline. Competition may result in price reductions, reduced gross margins and loss of market share.
 
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We cannot assure that our products will compete successfully against competitive products or that developments by others will not render our products obsolete or uncompetitive. If we cannot maintain competitive products and technologies, our current and potential strategic partners may choose to adopt the drug delivery technologies of our competitors or their own internally developed technologies.

Our product may be displaced by more effective medications or newer technologies.

The drug development and delivery industries are undergoing rapid and significant change. Others may succeed in developing and marketing drugs and products that are more effective than those developed or marketed by us, or that would make our product obsolete or non-competitive. Additionally, researchers could develop new delivery devices and medications that replace or reduce the importance of our products. Accordingly, our success will depend, in part, on our ability to respond quickly to medical and technological changes through the development and introduction of new products. Currently, we do not have the financial or personnel resources to do this. If our products become obsolete and our efforts to develop new products do not result in any commercially successful products, our sales and revenues will decline.

Competitors may use legal, regulatory and legislative strategies to prevent or delay our launch of generic products.

The Hatch-Waxman Act provides for a period of 180 days of generic marketing exclusivity for each ANDA applicant that is first to file an ANDA containing a certification of invalidity, non-infringement or unenforceability related to a patent listed with respect to a reference drug product, commonly referred to as a Paragraph IV certification. During this exclusivity period, the FDA cannot grant final approval to any other Paragraph IV filer. If an ANDA containing a Paragraph IV certification is successful, it generally results in higher market share, net revenues and gross margin for that applicant for a period of time. Even if we obtain FDA approval for generic drug products, we may lose significant advantages to a competitor who was first to file an ANDA containing a Paragraph IV certification.

Competitors may also pursue legislative and other regulatory or litigation strategies to prevent or delay our launch of a generic product. These strategies include, but are not limited to: seeking to obtain new patents on drugs for which patent protection is about to expire, changing the labeling for the branded product, filing a citizen petition with the FDA, pursuing state legislative efforts to limit the substitution of generic versions of brand pharmaceuticals, filing patent infringement lawsuits that automatically delay FDA approval of many generic products, introducing a second generation product prior to the expiration of market exclusivity for the first generation product which may reduce demand for a generic first generation product, and obtaining market exclusivity extensions by conducting pediatric trials of brand drugs.

Unfavorable pricing regulations, third-party reimbursement practices or healthcare reform initiatives applicable to our product could limit our potential product revenue.

The healthcare industry is undergoing fundamental changes resulting from political, economic and regulatory influences. In the United States, comprehensive programs have been proposed that seek to increase access to healthcare for the uninsured, control the escalation of healthcare expenditures within the economy and use healthcare reimbursement policies to balance the federal budget.
 
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We expect that Congress and state legislatures will continue to review and assess healthcare proposals, and public debate of these issues will likely continue. We cannot predict which, if any, of such reform proposals will be adopted and when they might be adopted. Significant changes in the healthcare system could have a substantial impact on the manner in which we conduct our business and could require us to revise our strategies and negatively affect our business, prospects and results of operations.

Legislative or regulatory programs that may influence prices of prescription drugs could have a material adverse effect on our business, financial position and results of operations.

Current or future federal or state laws and regulations may influence the prices of drugs and, therefore, could adversely affect the price that we receive for our product. Programs in existence in certain states seek to set prices of all drugs sold within those states through the regulation and administration of the sale of prescription drugs. Expansion of these programs, in particular, state Medicaid programs, or changes required in the way in which Medicaid rebates are calculated under such programs, could adversely affect the price we can charge for our product and could have a material adverse effect on our business, financial position and results of operations.

We cannot be certain of the protection or confidentiality of our patents and proprietary rights.

Our success will depend, in part, on our ability to obtain or license patents for our products, processes and technologies. If we do not do so, our competitors may exploit our innovations and deprive us of the ability to realize revenues from those innovations. There is no assurance that we will be issued patents for any patent applications we may file, that any existing or future patents that we receive or license will provide competitive advantages for our products, or that we will be able to enforce successfully our patent rights. Additionally, there can be no assurance that our patents or any future patents we may be issued will prevent other companies from developing similar or functionally equivalent products, or challenging, invalidating or avoiding our patent applications or any existing or future patents that we receive or license.

We also rely on trade secrets, unpatented proprietary know-how and continuing technological innovation. We use confidentiality agreements with purchasers, suppliers, employees and consultants to protect our trade secrets, unpatented proprietary know-how and continuing technological innovation, but there can be no assurance that these parties will not breach their agreements with us or that we will be able to effectively enforce our rights under those agreements. We also cannot be certain that we will have adequate remedies for any breach. Disputes may arise concerning the ownership of intellectual property or the applicability of confidentiality agreements. Furthermore, we cannot be sure that our trade secrets and proprietary technology will not otherwise become known or that our competitors will not independently develop our trade secrets and proprietary technology.

Third parties may claim that we infringe their proprietary rights, forcing us to expend substantial resources in resulting litigation, the outcome of which is uncertain. Any unfavorable outcome could negatively affect our financial position and results of operations.

Our success will depend, in part, on our ability to operate without infringing the proprietary rights of others, and there can be no assurance that our products and processes will not infringe upon the patents of others. Third parties may also institute patent litigation against us for competitive reasons unrelated to any infringement by us. If a third party asserts a claim of infringement, we may have to seek licenses, defend infringement actions or challenge the validity of those third-party patents in court. If we cannot obtain the required licenses, or are found liable for infringement or are not able to have these patents declared invalid, we may be liable for significant monetary damages, encounter significant delays in bringing products to market or be precluded from participating in the manufacture, use or sale of products or methods of drug delivery covered by the patents of others. There can be no assurance that we have identified, or that in the future we will be able to identify, all U.S. and foreign patents that may pose a risk of potential infringement claims.
 
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We may not be able to manufacture new products in commercial quantities efficiently.

We may seek to bring to market new products that we have never manufactured on a commercial scale. Accordingly, inefficiencies and other scale-up problems may occur in the process of manufacturing new products in commercial quantities. If we experience manufacturing difficulties, our overall manufacturing costs may be higher than we had anticipated.

We may be subject to product liability claims and we cannot be certain that we will have adequate insurance coverage.

The testing, manufacturing and marketing of our products may expose us to potential product liability and other claims resulting from their use. If any such claims against us are successful, we may be required to make significant compensation payments and suffer adverse publicity. Even unsuccessful claims could result in the expenditure of funds in litigation and the diversion of management time and resources. We maintain product liability insurance, but there can be no assurance that our insurance will cover all future claims or that we will be able to maintain existing coverage or obtain additional coverage at reasonable rates. If a claim is not covered or if our coverage is insufficient, we may incur significant liability payments that would negatively affect our business, financial position or results of operations.

All of our products are manufactured at one location and any interruption of production at this facility could negatively affect our business, financial position and results of operations.

All of our products are manufactured at a single facility located in Emigsville, Pennsylvania. An interruption of manufacturing resulting from regulatory issues, technical problems, casualty loss or other factors could result in our inability to meet production requirements, which may cause us to lose revenues and which could have an adverse effect on our relationships with our partners and customers, any of which could have a material adverse effect on our business, financial position or results of operations. We maintain business interruption insurance, but we cannot assure investors that our insurance will cover all future claims or that we will be able to maintain existing coverage or obtain additional coverage at reasonable rates. Without our existing production facility, we would have no other means of manufacturing our products until we were able to restore the manufacturing capability at our facility or develop an alternative manufacturing facility.

Our insurance coverage may not be adequate and rising insurance premiums could negatively affect our profitability.

We rely on insurance to protect us from many business risks, including product liability, business interruption, property and casualty loss and employment practices liability. The cost of insurance has risen significantly in recent years. In response, we may increase deductibles and/or decrease certain coverages to mitigate these costs. There can be no assurance that the insurance that we maintain and intend to maintain will be adequate, or that the cost of insurance and limitations in coverage will not adversely affect our business, financial position or results of operations. Furthermore, it is possible that, in some cases, coverage may not be available at any price.
 
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We enter into agreements that include provisions that require us to indemnify the other party under certain circumstances. If we are required to perform under these indemnification provisions, our financial condition and results of operations could be negatively affected.

Many of the license, development, supply, employment and other agreements we enter into include indemnification provisions. The various indemnification provisions in these agreements are not uniform and may be subject to differing legal interpretations. Accordingly, it may be difficult for us to determine or accurately predict in advance what indemnification obligations we may owe under these provisions or, alternatively, what obligations may be owed to us by these parties, including as it relates to potential damages, settlement amounts and defense costs associated with the product liability lawsuits that claim the use of products manufactured by us and distributed by third parties. Our insurance coverage may mitigate the costs of some of our obligations under these indemnification provisions but our business, financial position and results of operations could be harmed if we are required to perform under these indemnification provisions and there is no or insufficient insurance coverage.

We may have difficulty raising capital, which could deprive us of necessary resources.

We expect to require capital for many purposes, including developing new products, retaining qualified personnel, funding research and development and maintaining existing manufacturing capacity. In order to support the initiatives envisioned in our business plan, we may need to raise additional funds through the sale of assets, public or private debt or equity financing, collaborative relationships or other arrangements. Our ability to raise financing depends on many factors beyond our control, including the state of capital markets and the development or prospects for development of competitive technology by others. Because our common stock is not listed on a major stock market, many investors may not be willing or allowed to purchase it or may demand steep discounts. Our current financial condition and the status of our obligations under the Key License and Health-Chem’s obligations under the Debentures have prevented us and the Group from borrowing money from third parties or raising capital from the sale of equity. Sufficient additional financing may not be available to us or may be available only on terms that would result in further dilution to the current owners of our common stock. If we are unable to raise additional funds when we need them, we may have to severely curtail our operations.

Our success depends on attracting and retaining our key employees.

Our success depends on our ability to attract and retain qualified, experienced personnel. We face significant competition in recruiting talented personnel. The loss of key personnel, or the inability to attract and retain additional, competent employees, could adversely affect our business, financial position or results of operations.

Limitations on liability and indemnification matters.

As permitted by the corporate laws of the State of Delaware, we have included in our Certificate of Incorporation a provision to eliminate the personal liability of our directors for monetary damages for breach or alleged breach of their fiduciary duties as directors, subject to certain exceptions. In addition, our By-Laws provide that we are required to indemnify our officers and directors under certain circumstances, including those circumstances in which indemnification would otherwise be discretionary, and we will be required to advance expenses to our officers and directors as incurred in connection with proceedings against them for which they may be indemnified.
 
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We have no intention of paying dividends on our common stock in the near future and holders of our common stock will have to rely on the appreciation thereof to realize any monies from holding these securities.

We have not paid any dividends on our common stock and do not anticipate paying cash dividends in the foreseeable future. Management intends to retain any earnings to finance the growth of the Company’s business. Management cannot assure you that the Company will ever pay cash dividends. Accordingly, holders of our common stock will have to rely on the appreciation thereof to realize any monies from holding these securities.

Our common stock is not traded or admitted to quotation on any market, so you may not be able to sell your shares of common stock and thus you may never realize any monies from holding these securities.

Our common stock is not listed on any stock market or admitted to quotation on the over-the-counter bulletin board, accordingly, there is no established public trading market for our common stock. Management does not expect to seek to develop a market for our common stock. Therefore, you may only be able to dispose of our common stock in a private transaction.  

We must maintain adequate internal controls and in the future be able, on an annual basis, to provide an assertion as to the effectiveness of such controls.

Effective internal controls are necessary for the Company to provide reasonable assurance with respect to its financial reports. We may be required to spend a substantial amount of management time and resources to comply with changing laws, regulations and standards relating to corporate governance and public disclosure, including the Sarbanes-Oxley Act of 2002 and new SEC regulations. In particular, Section 404 of the Sarbanes-Oxley Act of 2002 requires management’s annual review and evaluation of our internal control systems, and attestations as to the effectiveness of these systems by our independent public accounting firm. If we fail to maintain the adequacy of our internal controls, we may not be able to ensure that we can conclude on an ongoing basis that we have effective internal control over financial reporting. Additionally, internal control over financial reporting may not prevent or detect misstatements because of its inherent limitations, including the possibility of human error, the circumvention or overriding of controls, or fraud. Therefore, even effective internal controls can provide only reasonable assurance with respect to the preparation and fair presentation of financial statements. In addition, projections of any evaluation of effectiveness of internal control over financial reporting to future periods are subject to the risk that the control may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate. If the Company fails to maintain the adequacy of its internal controls, including any failure to implement required new or improved controls, this could have a material adverse effect on our business, financial position and results of operations.

There are inherent uncertainties involved in estimates, judgments and assumptions used in the preparation of financial statements in accordance with GAAP.

The consolidated and condensed consolidated financial statements included in the periodic reports we are required to file with the SEC are prepared in accordance with accounting principles generally accepted in the United States of America (“GAAP”). The preparation of financial statements in accordance with GAAP involves making estimates, judgments and assumptions that affect reported amounts of assets (including intangible assets), liabilities, revenues, expenses and income. Estimates, judgments and assumptions are inherently subject to change in the future and any necessary revisions to prior estimates, judgments or assumptions could lead to a restatement. Any such changes could result in corresponding changes to the amounts of assets (including goodwill and other intangible assets), liabilities, revenues, expenses and income. Any such changes could have a material adverse effect on our business, financial position and results of operations.
 
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