UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, DC 20549

FORM 10-Q

[x]

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

For the quarterly period ended March 31, ~~2006~~ 2007 OR

[_] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the transition period from to
Commission file number 1-31680

BRADLEY PHARMACEUTICALS, INC.
(Exact name of Registrant as specified in its charter)

DELAWARE
(State or other jurisdiction of
incorporation or organization)

22-2581418
(I.R.S. Employer
Identification Number)

383 Route 46 W., Fairfield, NJ
(Address of principal executive offices)

07004
(Zip Code)

(973) 882-1505

(Registrant’s telephone number, including area code)

Indicate by check mark whether the Registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the Registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. YES [X] NO [_]

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer. See definition of “accelerated filer and large accelerated filer” in Rule 12b-2 of the Exchange Act. (Check one): Large accelerated filer [_] Accelerated filer [ X ] Non-accelerated filer [_]

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes [_] No [ X ]

As of ~~June~~May 164, ~~2006~~2007, there were outstanding 16,~~845~~443,~~084~~417 shares of common stock, $.01 par value, and 429,752 shares of Class B common stock, $.01 par value.

BRADLEY PHARMACEUTICALS, INC.

Table of Contents

	Page	~~Page~~
PART I. FINANCIAL INFORMATION
Item 1. Financial Statements
Consolidated Balance Sheets as of March 31, 2006 (unaudited) and December 31, 2005		3
Consolidated Balance Sheets as of March 31, 2007 (unaudited) and December 31, 2006	3
Consolidated Statements of Income (unaudited) for the Three Months Ended
March 31, 2006 and 2005		5
March 31, 2007 and 2006	5
Consolidated Statements of Cash Flows (unaudited) for the Three Months Ended
March 31, 2006 and 2005		6
March 31, 2007 and 2006	6
Notes to the Consolidated Financial Statements	8	8
Item 2. Management’s Discussion and Analysis of Financial Condition and Results of
Operations	29	31
Item 3. Quantitative and Qualitative Disclosures About Market Risk	54	46
Item 4. Controls and Procedures	54	46
PART II. OTHER INFORMATION
Item 1. Legal Proceedings	55	48
Item 1A. Risk Factors	58	50
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds	58	50
Item 3. Defaults Upon Senior Securities	58	50
Item 4. Submission of Matters to a Vote of Security Holders	58	51
Item 5. Other Information	58	51
Item 6. Exhibits	58	51
SIGNATURES	60	52
Certifications
CERTIFICATIONS

Part I. Financial Information

Item 1. Financial Statements

BRADLEY PHARMACEUTICALS, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS

	March 31, 2006	December 31, 2005
	March 31, 2007 (unaudited)	December 31, 2006 (a)
	(unaudited)	(a)
Assets
Current assets:
Cash and cash equivalents	$ 1646,~~671~~486,~~008~~635	$ 1939,~~798~~608,~~728~~987
Accounts receivable, net	16,858,163	15,871,269
Short-term investments	6,373,772	7,083,678
Inventories, net	7,510,700	6,895,208
Accounts receivable, net of allowances	9,853,451	14,489,623
Deferred tax assets	15,014,832	14,334,362
Inventories, net	7,268,571	6,881,218
Prepaid expenses and other	2,171,346	1,493,867
Deferred tax assets	15,098,121	13,332,666
Prepaid income taxes	6,863,528	6,653,425
Prepaid expenses and other	2,406,547	2,100,487
Total current assets	65,089,577	65,046,859
Prepaid income taxes	—	4,934,119
Property and equipment, net	1,297,254	1,499,398
Total current assets	87,487,097	88,430,778
Intangible assets, net	149,019,162	151,354,333
Property and equipment, net	673,040	813,794
Intangible assets, net	163,226,196	165,985,767
Goodwill	27,478,307	27,478,307
Deferred financing costs	64,~~028~~334,~~952~~577	54,~~834~~798,~~318~~034
Restricted cash and investments	4525,000,000	4525,000,000
Other assets	16,229	16,229
Total assets	$~~293~~308,~~929~~215,~~481~~446	$~~296~~312,~~229~~522,~~444~~909

(a) Derived from audited financial statements.

See accompanying notes to consolidated financial statements.

BRADLEY PHARMACEUTICALS, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS

	March 31, 2006		December 31, 2005
	March 31, 2007 (unaudited)		December 31, 2006 (a)
	(unaudited)		(a)
Liabilities
Current liabilities:
Current maturities of long-term debt	$ 1013,~~073~~920,~~097~~058		$ 915,~~075~~660,~~781~~085
Accounts payable	5,521,254		7,667,667
Milestone payable - ELESTRIN™	3,252,145		10,115,083
Accrued expenses	37,786,477		37,109,475
Accounts payable	5,734,167		4,948,754
Total current liabilities	53,380,828		53,852,923
Accrued expenses	38,332,936		38,728,413
Income taxes payable	2,168,979		—
Total current liabilities	63,408,285		69,452,335
Long-term liabilities:
Long-term debt, less current maturities	6651,~~010~~479,~~375~~901		6953,~~011~~400,~~998~~000
Deferred tax liabilities	1647,~~375,460~~063		~~925~~2,~~092~~054,145
Total long-term liabilities	6752,~~385~~126,~~835~~964		6955,~~937~~454,~~090~~145
Stockholders’ Equity
Preferred stock, $0.01 par value; shares authorized:
2,000,000; no shares issued	—		—
Common stock, $0.01 par value; authorized: 26,400,000
shares; issued and outstanding: 16,845,084 shares at
shares; issued and outstanding: 17,320,475 shares at
March 31, 2006 and 16,820,084 shares at December 31, 2005	168,451		168,201
March 31, 2007 and 16,965,578 shares at December 31, 2006	173,205		169,656
Class B common stock, $0.01 par value; shares authorized:
Class B common stock, $0.01 par value; authorized: 900,000
900,000; issued and outstanding: 429,752 shares at
shares; issued and outstanding: 429,752 shares at
March 31, 2006 and at December 31, 2005	4,298		4,298
March 31, 2007 and at December 31, 2006	4,298		4,298
Additional paid-in capital	~~135~~145,~~328~~791,~~959~~723		~~134~~139,~~254~~754,~~460~~887
Retained earnings	4050,~~956~~002,~~959~~067		4150,~~309~~977,~~602~~625
Accumulated other comprehensive loss	~~(4,669~~84	)	(51,~~950~~143	)
Treasury stock — common stock — at cost; 877,058 shares at
Treasury stock - common stock - at cost; 877,058 shares at
March 31, 2006 and December 31, 2005	(3,291,180	)	(3,291,180	)
March 31, 2007 and December 31, 2006	(3,291,180	)	(3,291,180	)
Total stockholders’ equity	~~173~~192,~~162~~680,~~818~~197		~~172~~187,~~439~~616,~~431~~429
Total liabilities and stockholders’ equity	$ ~~293~~308,~~929~~215,~~481~~446		$ ~~296~~312,~~229~~522,~~444~~909
(a) Derived from audited financial statements.

(a) Derived from audited financial statements.

See accompanying notes to consolidated financial statements.

BRADLEY PHARMACEUTICALS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF INCOME
(unaudited)

	Three Months Ended March 31,
	Three Months Ended
	2006		2005
	March 31, 2007		March 31, 2006
Net sales	$ 3437,~~753~~802,~~358~~957		$ 3334,~~202~~753,~~801~~358
Cost of sales	5,005,649		5,041,400
Cost of sales (1)	6,682,255		5,005,649
	29,747,709		28,161,401
	31,120,702		29,747,709
Selling, general and administrative	19,893,498		20,621,492
Selling, general and administrative expense	21,296,255		19,893,498
Research and development	5,262,724		256,904
Research and development expense	680,444		5,262,724
Depreciation and amortization	2,550,178		2,472,074
Depreciation and amortization expense	2,927,791		2,550,178
Loss on investment	—		2,434
Interest expense	2,266,408		2,114,016
Interest expense	3,076,991		1,648,815
Interest income	(554,354	)	(427,040	)
Interest income	(427,040	)	(377,271	)
	26,616,544		29,393,376
	30,356,351		24,624,448
Income before income tax expense	4,504,158		354,333
Income (loss) before income tax expense (benefit)	(608,642	)	3,536,953
Income tax expense	1,979,606		149,000
Income tax expense (benefit)	(256,000	)	1,383,000
Net income	$ 2,524,552		$ 205,333
Net income (loss)	$ (352,642	)	$ 2,153,953
Basic net income per common share	$ 0.15		$ 0.01
Basic net income (loss) per common share	$ (0.02	)	$ 0.13
Diluted net income per common share	$ 0.15		$ 0.01
Diluted net income (loss) per common share	$ (0.02	)	$ 0.13
Shares used in computing basic net income per
Shares used in computing basic net income (loss)
common share	16,570,000		16,380,000
per common share	16,380,000		15,960,000
Shares used in computing diluted net income per
Shares used in computing diluted net income
common share	16,780,000		16,500,000
(loss) per common share	16,380,000		18,180,000
(1) Amounts exclude amortization of intangible assets related to acquired product.

See accompanying notes to consolidated financial statements.

BRADLEY PHARMACEUTICALS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(unaudited)

	March 31, 2006		March 31, 2005 (a)
	Three Months Ended
	March 31, 2007		March 31, 2006
Cash flows from operating activities:
Net income (loss)	$ (352,642	)	$ 2,153,953
Net income	$ 2,524,552		$ 205,333
Adjustments to reconcile net income (loss) to net cash provided
Adjustments to reconcile net income to net cash provided by
by (used in) operating activities:
(used in) operating activities:
Depreciation and amortization	2,~~550~~927,~~178~~791		2,~~472~~550,~~074~~178
Amortization of deferred financing costs	~~325~~463,~~366~~456		~~235~~325,~~096~~366
Deferred income taxes	(~~230~~1,~~102~~610,809	)	1(230,~~295,164~~102	)
Increase in allowance for doubtful accounts	~~712~~33,~~628~~300		~~137~~712,~~210~~628
Increase in return reserve	2,616,224		1,508,449
Increase (decrease) in return reserve	(235,900	)	2,616,224
Increase (decrease) in inventory valuation reserve	~~(49~~886,~~303~~599	)	~~331~~(49,~~866~~303	)
Increase (decrease) in rebate reserve	(1,~~797~~957,~~619~~473	)	~~524~~(1,~~246~~797,619	)
Increase in fee-for-service	~~204~~21,~~833~~262		—204,833
Non-cash share-based compensation expense	~~927~~833,000		—927,000
Loss on short-term investments	—		2,434
Changes in operating assets and liabilities:
Accounts receivable	(14,~~904~~581,~~355~~610	)	2(1,~~191~~904,~~588~~355	)
Inventories	(~~566~~1,~~189~~273,952	)	(~~962~~566,~~087~~189	)
Prepaid expenses and other	(~~677~~306,~~479~~060	)	(~~456~~677,~~367~~479	)
Accounts payable	(2785,~~146,~~413	)	1(2,~~462~~146,~~088~~413	)
Accrued expenses	(~~141~~2,~~603~~117,050	)	(1,~~974~~104,~~846~~579	)
Prepaid income taxes	~~(210~~2,~~103~~041,261	)	~~(161~~194,~~836~~897	)
Net cash provided by (used in) operating activities	~~(739~~11,~~580~~511,946	)	8(739,~~759,032~~580	)
Cash flows from investing activities:
Sales (Purchases) of short-term investments- net	1,281		(4,883,344	)
Sales of short-term investments, net	708,847		1,281
Acquisition costs	—		(39,875	)
Purchases of property and equipment	(27,466	)	(12,863	)
Purchases of property and equipment	(12,863	)	(449,753	)
Net cash provided by (used in) investing activities	681,381		(11,582	)
Net cash used in investing activities	(11,582	)	(5,372,972	)
Cash flows from financing activities:
Payment of notes payable	~~(4,307~~—	)	(234,~~110~~307	)
Payment of term note	(2,000,000	)	(3,750,000	)
Payment of the $110 million credit facility’s term loan	(3,660,126	)	(2,000,000	)
Proceeds from exercise of stock options and warrants	54,140		—
Payment for milestone payable-ELESTRIN™	(6,862,938	)	—
Tax benefit due to exercise of non-qualified options and warrants	93,609		—
Proceeds from exercise of stock options	4,433,341		54,140
Payment of deferred financing costs	(520,000	)	—
Tax benefit due to exercise of non-qualified options	774,044		93,609
Purchase of treasury shares	—		(208,805	)
Payment of deferred financing costs	—		(520,000	)
Distribution of treasury shares	—		32,888
Net cash used in financing activities	(5,315,679	)	(2,376,558	)
Net cash used in financing activities	(2,376,558	)	(3,949,027	)

(Continued)

BRADLEY PHARMACEUTICALS, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CASH FLOWS (unaudited)

	March 31, 2006		March 31, 2005 (a)
	Three Months Ended
	March 31, 2007		March 31, 2006
Net decrease in cash and cash equivalents	(3,127,720	)	(562,967	)
Net increase (decrease) in cash and cash equivalents	6,877,648		(3,127,720	)
Cash and cash equivalents at beginning of period	1939,~~798~~608,~~728~~987		3919,~~911~~798,~~543~~728
Cash and cash equivalents at end of period	$ 1646,~~671~~486,~~008~~635		$ 3916,~~348~~671,~~576~~008
Supplemental disclosures of cash flow information:
Cash paid during the period for:
Interest	$ 21,~~745~~801,~~494~~486		$ 1,~~208~~869,~~000~~106
Income taxes	$ 97903,~~329~~486		$ ~~275~~97,~~000~~329

AtAs ~~March~~of 31January 1, ~~2006~~2007, the ~~restricted~~Company ~~cash~~recorded ~~and~~increases ~~investments~~in ~~amounts~~income ~~include~~taxes ~~short~~payable of $5,061,839 and long-term ~~investments~~deferred tax assets of $291,~~960~~561,~~868~~729 and a decrease in retained earnings of $3,500,110 ~~see~~as a result of the adoption of FIN 48 - (See Note GK).

During the three months ended March 31, 2006, the Company received $3,003,939 of proceeds from sales of short-term investments, which have been applied to restricted cash and investments.

(a) As restated, see Note C.

See accompanying notes to consolidated financial statements.

BRADLEY PHARMACEUTICALS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)

NOTE A – Basis of Presentation

The accompanying unaudited interim consolidated financial statements of Bradley Pharmaceuticals, Inc. and Subsidiaries (the “Company”, “Bradley”, “we” or “us”) have been prepared in accordance with accounting principles generally accepted in the United States of America and rules and regulations of the Securities and Exchange Commission ~~for~~(“SEC”) for interim financial information. Accordingly, they do not include all of the ~~information~~ information and footnote disclosures required by accounting principles generally accepted in the United States of America for complete financial statements.

In the opinion of the Company, the accompanying unaudited consolidated financial statements contain all adjustments (consisting of normal recurring entries) necessary to present fairly the Company’s financial position as of March 31, ~~2006~~2007, and its results of operations and cash flows for the three months ended March 31, ~~2006~~2007 and ~~2005~~2006.

The accounting policies followed by the Company are set forth in Note A of the Company’s consolidated financial statements as contained in the Company’s Annual Report on Form 10-K for the year ended December 31, ~~2005~~2006 filed with the ~~Securities and Exchange Commission~~SEC. These financial statements should be read in conjunction with the financial statements and notes thereto included in the Company’s Annual Report on Form 10-K for the year ended December 31, ~~2005~~2006.

The results reported for the three months ended March 31, ~~2006~~2007 are not necessarily indicative of the results of operations that may be expected for a full year.

NOTE B – Adoption of New Accounting Standards

~~Effective~~In ~~January~~July 1, 2006, the ~~Company adopted the provisions of Statement of~~ Financial Accounting Standards ~~No.~~Board ~~123R~~ (“~~SFAS No. 123R~~FASB”), ~~Share-Based~~issued ~~Payment,~~Interpretation ~~as supplemented by the~~No. ~~interpretation~~48, ~~provided by SEC Staff~~ “Accounting ~~Bulletin No.~~for ~~107,~~Uncertainty ~~issued~~ in ~~March 2005.~~Income ~~SFAS~~Taxes-an ~~No.~~Interpretation ~~123R~~of ~~replaced~~FASB ~~SFAS~~Statement No. 109” ~~123, Stock-Based Compensation~~ (“~~SFAS~~FIN ~~No. 123~~48”), ~~issued~~ inwhich ~~1995,~~clarifies ~~and requires~~the ~~stock-based~~accounting ~~compensation~~for touncertainty bein ~~measured~~tax ~~based~~positions. onThis Interpretation ~~the~~requires ~~fair~~that ~~value of~~ the ~~awards~~Company ~~on the~~recognize ~~grant~~in ~~date.~~its ~~The~~financial ~~Company~~statements ~~elected~~ the ~~“modified prospective method”~~ impact of ~~transition~~a ~~as permitted~~tax ~~by SFAS No. 123R and~~position, asif ~~such,~~that ~~prior~~position ~~period~~is ~~financial~~more ~~statements~~likely ~~have~~than not ~~been restated.~~of ~~Under~~being ~~this~~sustained ~~method~~on audit, based on the ~~fair~~technical ~~value~~merits of ~~all~~the ~~stock~~position. ~~options~~This ~~granted~~interpretation oris ~~modified~~effective for ~~after~~fiscal ~~adoption~~years ~~must~~beginning beafter ~~recognized~~December in15, 2006, with the ~~consolidated~~cumulative ~~statement~~effect of ~~income~~the ~~and total~~change ~~compensation~~in ~~cost~~accounting ~~related~~principle torecorded ~~nonvested~~as ~~awards~~an ~~not~~adjustment ~~yet~~to ~~recognized,~~opening ~~determined~~retained ~~under~~earnings. ~~the~~The ~~original~~Company ~~provisions~~adopted ofFIN ~~SFAS~~48 ~~No.~~on ~~123~~January 1, ~~must~~2007. ~~also~~The beadoption ~~recognized~~of FIN 48 resulted in ~~the~~an ~~consolidated~~opening ~~statement~~retained earnings adjustment of ~~income~~$3,500,000 (See Note K).

In June 2006, the Emerging Issues Task Force (“EITF”) issued EITF Issue 06-3, “How Taxes Collected from Customers and Remitted to Governmental Authorities Should

~~Prior to~~Be ~~January~~Presented 1,in ~~2006~~the Income Statement (That Is, weGross ~~accounted~~versus ~~for~~Net ~~stock~~Presentation).” ~~options~~EITF ~~under~~Issue ~~Accounting~~06-3 ~~Principle~~provides ~~Board~~guidance related to ~~Opinion~~the ~~No.~~presentation ~~25,~~in ~~Accounting~~financial ~~for~~statements ~~Stock~~of ~~Issued~~any totax ~~Employees,~~assessed anby ~~elective~~a ~~accounting~~governmental authority ~~policy~~that ~~permitted~~is bydirectly ~~SFAS~~imposed ~~No.~~on ~~123.~~a ~~Under~~revenue-producing ~~this~~transaction ~~standard~~between a seller and a customer, ~~since~~including, ~~the~~but ~~exercise~~not ~~price~~limited ofto, ~~our stock~~sales, ~~options~~use, ~~granted~~value isadded, ~~set~~and ~~equal~~some toexcise ortaxes. The ~~above~~EITF concluded that the ~~market~~presentation ~~price~~of ontaxes within the ~~date~~scope of ~~the~~EITF ~~grant,~~Issue 06-3 on weeither ~~did~~a ~~not~~gross ~~record~~(included ~~any~~in ~~expense~~revenues toand ~~the~~costs) ~~condensed~~or ~~consolidated~~a ~~statement~~net of(excluded ~~income~~from ~~related~~revenues) basis tois ~~stock~~an ~~options~~accounting policy decision that should be disclosed. ~~However~~In addition, asthe ~~required,~~aggregate amount weof any such taxes that are reported on a gross basis should be disclosed, in interim ~~the~~and ~~Notes~~annual tofinancial ~~Consolidated Financial~~statements. ~~Statements,~~The ~~the~~guidance ~~pro~~in ~~forma~~EITF ~~expense~~Issue ~~impact~~06-3 ofis ~~the~~effective ~~stock~~for interim ~~option~~and ~~grants~~annual asreporting ifperiods ~~we had~~beginning ~~applied~~after ~~the~~December ~~fair-value-based~~15, ~~recognition~~2006. ~~provisions~~The adoption of EITF ~~SFAS~~Issue ~~No.~~06-3 ~~123.~~did not have a material impact on the Company’s consolidated financial statements.

~~The adoption~~NOTE ofC ~~SFAS~~– ~~No. 123R primarily impacted our accounting for stock options (See Note~~Net ~~L, Incentive and Non-Qualified Stock Option Plan and Note K,~~ Income ~~Taxes).~~Per Common Share

~~NOTE~~ Basic net Cincome –per ~~Restatement~~common share is determined by dividing net income by the weighted average innumber of shares of common stock outstanding. Diluted net income per common share is determined by dividing net income by the ~~Classification~~weighted number of ~~Auction~~shares ~~Rate~~outstanding ~~Municipal~~adjusted for ~~Bonds~~ dilutive common equivalent shares from stock options and warrants. A reconciliation of the weighted average basic common shares outstanding to weighted average diluted common shares outstanding is as follows:

During the Fourth Quarter of fiscal 2005, the Company restated its auction rate municipal bonds to short-term investments available for sale. Previously, such investments had been classified as cash and cash equivalents. This restatement results from recent interpretations regarding the application of FASB 95. The changed interpretation is based on the view that the legal maturity dates of these types of investments are generally outside the three-month term limitation specified in FASB 95. Previously, it was the Company’s view that auction rate securities satisfied the cash equivalents criteria of FASB 95 because of the short-term nature (i.e., less than 90 days) of reset periods available to investors. There is no impact from this restatement on the Company’s debt classification, working capital, net income (loss) or cash flows from operations or from financing activities. All amounts for prior periods have been restated to conform to this presentation. The Company made a corresponding adjustment of $12,990,829 to its Consolidated Statement of Cash Flows for the three months ended March 31, 2005, to reflect the net purchases of these securities as investing activities rather than as components of cash and cash equivalents.

	Three Months Ended
	March 31, 2007	March 31, 2006
Basic shares	16,570,000	16,380,000
Dilution:
Stock options and warrants	210,000	120,000

Diluted shares	16,780,000	16,500,000

Net income, as reported	$ 2,525,000	$ 205,000

Basic income per share	$ 0.15	$ 0.01

Diluted income per share	$ 0.15	$ 0.01

~~NOTE~~ In addition Dto –stock ~~Net~~options ~~Income~~and warrants included in the above computation for the three ~~(Loss)~~months ~~Per~~ended ~~Common~~March ~~Share~~ 31, 2007, options to purchase 224,765 shares of common stock at prices ranging from $20.31 to $27.12 per share were outstanding and not

Basic net income (loss) per common share is determined by dividing net income (loss) by the weighted average number of shares of common stock outstanding. Diluted net income (loss) per common share is determined by dividing net income (loss) adjusted for applicable after-tax interest expense and related offsets from convertible notes by the weighted number of shares outstanding adjusted for dilutive common equivalent shares from stock options, warrants and convertible notes. A reconciliation of the weighted average basic common shares outstanding to weighted average diluted common shares outstanding is as follows:

	Three Months Ended
	March 31, 2006		March 31, 2005
Basic shares	16,380,000		15,960,000
Dilution:
Stock options and warrants	—		370,000
Convertible notes	—		1,850,000
Diluted shares	16,380,000		18,180,000
Net income (loss), as reported	$ (352,642	)	$ 2,153,953
After-tax interest expense and other from convertible notes	—		253,979
Adjusted net income (loss)	$ (352,642	)	$ 2,407,932
Basic income (loss) per share	$ (0.02	)	$ 0.13
Diluted income (loss) per share	$ (0.02	)	$ 0.13

included for the purpose of calculating per share amounts. Further, in addition to stock options and warrants included in the above computation for the three months ended March 31, 2006, options to purchase 1,572,169 shares of common stock at prices ranging from $12.09 to $27.12 were outstanding and not included. These options were excluded from the calculation of diluted earnings per share for the applicable period because the exercise price of the option was greater than the average market price of the common shares or because of the anti-dilutive impact on the calculation of certain options associated with unrecognized compensation and related tax benefits.

~~Since we~~Note ~~had~~D a– ~~net loss for the three months ended March 31, 2006, basic and diluted net loss~~Comprehensive per share is the same. As a result, the computation of diluted net loss per share excludes the effect of the potential exercise of stock options and warrants to purchase shares of common stock, totaling 120,000 shares, because the effect would be anti-dilutive. Income

InStatement ~~addition~~of toFinancial ~~the~~Accounting ~~stock~~Standards ~~options~~(“SFAS”) ~~and~~No. ~~warrants~~130, ~~included~~“Reporting inComprehensive ~~the above computation~~Income”, ~~options to~~ ~~purchase~~requires ~~1,572,169~~that ~~shares~~items ~~and~~defined ~~677,085~~as ~~shares~~other ofcomprehensive ~~common~~income, ~~stock~~such atas ~~prices~~net ~~ranging~~income ~~from~~and ~~$12.09~~unrealized togains ~~$27.12~~ and ~~$12.86~~losses toon ~~$27.12 per share were outstanding~~ available-for-sale ~~purposes~~securities, ~~of calculating~~be ~~per~~reported ~~share~~separately ~~amounts for~~ in the ~~three~~financial ~~months ended March 31, 2006 and 2005, respectively~~statements. ~~These~~The ~~were~~components ~~not included in the computation~~ of ~~diluted~~comprehensive income ~~per~~for ~~share because their exercise price was greater than~~ the ~~average~~three ~~market price of the Company’s~~months ~~common~~ended ~~stock~~March ~~for~~31, ~~the~~2007 ~~period~~ and, ~~therefore,~~2006 ~~their~~are ~~effect~~as ~~would~~follows: ~~be anti-dilutive.~~

In connection with the closing of the Company’s $110 million credit facility on November 14, 2005, as discussed in more detail in Note P (the “New Facility”), the convertible notes have been extinguished and during the Fourth Quarter 2005 are no longer convertible into shares of common stock, and there are, starting in the Fourth Quarter 2005, 1,850,000 fewer shares of common stock reserved for issuance and outstanding on a fully diluted basis. In addition, since the convertible notes have been extinguished, the Company no longer has an adjustment for after-tax interest expense and other of approximately $254,000 per quarter in determining earnings per share on a fully diluted basis.

	Three Months Ended
	March 31, 2007		March 31, 2006
Comprehensive income:
Net income	$ 2,525,000		$205,000
Other comprehensive income:
Net unrealized (loss) income on available for sale
securities	(1,000	)	1,000

Comprehensive income	$ 2,524,000		$206,000

Note E – ~~Comprehensive~~Business ~~Income~~Segment ~~(Loss)~~Information

The Company’s three reportable segments are Doak Dermatologics (dermatology and podiatry), which includes the previously reported Bioglan Pharmaceuticals Corp. (dermatology), Kenwood Therapeutics (gastrointestinal, women’s health, respiratory, nutritional and other) and A.Aarons (generic), which began operations in the Second Quarter of 2006. Each segment has been identified by the Company to be a distinct operating unit distributing different pharmaceutical products. Doak Dermatologics’ products are marketed, promoted and distributed primarily to physicians practicing in the fields of dermatology and podiatry; Kenwood Therapeutics’ products are marketed, promoted and distributed primarily to physicians practicing in the fields of internal medicine/ gastroenterology and women’s health; and A.Aarons’ products are the generic versions of some of Doak Dermatologics’ and Kenwood Therapeutics’ products.

~~SFAS~~The ~~No.~~accounting ~~130,~~policies ~~Reporting~~used ~~Comprehensive~~to ~~Income,~~develop ~~requires~~segment ~~that~~information ~~items~~correspond ~~defined~~to asthose ~~other~~described in ~~comprehensive~~the ~~income~~summary ~~(loss),~~of ~~such~~significant asaccounting ~~net~~policies ~~income~~in ~~(loss)~~the ~~and~~notes ~~unrealized~~to ~~gains~~the ~~and~~financial ~~losses~~statements in the Company’s Annual Report on ~~available~~ Form 10-K for~~-sale~~ ~~securities~~the year ended December 31, be2006. ~~reported~~The reportable ~~separately~~segments inare ~~the~~distinct ~~financial~~business ~~statements~~units with no inter-segment sales. The ~~components~~following ofinformation ~~comprehensive~~about ~~income~~the ~~(loss)~~three segments is for the three months ended March 31, 2007 ~~2006~~ and ~~2005~~ ~~are as follows~~2006:

	Three Months Ended
	March 31, 2006		March 31, 2005
	March 31, 2007		March 31, 2006
Comprehensive income (loss):
Net sales:
Net income (loss)	$(352,642	)	$2,153,953
Doak Dermatologics, Inc.	$ 28,338,000		$ 29,403,000
Other comprehensive income:
Kenwood Therapeutics	9,465,000		5,350,000
Net unrealized income on available for sale
A.Aarons	—		—
securities	1,281		37,679
	$ 37,803,000		$ 34,753,000
Comprehensive income (loss)	$(351,361	)	$2,191,632
Depreciation and amortization:
Doak Dermatologics, Inc.	$ 2,460,000		$ 2,246,000
Kenwood Therapeutics	468,000		304,000
A.Aarons	—		—
	$ 2,928,000		$ 2,550,000
Income (loss) before income tax (benefit):
Doak Dermatologics, Inc,	$ 1,716,000		$ 526,000
Kenwood Therapeutics	2,854,000		(172,000	)
A.Aarons	(66,000	)	—
	$ 4,504,000		$ 354,000
Income tax expense (benefit):
Doak Dermatologics, Inc.	$ 754,000		$ 221,000
Kenwood Therapeutics	1,254,000		(72,000	)
A.Aarons	(29,000	)	—
	$ 1,979,000		$ 149,000
Net income (loss):
Doak Dermatologics, Inc.	$ 962,000		$ 305,000
Kenwood Therapeutics	1,600,000		(100,000	)
A.Aarons	(37,000	)	—
	$ 2,525,000		$ 205,000
Geographic information (revenues):
Doak Dermatologics, Inc.
United States	$ 27,597,000		$ 28,792,000
Other countries	741,000		611,000

Note F – Business Segment Information

The Company’s two reportable segments are Doak Dermatologics (dermatology and podiatry), which includes the previously reported Bioglan Pharmaceuticals Corp. (dermatology), and Kenwood Therapeutics (gastrointestinal, respiratory, nutritional and other). Each segment has been identified by the Company to be a distinct operating unit distributing different pharmaceutical products. Doak Dermatologics’ products are marketed, promoted and distributed primarily to physicians practicing in the fields of dermatology and podiatry; and Kenwood Therapeutics’ products are marketed, promoted and distributed primarily to physicians practicing in the field of internal medicine/ gastroenterology.

The Company previously reported Bioglan Pharmaceuticals Corp. as a separate reportable segment. Effective January 1, 2006, based upon the following, the Company started to report both Bioglan Pharmaceuticals Corp. and Doak Dermatologics as a single reportable segment, Doak Dermatologics:

1. Bioglan Pharmaceuticals Corp. is now operated and managed within one management group as Doak Dermatologics. Accordingly, Bioglan Pharmaceuticals Corp.’s chief operating decision maker does not regularly review its operating results in order to make decisions about resources to be allocated to Bioglan Pharmaceuticals Corp.

2. Both Doak Dermatologics and Bioglan Pharmaceuticals Corp. have similar (a) types of products (dermatology and podiatry); (b) types of production processes (both are outsourced and have similar gross profit percentages); (c) classes of customers for their products (both are marketed to dermatologists and podiatrists); (d) methods used to distribute their products (both are distributed through the Company’s third party warehouse to primarily large drug wholesalers using the same sales force); and (e) types of regulatory environments.

	Three Months Ended
	$ 28,338,000		$ 29,403,000
	March 31, 2006		March 31, 2005 (a)
Net sales:
* Doak Dermatologics	$ 29,402,821		$ 27,473,486
Kenwood Therapeutics	5,350,537		5,729,315
	$ 34,753,358		$ 33,202,801
Depreciation and amortization:
* Doak Dermatologics	$ 2,245,784		$ 2,165,318
Kenwood Therapeutics	304,394		306,756
	$ 2,550,178		$ 2,472,074
Income (loss) before income tax (benefit):
* Doak Dermatologics	$ (283,138	)	$ 3,996,569
Kenwood Therapeutics	(325,504	)	(459,616	)
	$ (608,642	)	$ 3,536,953
Income tax expense (benefit):
* Doak Dermatologics	$ (119,000	)	$ 1,563,000
Kenwood Therapeutics	(137,000	)	(180,000	)
	$ (256,000	)	$ 1,383,000
Net income (loss):
* Doak Dermatologics	$ (164,138	)	$ 2,433,569
Kenwood Therapeutics	(188,504	)	(279,616	)
	$ (352,642	)	$ 2,153,953
Geographic information (revenues):
* Doak Dermatologics
United States	$ 28,792,085		$ 26,513,475
Other countries	610,736		960,011
	$ 29,402,821		$ 27,473,486
Kenwood Therapeutics
United States	$ 9,244,000		$ 5,224,000
Other countries	221,000		126,000
	$ 9,465,000		$ 5,350,000
Net sales by category:
Dermatology and podiatry	$ 28,338,000		$ 29,403,000
Gastrointestinal	6,553,000		4,712,000
Respiratory	2,513,000		290,000
Nutritional	344,000		300,000
Other	55,000		48,000
	$ 37,803,000		$ 34,753,000
	March 31, 2007		December 31, 2006
Total Assets:
Doak Dermatologics, Inc.	$182,474,000		$185,291,000
Kenwood Therapeutics	15,021,000		15,297,000
A.Aarons	1,152,000		571,000
*Unallocated assets	109,568,000		111,364,000
	$308,215,000		$312,523,000

Unallocated assets include cash and cash equivalents, short-term investments, accounts receivable, deferred tax assets, prepaid expenses and other, prepaid income taxes, deferred financing costs and restricted cash and investments.

The Company’s sales and cost of goods sold are product identifiable and recorded to each business segment by product. Additionally, certain operating expenses, such as those attributable to product marketing, are product specific and also charged directly to the product and corresponding segment. The Company allocates all other expenses that are not product identifiable to each of the segments based on a percentage of the net sales of each segment to the Company totals. Accordingly, the expense allocation percentages can differ between years depending on the segment’s proportionate share of net sales.

Note F – Short-Term Investments

The Company’s short-term investments are intended to establish a high-quality portfolio that preserves principal, meets liquidity needs and delivers an appropriate yield in relationship to the Company’s investment guidelines and market conditions.

The Company invests primarily in money market funds, short-term commercial

United States	$ 5,223,934	$ 5,620,771
Other countries	126,603	108,544
	$ 5,350,537	$ 5,729,315
Net sales by category:
Dermatology and podiatry	$ 29,402,830	$ 27,473,486
Gastrointestinal	4,712,119	4,047,040
Respiratory	290,306	1,048,092
Nutritional	300,068	573,841
Other	48,035	60,342
	$ 34,753,358	$ 33,202,801

paper, short-term municipal bonds, treasury bills and treasury notes. By policy, the Company invests primarily in high-grade investments.

*Includes The following ~~Bioglan~~is ~~Pharmaceuticals Corp.~~a summary of available-for-sale securities at March 31, 2007:

(a) Certain amounts have been consolidated to be consistent with current period presentation.

	Cost	Gross Unrealized Gain/(Loss)	Fair Value
Municipal bonds	$31,374,000	$ —	$31,374,000

Total available-for-sale
securities	$31,374,000	$ —	$31,374,000

The ~~basis~~following ~~of accounting that~~ is ~~used~~a bysummary ~~the Company to record business segments’ sales and cost~~ of ~~goods~~available-for-sale ~~sold~~securities ~~has~~at ~~been~~December recorded and allocated by each business segment’s identifiable products. The basis of accounting that is used by the Company to allocate operating expenses that relate to the segments is based upon the proportionate quarterly net sales of each segment. Accordingly31, ~~the~~2006: ~~allocation percentage used can differ between quarters and years depending on the segment’s proportionate share of net sales.~~

Note G – Short-Term Investments

	Cost	Gross Unrealized Gain	Fair Value
Municipal bonds	$32,083,000	$1,000	$32,084,000

Total available-for-sale
securities	$32,083,000	$1,000	$32,084,000

~~The~~During the three months ended March 31, 2007 and March 31, 2006, the Company’s ~~short-term~~did ~~investments~~not ~~are~~have ~~intended~~gross realized tolosses ~~establish~~on asales ~~high~~of available-~~quality~~for-sale ~~portfolio~~securities. ~~that~~The net adjustment to ~~preserves~~unrealized ~~principal,~~gains/losses ~~meets~~during ~~liquidity~~the ~~needs~~three months ended March 31, 2007 and ~~delivers~~March an31, ~~appropriate~~2006 on ~~yield~~available-for-sale securities included in accumulated other comprehensive loss totaled a loss of $1,000 ~~based~~and ~~upon~~a gain of $1, ~~the~~000, respectively. The Company’s ~~investment~~views ~~guidelines~~its available-for-sale ~~and~~securities ~~market~~as ~~conditions~~available for current operations.

The ~~Company~~amortized ~~invests~~costs ~~primarily~~and inestimated ~~money~~fair ~~market~~values ~~funds,~~of ~~short~~the available-~~term~~for-sale ~~commercial~~securities ~~paper,~~at ~~short-term~~March ~~municipal~~31, ~~bonds~~2007 and December 31, ~~treasury~~2006, ~~bills~~by ~~and~~maturity, ~~treasury~~are ~~notes~~shown below. ~~The~~Expected ~~Company’s~~maturities ~~policy~~will differ isfrom tocontractual ~~invest~~maturities because the issuers of the securities may have the ~~primarily~~right into ~~high~~prepay obligations without prepayment penalties, and the Company views its available-~~grade~~for-sale ~~investments~~securities as available for current operations.

During the fourth quarter of 2005, the Company restated its presentation of its auction rate municipal bonds to short-term investments. Previously, such investments had been classified as cash equivalents. For more information, see Note C.

	March 31, 2007		December 31, 2006
Available-for-sale	Cost	Estimated Fair Value	Cost	Estimated Fair Value
Due in one year or less	$ 9,000	$ 9,000	$ 8,000	$ 9,000
Due after one year through
two years	—	—	—	—
Due after two years	31,365,000	31,365,000	32,075,000	32,075,000

Total	$31,374,000	$31,374,000	$32,083,000	$32,084,000

As of March 31, 2007 and December 31, 2006, the Company had a restriction on the ability to use its short-term investments arising from the $110,000,000 credit facility (See Note P). The total amount of restricted cash and investments from the $110,000,000 credit facility at March 31, 2007 and December 31, 2006, was $25,000,000 at the end of each period. The following istable aexhibits ~~summary~~the application of ~~available-for-sale~~the ~~securities~~restriction on the short-term investments at March 31, 2007 and December 31, 2006:

	Cost	Gross Unrealized Loss	Fair Value
Municipal bonds	$29,965,537	$4,669	$29,960,868
Total available-for-sale
securities	$29,965,537	$4,669	$29,960,868

During the three months ended March 31, 2006 and March 31, 2005, the Company had gross realized losses on sales of available-for-sale securities of zero and

$2,434, respectively. The net adjustment to unrealized gains during the three months ended March 31, 2006 and March 31, 2005 on available-for-sale securities included in accumulated other comprehensive loss totaled $1,281 and $37,679, respectively. The Company views its available-for-sale securities as available for current operations.

	March 31, 2007		December 31, 2006
Unapplied short-term investments	$ 31,374,000		$ 32,084,000
Amount of short-term investments
applied to restricted cash and
investments	(25,000,000	)	(25,000,000	)

Short-term investments	$ 6,374,000		$ 7,084,000

~~The Company~~Note ~~had~~G no– ~~held-to-maturity investments at March 31, 2006.~~ Accounts Receivable

The ~~amortized~~Company ~~cost~~extends ~~and~~credit ~~estimated~~on ~~fair~~an ~~value~~uncollateralized ofbasis primarily to wholesale drug distributors. Historically, the ~~available-~~Company has not experienced significant credit losses on its accounts. The Company’s three largest customers accounted for~~-sale~~ ~~securities~~an aggregate of approximately 87% of gross trade accounts receivable at March 31, 2007. On a gross trade ~~2006,~~accounts byreceivable ~~maturity~~basis, ~~are~~Cardinal ~~shown~~Health, ~~below~~Inc. ~~Expected~~(“Cardinal”) ~~maturities~~owed ~~will~~approximately $5,440,000 ~~differ~~to ~~from~~the ~~contractual~~Company, or 39% of accounts receivable, McKesson Corporation ~~maturities~~(“McKesson”) ~~because~~owed approximately $5,889,000 to the ~~issuers~~Company, or 42% of ~~the~~accounts ~~securities~~receivable, and ~~may~~AmerisourceBergen ~~have~~Corporation ~~the~~(“AmerisourceBergen”) ~~right~~owed toapproximately ~~prepay~~$886,000 ~~obligations~~to ~~without~~the ~~prepayment~~Company, ~~penalties~~or 6% of accounts receivable. At December 31, ~~and~~2006, the Company’s ~~views~~four largest ~~its~~customers ~~available-~~accounted for~~-sale~~ ~~securities~~an asaggregate of approximately 97% of gross trade accounts ~~available~~receivable. ~~for~~Two ~~current~~of ~~operations~~these customers, Cardinal and McKesson, owed approximately $7,614,000, or 44% and $7,520,000, or 43%, respectively, of the gross trade accounts receivable to the Company on December 31, 2006.

	Cost	Estimated Fair Value
Available-for-sale
Due in one year or less	$ 8,344	$ 8,433
Due after one year through two
years	—	—
Due after two years	29,957,193	29,952,435
Total	$29,965,537	$29,960,868

In addition, the Company’s three largest customers accounted for 80% and 83% of the gross sales for the three months ended March 31, 2007 and 2006, respectively. The following table presents a summary of sales to these customers, who are wholesalers, during the three months ended March 31, 2007 and 2006 as a percentage of the Company’s total gross sales:

As of March 31, 2006, the Company had a restriction on the ability to use its short-term investment arising from the $110 million credit facility (See Note P). The total amount of restricted cash and investments required by the $110 million credit facility is $45,000,000. The following table exhibits the application of the restriction on the short-term investments and cash at March 31, 2006.

Short-term investments	$	29,960,868
Cash and cash equivalents		15,039,132
Restricted cash and investments	$	45,000,000

Note H – Accounts Receivable

The Company extends credit on an uncollateralized basis primarily to wholesalers. Historically, the Company has not experienced significant credit losses on its accounts. The Company’s three largest customers accounted for an aggregate of approximately 94% of gross trade accounts receivable at March 31, 2006 as follows: Cardinal 52%, McKesson 36%, and AmerisourceBergen Corporation 6%.

In addition, the Company’s three largest customers accounted for 83% and 81% of the gross sales for the three months ended March 31, 2006 and 2005, respectively. The following table presents a summary of sales to these customers, who are wholesalers, during the three months ended March 31, 2006 and 2005 as a percentage of the Company’s total gross sales:

	Three Months Ended
Customer*	March 31, 2007	March 31, 2006
AmerisourceBergen	12%	12%
Cardinal	31%	44%
McKesson	37%	27%

Total	80%	83%

* No other customer had a percentage of the Company’s total gross sales greater than 5% during the three months ended March 31, 2007 and 2006.

Customer*	Three Months Ended March 31, 2006	Three Months Ended March 31, 2005
AmerisourceBergen Corporation	12%	16%
Cardinal Health, Inc.	44%	39%
McKesson Corporation	27%	26%
Total	83%	81%

Accounts receivable balances at March 31, 2007 and December 31, 2006 are as follows:

* No other customer had a percentage of the Company’s total gross sales greater than 5% during the three months ended March 31, 2006 and 2005.

	March 31, 2007	December 31, 2006
Accounts receivable:
Trade	$14,024,000	$17,417,000
Other	57,000	1,380,000

	14,081,000	18,797,000

Less allowances:
Chargebacks	105,000	135,000
Discounts	288,000	392,000
Fee-for-service	1,800,000	1,779,000
Doubtful accounts	2,035,000	2,002,000

	4,228,000	4,308,000

Accounts receivable, net of allowances	$ 9,853,000	$14,489,000

~~Accounts~~Trade ~~receivable~~receivables ~~balances~~consist atof ~~March~~sales ~~31,~~of ~~2006~~product ~~and~~primarily ~~December~~to 31wholesale customers. Other receivables primarily consist of a royalty due to the Company from Par Pharmaceuticals Companies, ~~2005~~Inc. ~~are~~for asthe ~~follows:~~authorized generic version of ADOXA®.

The Company records an estimate of the discount deducted from customer’s payments at the time of sale. Typically, the Company offers a 2% discount based upon

	March 31, 2006	December 31, 2005
Accounts receivable:
Trade	$19,484,403	$17,897,760
Other	970,903	612,034
Less allowances:
Chargebacks	125,537	134,886
Discounts	372,784	322,278
* Fee-for-service	955,796	750,963
Doubtful accounts	2,143,026	1,430,398
Accounts receivable, net of allowances	$16,858,163	$15,871,269

prompt payments by the customer. Management estimates its reserves for discounts based upon historical discounts claimed.

* The Company ~~Fee~~has Distribution and Service Agreements (“DSAs”) with three of its customers, McKesson, Cardinal and Kinray, Inc. (“Kinray”). DSAs are a result of the wholesalers shifting from the “buy and hold” model (i.e., wholesalers purchasing in bulk in anticipation of price increases or in exchange for discounts) to the “fee-for-service” model at(i.e., ~~March~~where ~~31,~~pharmaceutical ~~2006 includes~~providers ~~$750,963~~pay wholesalers a fee for the service of distributing ~~fees~~the ~~incurred~~pharmaceutical provider’s products) in an effort to align wholesaler purchasing patterns with end-user demand. The terms of the ~~Fourth~~DSAs ~~Quarter~~require ~~2005~~the Company to pay fees to Cardinal, McKesson and Kinray, which ~~were~~are ~~paid~~offset inby any price appreciation of the inventory that Cardinal, McKesson and Kinray have on-hand and also by any discounts ~~Second~~that ~~Quarter~~the Company gives to Cardinal, McKesson and Kinray for new product promotions. In return, Cardinal, McKesson and Kinray are obligated to maintain their respective inventory levels of the Company’s products to the agreed upon months-on-hand and to provide the Company with monthly inventory and sales reports. Based upon these DSAs, the Company owed these customers $1,800,000 as of March 31, 2007 and $1,779,000 as of December 31, 2006. The Company records fees-for-service as deductions from gross sales in its consolidated statements of income.

~~Trade~~The ~~receivables~~Company ~~consist~~also ofmaintains ~~sales~~a ofprovision ~~product~~for ~~primarily~~doubtful toaccounts, ~~wholesale~~with ~~customers.~~respect ~~Other~~to which the ~~receivables~~Company ~~primarily~~believes ~~consist~~the probability of acollecting ~~royalty~~accounts ~~due~~receivable tois ~~the~~remote. ~~Company~~Based ~~from~~upon specific ~~Par~~analysis ~~Pharmaceuticals for~~of the ~~authorized~~Company’s ~~generic~~accounts, ~~version~~the ofCompany ~~ADOXA®~~maintains ~~50mg~~a ~~and 100mg tablets~~reserve.

Chargebacks are based on the difference between the prices at which the Company sells its products to wholesalers and the sales price ultimately paid under fixed price contracts by third party payors, who are often governmental agencies and managed care buying groups. The ~~Company records an estimate of the~~ amount ~~to be charged back to the Company at the time~~ of ~~sale~~actual ~~to the wholesaler. The Company has recorded reserves for~~ chargebacks ~~based upon various factors~~, ~~including current contract prices~~discounts, ~~historical~~fees-for ~~trends~~service and ~~the~~customer ~~Company’s~~defaults, as ~~future~~described ~~expectations.~~above, ~~The amount of actual chargebacks claimed~~ could be either higher or lower than the amounts accrued by the Company. Changes in the Company’s estimates would be recorded in the income statement in the period of the change.

~~The Company~~Note ~~records~~H an– estimate of the discount amount deducted from customer’s payments at the time of sale. Typically, the Company offers a 2% discount based upon prompt payments by the customer. Management estimates its reserves for discounts based upon historical discounts claimed. The amount of actual discounts claimed could differ (either higher or lower) in the near term from the amounts accrued by the Company. Inventories

The Company entered into Distribution and Service Agreements (“DSAs”) with two of its major customers, McKesson and Cardinal. DSAs are a result of the wholesalers shifting from the “buy and hold” model (i.e., wholesalers purchasing in bulk in anticipation of price increases or in exchange for discounts) to the “fee-for-service”

model (i.e., where pharmaceutical providers pay wholesalers a fee for the service of distributing the pharmaceutical provider’s products) in an effort to align wholesaler purchasing patterns with end-user demand. In particular, the Company entered into DSAs with Cardinal and McKesson during 2005, which DSAs had effective dates during 2004. The terms of the DSAs require the Company to pay fees to Cardinal and McKesson which fees are offset by any price appreciation of the inventory that Cardinal and McKesson have on-hand and also by any discounts that the Company gives to Cardinal and McKesson for new product promotions. In return for this “fee,” Cardinal and McKesson are obligated to maintain their respective inventory levels of the Company’s products to the agreed upon months-on-hand and to provide the Company with monthly inventory and sales reports. Based upon these DSAs, the Company owes, as of March 31, 2006, $955,796.

The Company also maintains a provision for doubtful accounts, with respect to which the Company believes the probability of collecting accounts receivable is remote. Based upon specific analysis of the Company’s accounts, the Company maintains a reserve. The amount of actual customer defaults could differ (either higher or lower) in the near term from the amounts accrued by the Company.

Note I – Inventories

The Company purchases raw materials and packaging components for some of its third party manufacturing vendors. The Company uses these third party manufacturers to manufacture and package finished goods held for sale, takes title to certain finished inventories once manufactured, and warehouses such goods until final distribution and sale. Finished goods consist of salable products that are primarily held at a third party warehouse. Inventories are valued at the lower of cost or market using the first-in, first-out method. The Company provides valuation reserves for estimated obsolescence or unmarketable inventory in an amount equal to the difference between the cost of inventory and the estimated market value based upon assumptions about future demand and market conditions.

~~Inventory balances at March 31, 2006 and December 31, 2005 are as follows:~~ 16

	March 31, 2006		December 31, 2005
Finished goods	$ 6,322,818		$ 5,877,815
Raw materials	2,470,032		2,348,846
Valuation reserve	(1,282,150	)	(1,331,453	)
Inventories, net	$ 7,510,700		$ 6,895,208

Inventory balances at March 31, 2007 and December 31, 2006 are as follows:

	March 31, 2007		December 31, 2006
Finished goods	$ 7,335,000		$ 6,472,000
Raw materials	1,762,000		1,351,000
Valuation reserve	(1,828,000	)	(942,000	)

Inventories, net	$ 7,269,000		$ 6,881,000

As a result of the Company’s returns and inventory optimization plan discussed elsewhere in this Form 10-Q, the Company’s inventory reserves increased by approximately $886,000 at March 31, 2007 (see-Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations-Critical Accounting Policies-Allowance for Returns).

Note I – Accrued Expenses

Accrued expenses balances at March 31, 2007 and December 31, 2006 are as follows:

	March 31, 2007	December 31, 2006
Employee compensation and benefits	$ 2,234,000	$ 2,942,000
Rebate payable	1,000	2,116,000
Rebate liability	5,044,000	3,087,000
Deferred revenue	590,000	57,000
Return reserve	26,112,000	26,348,000
Settlement reserve	1,000,000	1,000,000
Royalty payable	1,829,000	1,974,000
Other	1,523,000	1,204,000

Accrued expenses	$38,333,000	$38,728,000

The Company establishes and maintains reserves for amounts payable to managed care organizations and state Medicaid programs for the reimbursement of a portion of the retail price of prescriptions filled that are covered by the respective plans. The amounts estimated to be paid relating to products sold are recognized as revenue reductions and as additions to either rebate payable or rebate liability at the time of sale based on the Company’s best estimate of the expected prescription fill rate to these managed care patients using historical experience adjusted to reflect known changes in the factors that impact such reserves. The rebate liability principally represents the estimated claims for rebates owed to Medicaid and managed care providers but not yet received by the Company. The rebate payable represents actual claims for rebate amounts received from Medicaid and managed care providers and payable by the Company.

A. Aarons first began selling products during the Third Quarter of 2006. The Company did not recognize revenue for A. Aarons during 2006 or in the First Quarter of 2007 because we did not have sufficient historical data in accordance with SFAS No. 48,

~~Note~~“Revenue JRecognition –When ~~Accrued~~Right of ~~Expenses~~Return Exists,” in order for us to accrue and reserve for returns of A. Aarons’ products. In addition, the prescription data did not support sufficient resales to the end user and we did not have sufficient customer payments for product shipped. During 2006 and in the First Quarter of 2007, A. Aarons shipped approximately $268,000 and $2,022,000, respectively, of products at each product’s respective gross selling price. The Company has recorded deferred revenue of $590,000 from these sales at March 31, 2007, which represents the payments received from customers through that date.

~~Accrued~~The ~~expenses~~Company ~~balances~~records an estimate for returns at ~~March~~the 31time of sale. The Company’s return policy typically allows returns for products within an eighteen-month window from six months prior to the expiration date and up to twelve months after the expiration date. The Company believes that it has sufficient data to estimate future returns at the time of sale. These amounts are deducted from the Company’s gross sales to determine the Company’s net sales. The Company’s estimates take into consideration both quantitative and qualitative information including, ~~2006~~but not limited to, actual return rates by product, the level of product in the distribution channel, expected shelf life of the product, product demand, the introduction of competitive or generic products that may erode current demand, our new product launches and ~~December~~general 31economic and industry wide indicators. The Company periodically reviews the reserves established for returns and adjusts them based on actual experience. If the Company over or under estimates the level of sales that will ultimately be returned, ~~2005~~there ~~are~~may asbe ~~follows:~~a material impact to the Company’s financial statements.

	March 31, 2006	December 31, 2005
Employee compensation	$ 1,732,833	$ 1,874,883
Rebate payable	295,809	55,504
Rebate liability	3,234,425	5,032,044
Deferred revenue	904,439	904,439
Return reserve	27,550,306	24,934,080
Legal settlement reserve	500,000	500,000
Royalty payable	1,454,774	1,427,895
Other	2,113,891	2,380,630
Accrued expenses	$37,786,477	$37,109,475

The settlement reserve represents the Company’s estimate for potential settlements and the resolution of contractual disagreements discussed in Note O.

~~The Company~~Note ~~establishes~~J ~~and~~– ~~maintains reserves for amounts payable to managed care~~Milestone organizations and state Medicaid programs for the reimbursement of a portion of the retail price of prescriptions filled that are covered by the respective plans. The amounts estimated to be paid relating to products sold are recognized as revenue reductions and as additions to accrued expenses at the time of sale based on the Company’s best estimate of the expected prescription fill rate to these managed care patients using historical experience adjusted to reflect known changes in the factors that impact such reserves. The rebate liability principally represents the estimated claims for rebates owed to Medicaid and managed care providers but not yet received by the Company. The rebate payable represents actual claims for rebate amounts received from Medicaid and managed care providers and payable by the Company. The legal settlement reserve represents the Company’s estimate for potential legal settlements discussed in Note O.1. Payable

~~The~~On ~~Company~~November ~~records~~7, an2006, ~~estimate~~the ~~for~~Company ~~returns~~entered atinto ~~the~~an ~~time~~agreement of(the ~~sale.~~“BioSante ~~The~~Agreement”) ~~Company’s~~with BioSante ~~return~~Pharmaceuticals ~~policy typically~~(“BioSante”) ~~allows~~to ~~returns~~market ~~for~~its ~~products~~estradiol ~~within~~transdermal angel, ELESTRIN™ ~~eighteen~~(f/k/a Bio-~~month~~E-Gel®) ~~window~~(estradiol), ~~from~~in ~~six~~the ~~months prior~~United toStates. In consideration for the ~~expiration~~grant ~~date~~of ~~and~~the upCompany’s right to ~~twelve~~market ~~months~~ELESTRIN™, ~~after~~ the ~~expiration date. The~~ Company ~~believes~~paid ~~that~~BioSante itand its ~~has~~licensor ~~sufficient~~for ~~data~~ELESTRIN™ toan ~~estimate~~aggregate ~~future~~of ~~returns~~$3,500,000 atduring ~~the~~October ~~time~~2006, ofwhich was ~~sale.~~expensed ~~These~~as ~~amounts~~research ~~are~~and ~~deducted~~development ~~from~~during the ~~Company’s~~Fourth ~~gross~~Quarter ~~sales~~of to2006 ~~determine~~because ~~the~~there was ~~Company’s~~no ~~net~~FDA ~~sales.~~approval ~~The~~of ~~Company’s~~the ~~estimates~~product ~~take~~at ~~into~~that ~~consideration~~time. ~~historical~~Subsequently ~~returns of~~on aDecember ~~given~~18, ~~product~~2006, ~~product~~the ~~specific~~FDA approval ~~information~~of ~~provided~~ELESTRIN™ bytriggered ~~the~~milestones ~~Company’s~~payable ~~customers~~to BioSante and its licensor for ~~information~~ELESTRIN ~~obtained~~™ ~~regarding~~pursuant to the ~~levels~~BioSante Agreement of ~~inventory~~$7,000,000, ~~being~~which ~~held~~was paid by the ~~Company’s~~ ~~customers,~~Company asin ~~well~~March as2007, ~~overall~~and ~~purchasing~~$3,500,000 ~~patterns~~due byin ~~its~~December ~~customers~~2007. The milestones payable are non-interest bearing. At December 31, 2006, the Company utilized an imputed interest rate ~~periodically~~of ~~reviews~~7.35% to determine the ~~reserves~~principal ~~established~~owed ~~for~~at ~~returns~~that ~~and~~time ~~adjusts~~of ~~them~~$10,115,083, ~~based~~which onwas recorded ~~actual~~as ~~experience~~a milestone payable and corresponding intangible asset. At March 31, ~~including~~2007, ~~executing~~the milestone payable was $3,252,000 following the ~~Distribution~~Company’s ~~Service~~first ~~Agreements~~quarter ~~(“DSAs”)~~payment of $7,000,000.

in 2005 (but effective as of 2004), obtaining customer inventory data from the Company’s largest customers, changing market dynamics of these customers, having subsequent return visibility and having increased generic competition. If the Company over or under estimates the level of sales that will ultimately be returned, there may be a material impact to the Company’s financial statements.

Note K – Income Taxes

The provision for income taxes reflects management’s estimate of the effective tax rate expected to be applicable for the full fiscal year.

Deferred income taxes are provided for the future tax consequences attributable to the differences between the financial statement carrying amounts of assets and liabilities and their respective tax base. Deferred tax assets are reduced by a valuation allowance when, in the Company’s opinion, it is more likely than not that some portion of the deferred tax assets will not be realized. On March 31, ~~2006~~2007 and December 31, ~~2005~~2006, the Company determined that no deferred tax asset valuation allowance was necessary. The Company believes that its projections of future taxable income makes it more likely than not that such deferred tax assets will be realized. If the Company’s current projection of future taxable income ~~changes~~ ~~in the future~~changes, the Company may be required to reduce deferred tax assets by a valuation allowance.

~~With~~The Company adopted the ~~adoption~~provisions of FIN 48 on January 1, 2007. Previously, the Company had accounted for tax contingencies in accordance with SFAS No. ~~123R~~5, on“Accounting ~~January~~for Contingencies.” 1As required by FIN 48, ~~2006~~which clarifies SFAS No. 109, “Accounting for Income Taxes,” the Company’s ~~effective~~recognizes the financial statement benefit of a tax ~~rate~~position ~~increased~~only ~~from~~after ~~39%~~determining inthat ~~2005~~the torelevant tax authority would more likely than not sustain the position following an ~~estimated~~audit. ~~42%~~For intax ~~2006~~positions ~~since~~meeting ~~expensing~~the ~~qualified~~more-likely-than-not ~~(incentive)~~threshold, ~~stock~~the ~~options~~amount ~~results~~recognized in the financial statements is the largest benefit that has a ~~permanent~~greater than 50 percent likelihood of being realized upon ultimate settlement with the relevant tax ~~difference~~authority. At the adoption date, the Company applied FIN 48 to all tax positions for which the statute of limitations remained open. As a result of the implementation of FIN 48, the Company recognized increases of $5,062,000 in income taxes payable for unrecognized tax liabilities and $1,562,000 in long-term deferred tax assets and a decrease of $3,500,000 in retained earnings at January 1, 2007.

The Company ~~has~~is ~~taken~~subject ~~certain~~to ~~tax~~income ~~positions,~~taxes ~~which~~in itthe ~~believes~~U.S. ~~are~~federal ~~appropriate~~jurisdiction, ~~but~~and ~~may~~various bestates ~~subject~~and toforeign ~~challenge~~jurisdictions. byTax ~~tax~~regulations ~~authorities.~~within ~~Should~~each ~~those~~jurisdiction ~~challenges~~are besubject ~~successful,~~to the ~~Company’s~~interpretation ~~best~~of ~~estimate~~the ofrelated ~~additional~~tax ~~possible~~laws ~~taxes~~and ~~due~~regulations ~~amounts~~and torequire ~~approximately~~significant ~~$1.1~~judgment ~~million~~to apply.

~~Note~~ The Company Lis –currently ~~Incentive~~under examination by several state jurisdictions for years prior to ~~and~~2005. ~~Non-Qualified~~The ~~Stock~~Company ~~Option~~expects ~~Plan~~ those examinations to be concluded in the next 12 months. Additionally, the statute of limitations in some jurisdictions will expire in the next 12 months. The Company has unrecognized tax benefits of $603,000, which will be recognized in the Second Quarter of 2007 because the statute of limitations expired without the relevant taxing authority examining the applicable returns.

~~Effective~~The ~~January 1, 2006, the~~ Company’s ~~adopted~~FIN ~~the~~48 ~~provisions~~adjustment ofincludes ~~Statement~~approximately ~~of Financial Accounting Standards No. 123R~~$1, ~~Share-Based Payment (“SFAS No. 123R”)~~155,000 ~~which~~for ~~requires stock-based compensation to be measured based on~~ the ~~fair~~payment ~~value~~ of ~~the~~interest and ~~awards~~penalties onat ~~the~~January ~~grant~~1, ~~date~~2007. ~~The Company~~Subsequent ~~elected~~changes ~~the~~to ~~“modified~~accrued ~~prospective~~interest ~~method” of transition as permitted by SFAS No. 123R~~ and, ~~as such, prior period financial statements~~ penalties have not been ~~restated~~significant. ~~Under~~The ~~this method,~~Company’s ~~the~~policy ~~fair~~is ~~value~~to ofrecognize ~~all~~interest ~~stock options granted or modified after adoption must be recognized in the consolidated statement of income~~ and ~~total compensation cost related to~~penalties ~~nonvested~~accrued ~~awards~~on ~~not~~uncertain ~~yet~~tax ~~recognized,~~positions ~~determined~~as ~~under~~part ~~the original provisions~~ of ~~SFAS No. 123, must also be recognized in the consolidated statement of~~ income. ~~The~~tax ~~Company recorded share-based compensation~~ expense ~~of $927,000 for the three months ended March 31, 2006~~.

~~The~~As ~~Company’s~~a ~~1990~~result ~~Stock~~of ~~Option~~the ~~Plan~~adoption ~~and~~of ~~its~~FIN ~~1999~~48, ~~Incentive and Non-Qualified Stock Option Plan are described more fully in Note H.2 of~~ the Company’s ~~Annual~~effective ~~Report~~tax onrate ~~Form~~for ~~10-K~~the ~~for~~first ~~the~~quarter ~~year~~of ~~ended~~2007 ~~December~~increased ~~31,~~from ~~2005.~~approximately A42% ~~summary~~to of44%. ~~the~~The Company’s ~~stock~~effective ~~option~~tax ~~activity during~~rate ~~the~~was ~~three~~estimated ~~months~~to ~~ended~~be ~~March~~approximately ~~31,~~42% ~~2006~~for ~~and~~the ~~March~~three ~~31,~~month ~~2005~~period isended asMarch ~~follows:~~31, 2006.

	2006					2005
	Number of Options		Weighted Average Exercise Price	Weighted Average Remaining Contractual Life (Years)	Aggregate Intrinsic Value	Number of Options		Weighted Average Exercise Price
Outstanding, January 1	1,875,089		$13.76			1,389,792		10.64
Granted	26,900		12.77			—		—
Exercised	(25,000	)	2.17			—		—
Canceled or forfeited	(66,780	)	14.90			(6,250	)	14.08
Outstanding, March 31	1,810,209		$13.87	8.60	1,818,087	1,383,542		10.63
Exercisable, March 31	733,818		$12.96	5.61	1,401,778	971,163		6.78

Note L – Incentive and Non-Qualified Stock Option Plan

~~There~~The ~~were~~Company’s ~~25,000~~1990 ~~options~~Stock ~~exercised~~Option ~~during~~Plan ~~the~~and ~~three~~its ~~month~~1999 ~~period~~Incentive ~~ended~~and ~~March~~Non-Qualified ~~31,~~Stock ~~2006, the~~Option ~~total~~Plan ~~intrinsic~~are ~~value~~described more fully in Note B of ~~those~~the ~~options~~Company’s ~~was~~Annual ~~$243,360.~~Report ~~Additionally,~~on Form 10-K for the ~~weighted~~year ~~average~~ended December 31, ~~grant~~ ~~date~~2006. ~~fair~~A ~~value~~summary of ~~options~~the ~~granted~~Company’s ~~during~~stock option activity during the three ~~month~~months ~~period~~ ended March 31, ~~2006~~ ~~was~~2007 ~~approximately~~and ~~$7.15~~2006 ~~per~~is ~~share~~as ~~using~~follows: ~~the Black-Scholes model.~~

There were no options granted during the three months ended March 31, 2005. All options issued during the three months ended March 31, 2006 were at or above the market price on the date of grant. The fair value of each option grant for the three months ended March 31, 2006 was estimated on the date of grant using the Black-Scholes option-pricing model with the following assumptions:

	2007					2006
	Number of Options		Weighted Average Exercise Price	Weighted Average Remaining Contractual Life (Years)	Aggregate Intrinsic Value	Number of Options		Weighted Average Exercise Price	Weighted Average Remaining Contractual Life (Years)	Aggregate Intrinsic Value
Outstanding,
January 1	1,651,617		$13.95			1,875,089		$13.76

Granted	60,600		21.07			26,900		12.77
Exercised	(354,897	)	12.49			(25,000	)	2.17

Canceled or forfeited	(55,058	)	19.26			(66,780	)	14.90

Outstanding March 31	1,302,262		$14.45	7.17	$7,041,000	1,810,209		$13.87	8.60	$1,818,000

Vested and expected to vest, March 31	1,212,080		$14.43	7.07	$6,621,000	1,746,098		$13.87	6.43	$3,714,000

Exercisable, March 31	576,810		$14.14	6.28	$3,582,000	733,818		$12.96	5.61	$1,402,000

Risk-free interest rate	4.6	0%
Expected option life in years	4.5	0
Expected stock price volatility	65.0	%
Expected dividend yield	0.0	%

There were 354,897 and 25,000 options exercised during the three month periods ended March 31, 2007 and 2006, respectively, the total intrinsic value of which was approximately $2,312,000 and $243,000 for the respective periods. Additionally, the weighted average, grant date fair value of options granted during the three month periods ended March 31, 2007 and 2006 was approximately $10.40 and $7.15 per share, respectively, using the Black-Scholes Option Valuation Model.

1 The Company used the Black-Scholes Option Valuation Model to estimate the fair value of stock options granted in 2007 and 2006 for purposes of recording stock compensation expense pursuant to the provisions of SFAS No. ~~Impact~~123R on(“SFAS ~~Net~~No. 123R”), “Share-Based Payment,” and ~~Income~~SEC Staff Accounting Bulletin (~~Loss~~“SAB”) No. 107.

Our net income (loss) for the first quarter of 2006 and 2005 includes $927,000 and $0 of total compensation cost for share-based payment arrangements ($824,000 and $0 net of tax), which was charged to selling, general and administrative expense.

~~The~~Key input assumptions used to ~~impact~~estimate the fair value of ~~share~~stock options include the expected term until the exercise of the option, expected volatility of the Company’s stock, the risk free-~~based~~rate ~~compensation~~of ~~expense~~return, option forfeiture rates, and dividends, if any. The expected term of the options is based on the ~~Statements~~historical weighted average exercise behavior of ~~Income~~officers and non officers. The expected volatility is asderived ~~follows:~~from the historical volatility of the Company’s stock on the secondary markets. The risk-free interest rate is the yield from a treasury bond corresponding to the expected term of the option. Option forfeiture rates are based on the Company’s historical forfeiture rates. The Company has not paid dividends and does not expect to pay dividends in the near future.

	Three Months Ended March 31,
	2006		2005
Net income before tax expense and share-based compensation
expense	$ 318,358		$ 3,536,953
Share-based compensation expense	(927,000	)	—
Net income (loss) before income tax (benefit) expense	$ (608,642	)	$ 3,536,953
Net income before share-based compensation expense	$ 471,358		$ 2,153,953
Share-based compensation expense (net of tax)	(824,000	)	—
Net income (loss)	$ (352,642	)	$ 2,153,953
Net income (loss) per share:
Basic income (loss) per share before share-based	$ 0.03		$ 0.13
compensation expense
Share-based compensation expense	(0.05	)	0.00
Basic income (loss) per share	$ (0.02	)	$ 0.13
Diluted income (loss) per share before share-based	0.03		$ 0.13
compensation expense
Share-based compensation expense	$ (0.05	)	0.00
Diluted income (loss) per share	$ (0.02	)	$ 0.13

All options issued during the three months ended March 31, 2007 and 2006 were at or above the market price on the date of grant. The fair value of each option grant for the three months ended March 31, 2007 and 2006 was estimated on the date of grant using the Black-Scholes Option Valuation Model with the following assumptions:

The following table shows the effect on results for the first quarter of 2005, as it compares to the first quarter of 2006, as if we had applied the fair-value-based recognition provisions of SFAS No. 123R to measure stock-based compensation expense for the option grants:

	Three Months Ended
	March 31, 2007		March 31, 2006
Expected dividend yield	0.0	%	0.0	%
Risk-free interest rate	4.69%-4.81	%	4.51%-4.78	%
Expected option life in years
Directors and officers	5.0	Years	6.0	years
Others	4.0	Years	4.5	years
Expected stock price volatility	52%-56	%	65	%

Unvested options as of March 31, 2007 and 2006, and changes in such options during the three month periods then ended are summarized below:

	2007			2006
	Number of Options		Weighted- Average Grant Date Fair Value Per Share	Number of Options		Weighted- Average Grant Date Fair Value Per Share
Unvested Balance, January 1	711,224		$ 9.22	1,107,256		$ 9.58
Granted	60,600		10.40	26,900		7.11
Vested	(29,883	)	10.00	(13,838	)	13.37
Expired or forfeited	(16,481	)	7.31	(43,927	)	10.59

Unvested Balance, March 31	725,460		$ 9.33	1,076,391		$ 9.42

	Three Months Ended March 31,
	2006		2005 (a)
Net income (loss), as reported	$(352,642	)	$ 2,153,953
Deduct: Total share-based employee compensation expense
determined under fair value based method for all awards,
net of related tax effects	—		(435,700	)
Pro forma net income (loss) for basic computation	$(352,642	)	$ 1,718,253
Net income (loss), as reported	$(352,642	)	$ 2,153,953
Deduct: Total share-based employee compensation expense
determined under fair value based method for all awards,
net of related tax effects	—		(435,700	)
Add: After-tax interest expense and other from 4% convertible
senior subordinated notes due 2013	—		253,979
Pro forma net income (loss) for diluted computation	$(352,642	)	$ 1,972,232
Net income (loss) per share:
Basic- as reported	$ (0.02	)	$ 0.13
Basic- pro forma	$ (0.02	)	0.11
Diluted- as reported	$ (0.02	)	$ 0.13
Diluted- pro forma	$ (0.02	)	$ 0.11

The impact on the Company’s financial statements related to the adoption of SFAS No. 123R on January 1, 2006 is described below.

~~(a) Amounts have been adjusted to reflect the provisions of SFAS No~~1. ~~123R~~Impact toon ~~conform~~Net ~~to current presentation.~~Income

The Company’s net income for the first quarter of 2007 and 2006 includes $833,000 ($690,000, or $0.04 per share on a fully diluted basis, net of tax) and $927,0000 ($824,000, or $0.05 per share on a fully diluted basis, net of tax), respectively, of total compensation cost for share-based payment arrangements, which was charged to selling, general and administrative expenses. For the first quarter of 2007 and 2006, the related income tax benefits of the compensation cost for share-based payment arrangements were $137,000 and $103,000, respectively.

Compensation costs for stock options with tiered vesting terms are recognized ratably over the vesting period. As of March 31, 2007 and 2006 the total unrecognized compensation expense related to unvested share-based compensation arrangements granted under the Plans was $5,517,000 and $8,087,000, respectively. These expenses are recognized over a weighted average periods of 23 and 33 months, respectively, assuming no changes to the underlying assumptions. The total fair value of shares vested during the three months ended March 31, 2007 and 2006 was $296,000 and $185,000, respectively.

2. Impact on Cash Flows

Prior to the adoption of SFAS No. 123R, the Company presented cash flows resulting from the tax benefits of deductions from the exercise of stock options as operating cash flows in the Statement of Cash Flows. SFAS No. 123R requires cash flows resulting from the tax benefits from tax deductions in excess of the compensation cost recognized for those options (excess tax benefits) to be classified as financing cash flows. The Company realized a tax benefit from the exercise of stock options during the three months ended March 31, 2007 and 2006 of $93774,~~609~~000 and $94,000, respectively.

3. Impact on Income Taxes

~~With~~During the ~~adoption of~~ ~~SFAS~~Quarters ~~No.~~ended ~~123R~~March on31, ~~January~~2007 1,and 2006, the Company’s estimated its effective tax rate ~~increased~~to ~~from~~be 39approximately 44% and 42%, respectively. The higher rate in ~~2005~~the tomost anrecent quarter ~~estimated~~reflects ~~42%~~the inCompany’s ~~2006~~adoption ~~since~~of FIN 48 on January 1, 2007. The expensing ~~qualified~~ of qualified (incentive) stock options pursuant to the adoption of SFAS No. 123R on January 1, 2006 results in a permanent tax difference which has the effect of increasing the Company’s effective tax rate.

Unvested options as of March 31, 2006, and changes in such options during the three month period then ended are summarized below:

	Number of Options		Weighted Average Exercise Price
Unvested Balance, January 1, 2006	1,107,256		14.71
Granted	26,900		12.77
Vested	(13,838	)	23.91
Canceled or forfeited	(43,927	)	16.42
Unvested Balance, March 31, 2006	1,076,391		14.48

Compensation costs for stock options with tiered vesting terms are recognized ratably over the vesting period. As of March 31, 2006 the total unrecognized compensation expense related to unvested share-based compensation arrangements granted under the Plans is $8,087,000. This expense will be recognized over a weighted average period of 33 months, assuming no changes to the und,erlying assumptions.

The Company estimates the fair value of stock options using a Black-Scholes valuation model, consistent with the provisions of SFAS No. 123R, Securities and Exchange Commission Staff Accounting Bulletin No. 107 and the Company’s prior pro-forma disclosures of net earnings, including the fair value of stock-based compensation. Key input assumptions used to estimate the fair value of stock options include the expected term until the exercise of the option, expected volatility of the Company’s stock, the risk free rate of return, option forfeiture rates, and dividends, if any. The expected term of the options is based on a historical weighted average of vesting periods. The expected volatility is derived from the historical volatility of the Company’s stock on the secondary markets. The risk-free interest rate is the yield from a treasury bond corresponding to the expected term of the option. Option forfeiture rates are based on the Company’s historical forfeiture rates. The Company has not paid dividends and does not expect to pay dividends in the near future.

Note M – Related Party Transactions

Transactions ~~With~~ with Shareholders and Officers

The Company currently leases approximately 33,000 square feet of office ~~and warehouse~~ space at 383 Route 46 West, Fairfield, New Jersey, under a lease expiring on January 31, ~~2008,~~2013. ~~with~~The aowner and manager of this property is a limited liability company (“LLC”) that is owned and controlled by ~~Daniel~~the Glassman, ~~the~~family. ~~Company’s~~The ~~Chairman~~ purpose of the ~~Board,~~LLC ~~Chief~~is ~~Executive~~to ~~Officer~~own and ~~President,~~manage ~~and~~the property ~~Iris~~at ~~Glassman,~~383 anRoute ~~officer,~~46 aWest. The lease agreement obligates the Company to pay 3% ~~member~~increases ofin annual lease payments per year. Rent expense, including the Company’s proportionate ~~Board~~share of ~~Directors~~real ~~and~~estate ~~spouse~~taxes, ofwas ~~Daniel~~approximately ~~Glassman.~~$166,000 ~~The~~and ~~purpose~~$144,000 of for the three ~~LLC~~months isended toMarch ~~own~~31, 2007 and ~~manage~~2006, ~~the~~respectively. ~~property~~As atof ~~383~~December ~~Route~~31, 462006, ~~West.~~the assets Atof the ~~Company’s~~LLC ~~option~~were approximately $1, 600,000 and the ~~Company~~estimated ~~can~~liabilities ~~extend~~were $1,400,000. Daniel Glassman, the ~~term~~Company’s Chairman of the ~~lease~~Board, ~~for~~Chief anExecutive ~~additional~~Officer and ~~five~~President, ~~years~~and ~~beyond expiration.~~Iris ~~The~~Glassman, ~~lease~~a ~~agreement~~former ~~contractually~~officer, ~~obligates~~a former member of the Company’s Board toof ~~pay~~Directors aand 3spouse of Daniel Glassman own 10% ~~increase~~and their children, including inBradley ~~annual~~Glassman, ~~lease~~Senior ~~payments~~Vice ~~per~~President ~~year.~~Sales ~~Rent~~and ~~expense~~Marketing of the Company, ~~including~~own 90% of this LLC.

23Note N – New Accounting Standards

In February 2007, the ~~Company’s~~FASB ~~proportionate~~issued ~~share~~SFAS ofNo. 159, “The Fair Value Option for Financial Assets ~~real~~and ~~estate~~Financial ~~taxes,~~Liabilities” ~~was~~(“SFAS ~~approximately~~No. ~~$143,922~~159”) which permits entities to choose to measure many financial instruments and ~~$138,416~~certain other items at fair value that are not currently required to be measured at fair value. SFAS No. 159 will be effective for the ~~three~~Company ~~months~~on January ~~ended~~1, 2008. The Company is currently evaluating the impact of adopting SFAS No. 159 ~~March~~on 31its financial position, ~~2006~~cash flows, and ~~2005,~~results ~~respectively.~~of operations.

~~Note~~ In September N2006, –the ~~Recent~~FASB issued SFAS No. 157, “Fair Value Measurements” (“SFAS No. 157”). ~~Accounting~~SFAS ~~Pronouncements~~No. 157 clarifies the principle that fair value should be based on the assumptions market participants would use when pricing an asset or liability and establishes a fair value hierarchy that prioritizes the information used to develop those assumptions. Under the standard, fair value measurements would be separately disclosed by level within the fair value hierarchy. SFAS No. 157 is effective for financial statements issued for fiscal years beginning after November 15, 2007, and interim periods within those fiscal years, with early adoption permitted. The Company has not yet determined the impact, if any, that the implementation of SFAS No. 157 will have on its results of operations or financial condition.

In November 2004, the FASB issued Statement 151, “Inventory Costs.” The standard clarifies that abnormal amounts of idle facility expense, freight, handling costs, and wasted materials should be recognized as current-period charges and requires the allocation of fixed production overheads to inventory based on the normal capacity of the production facilities. The standard is effective for inventory costs incurred during fiscal years beginning after June 15, 2005. The adoption of SFAS No. 151 did not have a material impact on the Company’s financial position or results of operations.

In December 2004, the Financial Accounting Standards Board (“FASB”) issued Statement 153, “Exchanges of Nonmonetary Assets, an amendment of APB Opinion No. 29.” The standard is based on the principle that exchanges of nonmonetary assets should be measured based on the fair value of the assets exchanged and eliminates the exception under ABP Opinion No. 29 for an exchange of similar productive assets and replaces it with an exception for exchanges of nonmonetary assets that do not have commercial substance. The standard is effective for nonmonetary exchanges occurring in fiscal periods beginning after June 15, 2005. The adoption of SFAS No. 153 did not have a material impact on the Company’s financial position or results of operations.

In December 2004, the FASB issued SFAS No. 123R (revised 2004), Share-Based Payment (“SFAS No. 123R”). SFAS No. 123R replaced SFAS No. 123, Accounting for Stock-Based Compensation (“SFAS No. 123“), and superseded Accounting Principles Board Opinion No. 25, Accounting for Stock Issued to Employees (“APB 25“). In March 2005, the U.S. Securities and Exchange Commission (“SEC”) issued Staff Accounting Bulletin No. 107, which expresses views of the SEC staff regarding the interaction between SFAS No. 123R and certain SEC rules and regulations, and provides the staff’s views regarding the valuation of share-based payment arrangements for public companies. SFAS No. 123R will require compensation cost related to share-based payment transactions to be recognized in the financial statements. SFAS No. 123R required public companies to apply SFAS No. 123R in the first interim or annual reporting period beginning after June 15, 2005. In April 2005, the SEC approved a new rule that delayed the effective date, requiring public companies to apply SFAS No. 123R in their next fiscal year, instead of the next interim reporting period, beginning after June 15, 2005. As permitted by SFAS No. 123, the Company elected to follow the guidance of APB 25, which allowed companies to use the intrinsic value method of accounting to value their share-based payment transactions with employees. SFAS No. 123R requires measurement of the cost of share-based payment transactions to employees at the fair value of the award on the grant date and recognition of expense over the requisite service or vesting period. SFAS No. 123R allows implementation using a modified version of prospective application, under which compensation expense of the unvested portion of previously granted awards and all new awards will be recognized on

or after the date of adoption. SFAS No. 123R also allows companies to adopt SFAS No. 123R by restating previously issued statements, basing the amounts on the expense previously calculated and reported in their pro forma footnote disclosures required under SFAS No. 123. The Company has adopted SFAS No. 123R in the first interim period of fiscal 2006 using the modified prospective method, See Note L.

In May 2005, the FASB issued Statement of Financial Accounting Standards No. 154, Accounting Changes and Error Corrections (“SFAS No. 154”). SFAS No. 154 requires retrospective application to prior-period financial statements of changes in accounting principles, unless it is impracticable to determine either the period-specific effects or the cumulative effect of the change. SFAS No. 154 also redefines “restatement” as the revising of previously issued financial statements to reflect the correction of an error. This statement is effective for accounting changes and corrections of errors made in fiscal years beginning after December 15, 2005. The adoption of SFAS No. 154 did not have a material impact on the Company’s financial position or results of operations.

Note O – Commitments & Contingencies

1. Legal Proceedings

Contract ~~Dispute~~Disputes

In 2004, the Company was named in a Complaint as a defendant in a civil action filed in the Superior Court of New Jersey alleging breach of contract by the Company and seeking unspecified monetary damages. During 2005, the Company filed an Answer and Counterclaim with respect to this matter, seeking monetary relief of its own. Discovery with respect to this dispute has not yet been scheduled by the Court. While the Company believes that it has meritorious defenses to the plaintiff’s allegations and valid bases to assert its counterclaims and demand for monetary damages, the Company accrued $500,000 as a probable settlement for this matter in the Fourth Quarter 2004. 23

In 2004, the Company was named in a Complaint as a defendant in a civil action filed in the Superior Court of New Jersey alleging breach of contract by the Company and seeking unspecified monetary damages. During 2005, the Company filed an Answer and Counterclaim with respect to this matter, seeking monetary relief for the Company. A June 11, 2007 trial date has been set with respect to this dispute. The Company believes that it has meritorious defenses to the plaintiff’s allegations and valid bases to assert the Company’s counterclaims and demand for monetary damages. While the Company believes that it has meritorious defenses to the plaintiff’s allegations and valid bases to assert its counterclaims and demand for monetary damages, the Company accrued $500,000 as a probable settlement for this matter in the Fourth Quarter 2004.

In addition, the Company and the licensor of one of the Company’s products currently disagree as to the interpretation of certain provisions in their license that relate to sales based milestones that may be payable by the Company. During the Fourth Quarter of 2006, the Company accrued $500,000 as a probable resolution of this contractual disagreement.

Shareholder Lawsuits

The Company, along with certain of ~~the~~its ~~Company’s~~ officers and directors, were named defendants in thirteen federal securities lawsuits that were consolidated on May 5, 2005 in the United States District Court of New Jersey. In the amended consolidated complaint, filed on June 20, 2005, the plaintiffs allege violations of Sections 10(b) and 20(a) of the Securities Exchange Act of 1934 and Rule 10b-5 promulgated thereunder, arising out of ~~disclosures~~ disclosures that plaintiffs allege were materially false and misleading. Plaintiffs also allege that the Company and the individual defendants falsely recognized revenue. Plaintiffs sought an unspecified amount of compensatory damages in an amount to be proven at trial. The Company and the individual defendants filed ~~their~~its initial response on July 20, 2005 seeking to dismiss the amended consolidated complaint in its entirety with prejudice. On March 23, 2006, the Court issued an order denying the Company’s motion to dismiss the federal securities class action lawsuit. The Company continues to dispute the allegations set forth in the class action lawsuit and intends to vigorously defend itself. Pursuant to a June 28, 2006 Scheduling Conference with the Court and the Court’s Pretrial Scheduling Order of that date, discovery in the federal securities class action lawsuit has begun. Plaintiffs filed a motion for class certification on January 15, 2007. Defendants filed their response on April 2, 2007. On April 20, 2007, the court issued an order staying further deadlines in this matter pending the completion of mediation between the parties.

25 Additionally, two related New Jersey state court shareholder derivative actions were filed on April 29, 2005 and May 11, 2005 against certain of the Company’s officers and directors alleging breach of fiduciary duty and other claims arising out of substantially the same allegations made in the federal securities class action lawsuit. Plaintiffs seek an unspecified amount of damages in addition to attorneys’ fees. On the parties’ agreement, these two related state shareholder derivative actions were consolidated on July 19, 2005 in the Superior Court of New Jersey. Plaintiffs in the state shareholder derivative actions filed a consolidated amended derivative complaint on May

~~vigorously defend itself. Discovery in the federal securities class action lawsuit has not yet been scheduled.~~ 24

~~Additionally~~12, ~~two~~ ~~related~~2006. ~~New~~The ~~Jersey state court shareholder derivative actions were filed on April 29, 2005 and May 11, 2005 against certain of the~~ Company’s ~~officers~~ and ~~directors alleging~~the ~~breach~~individual ofdefendants ~~fiduciary~~filed ~~duty~~its ~~and~~initial ~~other~~response ~~claims~~on ~~arising~~July ~~out~~17, of2006 ~~substantially~~seeking ~~the~~to ~~same allegations~~dismiss ~~made in~~ the ~~federal securities class action lawsuit. Plaintiffs seek an~~ ~~unspecified~~alleged ~~amount~~derivative ofcomplaint ~~damages~~ in ~~addition~~its toentirety ~~attorneys’~~with ~~fees~~prejudice. On ~~the~~October ~~parties’ agreement~~30, ~~these~~ ~~two related state shareholder derivative actions were consolidated on July 19~~2006, ~~2005~~the incourt ~~the~~granted ~~Superior Court of New Jersey and stayed in their entirety pending a decision on~~ the defendants’ motion to dismiss ~~the~~and ~~consolidated~~dismissed ~~federal~~the ~~securities~~derivative ~~class~~complaint with ~~action lawsuit~~prejudice. Plaintiffs ~~in the state shareholder derivative actions~~ filed a ~~consolidated~~notice ~~amended derivative~~of ~~complaint~~appeal on ~~May~~December 1214, 2006. ~~The~~and ~~Company~~their ~~disputes the allegations in the state~~appeal ~~shareholder~~papers ~~derivative~~on ~~lawsuit~~April ~~and~~27, ~~intends~~2007. toDefendants’ ~~move~~response tois ~~dismiss~~due ~~the~~on ~~consolidated~~June ~~amended derivative~~11, ~~complaint in its entirety~~2007.

Further, a federal shareholder derivative action was filed in the United States District Court of New Jersey against the Company and certain of its officers and directors. Service of process in this matter was accepted by the Company and the other defendants on April 26, 2006. ~~This~~After ~~action alleges breach of fiduciary duties arising out of~~ the ~~SEC~~Company ~~inquiry~~ and ~~the~~ ~~restatement of~~ the ~~Company’s~~other ~~financial~~defendants ~~results~~filed ~~for~~on ~~the~~June ~~quarter ended September 30~~16, ~~2004~~ ~~and~~2006 violations of Delaware law regarding annual meetings. Plaintiffs seek an unspecified amount of damages and attorneys’ fees and an order compelling the Company to schedule an Annual Meeting of Stockholders. The Company and the other defendants filed a motion to dismiss the derivative claim in this action ~~on June 16~~, ~~2006. After~~ the ~~Company sent~~shareholder ~~a notice~~filed toan ~~stockholders~~amended ~~that it has scheduled its 2006 Annual Meeting~~complaint ofon ~~Stockholders for~~ July 1814, 2006 ~~(which~~alleging ~~Annual~~a ~~Meeting,~~sole ~~the~~count ~~Company~~for ~~announced,~~breach ~~has been~~of ~~rescheduled),~~fiduciary ~~the~~duties ~~plaintiff~~arising inout ~~this lawsuit consented to the~~of ~~dismissal~~substantially ~~without prejudice of its claim under Delaware law relating to~~ the ~~failure~~same toallegations ~~hold~~made ~~an annual~~in ~~meeting. The parties filed a stipulation on June 15, 2006 requesting that~~ the ~~Court~~federal ~~enter~~securities ~~the~~class ~~order~~action ~~of dismissal~~lawsuit. The Company ~~expects~~and ~~to incur additional substantial defense costs regardless of~~ the ~~outcome~~individual ofdefendants ~~these lawsuits. Likewise, such events~~ have ~~caused,~~filed ~~and~~a ~~will~~motion ~~likely continue~~ to ~~cause,~~dismiss athe ~~diversion~~alleged derivative ofcomplaint ~~the~~in ~~Company’s~~its ~~management’s~~entirety ~~time~~with ~~and attention~~prejudice.

The Company expects to incur additional substantial defense costs regardless of the outcome of these lawsuits. Likewise, such events have caused, and will likely continue to cause, a diversion of the Company’s management’s time and attention.

SEC Inquiry

In December 2004, the Company was advised by the staff of the SEC that it is conducting an informal inquiry relating to the Company to determine whether there have been violations of the federal securities laws. In connection with the inquiry, the SEC staff has requested that the Company provide it with certain information and documents, including with respect to revenue recognition and capitalization of certain payments. The Company is cooperating with this inquiry, however, the Company is unable at this point to predict the final scope or outcome of the inquiry, and it is possible the inquiry could result in civil, injunctive or criminal proceedings, the imposition of fines and penalties, and/or other remedies and sanctions. The conduct of these proceedings could negatively impact the Company’s stock price. Since the Company cannot predict the outcome of this matter and its impact on the Company, the Company has made no provision relating to this matter in its financial statements. In addition, the Company expects to continue to incur expenses associated with the SEC inquiry and its repercussions, regardless of the outcome of the SEC inquiry, and the inquiry may divert the efforts and attention of the Company’s management team from normal business operations. During the Second Quarter 2006, the Audit Committee completed its previously announced internal review related to the SEC’s informal inquiry. The Audit Committee conducted its review with the assistance of independent counsel. The Audit Committee’s conclusions were delivered to the full Board of Directors, the SEC and the Company’s independent accountants.

26 In response to a resignation letter sent to members of the Board of Directors on April 13, 2007, from an employee of the Company, the Audit Committee, with the assistance of its outside counsel, conducted an internal review of the matters set forth in

this matter and its impact on the Company, the Company has made no provision relating to this matter in its financial statements. In addition, the Company expects to continue to incur expenses associated with the SEC inquiry and its repercussions, regardless of the outcome of the SEC inquiry, and the inquiry may divert the efforts and attention of the Company’s management team from normal business operations. 25

~~Shareholders~~the ~~Initiatives~~ letter. The Audit Committee’s review was completed on May 8, 2007, and the results of that review were reported to the full Board of Directors, the SEC and the Company’s independent accountants. No matters from the review affected the financial statements or books and records of the Company.

The Company received a letter, dated June 15, 2006, from a holder of approximately 9.1% of the Company’s outstanding common stock, which letter made certain assertions concerning federal securities laws and state corporate laws in connection with the timing of the Company’s 2006 Annual Meeting and the election of directors at that meeting.

While the Company disagrees with the assertions set forth in the letter, in an effort to avoid the cost and burden of litigation, the Company has rescheduled its Annual Meeting originally scheduled to occur on July 18, 2006. The Company has also reduced the number of directors constituting its Board of Directors from nine to eight members, effective as of the date of the rescheduled Annual Meeting. At the rescheduled Annual Meeting, the holders of the Company’s common stock voting separately as a class will be entitled to elect three directors and the holders of the Company’s Class B common stock voting separately as a class will be entitled to elect five directors, consistent with the Company’s Certificate of Incorporation and By-Laws.

On June 21, 2006, this shareholder filed a complaint against the Company in the United States District Court for the District of Massachusetts. The complaint seeks the relief described and requested in the shareholder’s June 15, 2006 letter.

The Company believes the complaint is moot in light of the actions the Company has taken described above.

Shareholders who wish to submit proposals to be considered, or to nominate Directors, at the rescheduled 2006 Annual Meeting must submit their proposals to the Company at its offices located at 383 Route 46 West, Fairfield, New Jersey on or before July 24, 2006.

General Litigation

The Company and its operating subsidiaries are parties to other routine actions and proceedings incidental to ~~their~~the Company’s business. There can be no assurance that an ~~adverse~~ adverse determination on any such action or proceeding would not have a material adverse ~~effect~~ effect on the Company’s business, financial condition or results of operations. The ~~Company~~ Company discloses ~~the~~material ~~amount~~amounts or ~~range~~ranges of reasonably possible losses in excess of ~~recorded~~ recorded amounts. ~~The Company accounts for legal fees as their services are incurred.~~

2. The Company ~~Collaboration~~accounts ~~and~~for ~~License Agreement~~ legal fees as services are incurred.

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

~~Additionally,~~On ~~under~~November ~~the~~14, ~~Agreement~~2005, the Company ~~agreed~~entered tointo ~~purchase~~a ~~exclusively from MediGene the active product ingredient~~$110,000,000 acredit ~~mixture of green tea catechins~~facility, ~~required~~or ~~for~~ the ~~Company’s~~ ~~commercialization of the products in the United States and have agreed to certain minimum purchase amounts. Under the Agreement~~Facility, ~~the~~with ~~Company~~a ~~and~~syndicate ~~MediGene~~of ~~will~~lenders ~~pursue~~led ~~the~~by ~~EGW Indication~~Wachovia ~~(as defined below)~~Bank, ~~for~~ which ~~MediGene~~has isbeen ~~obligated~~amended ~~to pay all further~~from ~~development~~time ~~and~~to ~~registration costs~~time. The ~~Agreement~~Facility ~~further~~is ~~provides~~comprised ~~that~~of ~~the~~an ~~parties~~$80,000,000 ~~may engage~~term inloan ~~development~~ and ~~registration~~a ~~activities relating to products covered by the~~$30,000,000 ~~Agreement~~revolving ~~for~~line ~~indications other than the EGW Indication or new development which would extend the scope~~ of ~~the EGW Indication~~credit. IfThe ~~the~~Facility’s ~~parties~~term ~~mutually~~loan ~~decide to pursue these other registration~~ and ~~development~~revolving ~~activities,~~line ~~the~~of ~~Company~~credit ~~and MediGene will share the~~both ~~costs~~mature ofon ~~such~~November ~~development and registration activities in varying percentages~~14, ~~depending on~~2010 ~~the indication sought~~ and ~~other~~are ~~circumstances.~~secured ~~MediGene~~by ~~retains~~a ~~the~~lien ~~rights~~upon tosubstantially ~~data generated~~all ~~under~~of ~~such activities for use outside~~ the Company’s ~~United States. Under the Agreement~~assets, if ~~certain~~including ~~criteria~~those ~~are~~of ~~not~~its ~~met~~subsidiaries, atand ~~various~~is ~~points~~guaranteed ~~along~~by the ~~development timeline for~~Company’s ~~particular~~domestic ~~products,~~subsidiaries. ~~or if certain products being developed cease to have economic viability, each party has the right to cease its~~

Amounts outstanding under the Facility, as amended to date, accrue interest at the Company’s choice from time to time of either (i) the alternate base rate (which is equal to the greater of the applicable prime rate or the federal funds effective rate plus 1/2 of 1%) plus 3%; or (ii) a rate equal to the sum of the applicable LIBOR rate plus 4%. In addition, the lenders under the New Facility are entitled to customary facility fees based on unused commitments under the Facility and outstanding letters of credit. At March 31, 2007, the effective interest rate accrued by the Company was 9.32%

The financial covenants under the Facility require that the Company maintain (i) a leverage ratio (which is a ratio of funded debt of the Company and its subsidiaries, to consolidated EBITDA) less than or equal to 2.50 to 1.00; (ii) a fixed charge coverage ratio (which is a ratio of (A) consolidated EBITDA, minus consolidated capital expenditures made in cash to (B) the sum of consolidated interest expense made in cash, scheduled funded debt payments, total federal, state, local and foreign income, value added and similar taxes paid or payable in cash, and certain restricted payments) greater than or equal to 1.50 to 1.00; and (iii) not less than $25,000,000 of unrestricted cash and cash equivalents on its balance sheet at all times. Further, the Facility limits the Company’s ability to declare and pay cash dividends. As of March 31, 2007, the Company is in compliance with the financial covenants under the Facility.

As a result of the Company classifying $10,500,000 of regulatory milestone payments owed to BioSante during 2007 as a milestone payable at December 31, 2006, the Company triggered a technical default under the Facility. On March 9, 2007, the Company received a waiver of this default from its lenders under the Facility. Concurrently, the Company’s lenders agreed to, among other things, modify the definitions of Consolidated EBITDA to add back the initial $3,500,000 payment made by the Company for ELESTRIN™ under the BioSante License during the Fourth Quarter of 2006 that the Company classified as an expense in accordance with U.S. GAAP, and further modify the definitions of Excess Cash Flow to exclude cash payments made with respect to Permitted Acquisitions and Permitted Acquisition and Scheduled Funded Debt Payments to permit the payment by the Company of its other obligations under the BioSante License. Further, pursuant to the March 9, 2007 waiver, the lenders had the option of not requiring the Excess Cash Flow principal prepayment due by March 31, 2007. The principal prepayment, which could have been up to $2,600,000, was included in current maturities of long-term debt at December 31, 2006. In March 2007, the lenders required and the Company paid $660,000 of this principal prepayment.

As of March 31, 2007, the Company had $65,340,000 in borrowings under the Facility’s term loan outstanding, no amounts outstanding under the Facility’s revolving line of credit and approximately $77,860,000 in cash and cash equivalents, short-term investments and restricted cash and investments.

As result of the waiver of the defaults on January 26, 2006, May 15, 2006 and March 9, 2007, the Company has classified $51,480,000 as a long-term liability at March 31, 2007 that would have otherwise been shown as current as a result of the defaults. Based upon the Company’s current projections, the Company will be in default under the Fixed Coverage Charge Ratio set forth in the Facility beginning in the Third Quarter of 2007. As a result of the projected default, the desire to reduce the interest rates charged under the Facility and provide the Company increased flexibility to potentially enter into future licensing, acquisition or other similar transactions, the Company currently expects to enter into a new credit facility prior to the Third Quarter of 2007.

Note Q – Changes in Stockholders’ Equity

Changes in the Company’s Common stock, Additional paid-in capital, Accumulated other comprehensive gain (loss) and Retained earnings during the three month period ended March 31, 2007 were as follows:

	Common stock, $.01 par value		Additional paid- in capital	Accumulated other comprehensive gain (loss)	Retained earnings
	Shares	Amount	Additional paid- in capital	Accumulated other comprehensive gain (loss)	Retained earnings
Balance at December 31, 2006	16,965,578	$170,000	$139,755,000	$ 1,000	$ 50,977,000
Cumulative effect of change in accounting principle for FIN 48 effective 1/1/07					(3,500,000)
Stock options exercised (1)	354,897	3,000	5,204,000
Non-cash share based compensation			833,000

participation in and funding of the development and registration activities relating to that particular product.

Other comprehensive income/(loss):
Net income					2,525,000
Net unrealized loss on available-for-sale securities				(1,000)

Balance at March 31, 2007	17,320,475	$173,000	$145,792,000	$ —	$ 50,002,000

In the First Quarter 2006, the Company paid to MediGene $5,000,000 in consideration for development and registration activities undertaken prior to the date of the Agreement. The Company expensed the $5,000,000 research and development payment during the First Quarter 2006. Additionally, if a product having an external genital wart and perianal wart indication to be applied three times per day (~~the “EGW Indication”~~1) Amounts ~~receives~~include ~~final regulatory~~tax ~~approval, the Company will pay MediGene a milestone payment which, when added~~benefit toresulting ~~the~~from ~~$5,000,000 already paid, will bring~~ the ~~aggregate~~exercise milestones payable with respect to the EGW Indication to $19,000,000. The Agreement also contemplates additional milestone payments which, when added to the milestones payable with respect to the EGW Indication, could aggregate to a maximum of ~~approximately~~stock ~~$69,000,000.~~options ~~These milestones are dependent upon specific achievements in the product development and regulatory approval process~~ of ~~products under the Agreement for indications other than the EGW Indication (which could aggregate to a maximum of~~ approximately $19774,000,000 in milestones) and also based upon the Company’s net sales of all products under the Agreement, including sales relating to the EGW Indication (which could aggregate to a maximum of approximately $31,000,000 in milestones). In addition to these payments, the Company will also pay MediGene, with respect to each product, a product royalty based on a percentage (in the mid-teens) of net sales during the product royalty term, which percentage is subject to reduction under certain circumstances. Thereafter, MediGene is entitled to a trademark royalty based on a percentage (in the low single digits) of net sales.

~~The Agreement~~There ~~commenced~~were onno ~~January~~changes ~~30, 2006 and, unless earlier terminated, expires on the last day of the Royalty Term (as defined~~ in the ~~Agreement)~~Class ofB ~~the~~common ~~product~~stock ~~whose Royalty Term is the last-to-expire of all products developed~~ and ~~marketed~~Treasury ~~under~~stock ~~the~~from ~~Agreement. Either~~December ~~party~~31, ~~may~~2006 ~~terminate the Agreement in its entirety by notice in writing~~ to ~~the other~~March ~~party upon or after any material breach of the Agreement by the other party~~31, if2007. ~~the other~~The ~~party~~balances ~~has~~for ~~not cured~~ the ~~breach~~Class ~~within~~B 60common ~~days~~stock ~~after~~and ~~written~~Treasury ~~notice~~stock towere ~~cure~~$4,000 ~~has~~and ~~been given~~$(3,291,000), ~~by the non-breaching party to the breaching party; however~~respectively, ifat ~~any~~both ~~breach~~December ~~relates solely to one or more products~~31, ~~then~~2006 ~~the~~and ~~non-breaching~~March ~~party may terminate the Agreement only to the extent it applies to such product or products~~31, ~~with certain exceptions~~2007. ~~Either~~ ~~party may also terminate the Agreement in certain other instances described in the~~ ~~Agreement.~~

Note P - Senior Credit Facility

On November 14, 2005, the Company entered into a new $110 million credit facility, or the New Facility, with a syndicate of lenders again led by Wachovia Bank. The New Facility is comprised of an $80 million term loan and a $30 million revolving line of credit. The New Facility’s term loan and revolving line of credit both mature on November 14, 2010 and are secured by a lien upon substantially all of the Company’s assets, including those of its subsidiaries, and is guaranteed by the Company’s domestic

subsidiaries. The New Facility was subsequently amended on January 26, 2006 and May 15, 2006, as described below.

Amounts outstanding under the New Facility accrue interest at the Company’s choice from time to time of either (i) the alternate base rate (which is equal to the greater of the applicable prime rate or the federal funds effective rate plus 1/2 of 1%) plus 3%; or (ii) a rate equal to the sum of the applicable LIBOR rate plus 4%. In addition, the lenders under the New Facility are entitled to customary facility fees based on unused commitments under the New Facility and outstanding letters of credit. At March 31, 2006, the effective interest rate accrued by the Company was 8.35%.

The financial covenants under the New Facility require that the Company maintain (i) a leverage ratio (which is a ratio of funded debt of the Company and its subsidiaries, to consolidated EBITDA) less than or equal to 2.50 to 1.00 beginning with the fiscal quarter ended September 30, 2005; (ii) a fixed charge coverage ratio (which is a ratio of (A) consolidated EBITDA minus consolidated capital expenditures made in cash to (B) the sum of consolidated interest expense made in cash, scheduled funded debt payments, total federal, state, local and foreign income, value added and similar taxes paid or payable in cash, and certain restricted payments) greater than or equal to 1.50 to 1.00 beginning with the fiscal quarter ended September 30, 2005; (iii) not less than $25 million of unrestricted cash and cash equivalents on its balance sheet at all times; and (iv) upon receipt of the audited financial statements for the fiscal year ended 2004, pro forma for the Bioglan acquisition, consolidated EBITDA of at least $42.2 million. Further, the New Facility limits our ability to declare and pay cash dividends.

On January 3, 2006, the Company received a notice from the administrative agent under the New Facility stating that the Company was in default under the New Facility with the minimum pro forma consolidated EBITDA covenant for the fiscal year ended December 31, 2004 and the covenant to file with the SEC the Company’s Annual Report on Form 10-K for the fiscal year ended December 31, 2004 by December 31, 2005. On January 26, 2006, the Company received a waiver of these defaults from its lenders under the New Facility. In connection with this waiver, the Company agreed with its lenders to file its Annual Report on Form 10-K for the year ended December 31, 2004 by January 31, 2006, have a minimum audited consolidated EBITDA for the fiscal year ended December 31, 2004, pro forma for the Bioglan acquisition, of at least $33.22 million, file its Annual Report on Form 10-K for the year ended December 31, 2005 by April 30, 2006, have a minimum audited consolidated EBITDA for the fiscal year ended December 31, 2005 of at least $40.0 million (before permitted reductions for non-recurring costs incurred by the Company during 2005 in connection with the restatement of the Company’ Third Quarter 2004 financial statements, the SEC inquiry and related lawsuits, including legal, accounting and other professional fees, and the costs associated with the Company’s elimination of debt during 2005 under the Old Facility and the Notes), satisfy the leverage ratio and fixed charge coverage ratio tests beginning with the fiscal quarter ended December 31, 2005 and pay to them waiver, amendment and arrangement fees of $520,000 in the aggregate. In addition, the Company agreed with its lenders that until the Company files its Quarterly Reports on Form 10-Q for the quarters ended March 31,

2005, June 30, 2005 and September 30, 2005, and Annual Report on Form 10-K for the year ended December 31, 2005, the Company will increase, from $25 million to $45 million, the amount of restricted cash and investments it will maintain at all times on its balance sheet, not incur any borrowings under the revolving credit line portion of its New Facility and provide them with monthly cash reports. The Company’s lenders ceased their accrual of default interest under the New Facility concurrently with their delivery to the Company of the waiver.

As a result of the Company’s failure to file its Annual Report on Form 10-K for the year ended December 31, 2005 by April 30, 2006, the Company triggered a default under the New Facility. On May 15, 2006, the Company received a waiver of this default from its lenders under the New Facility. In connection with this waiver, which also allowed the Company to continue outstanding LIBOR Rate Loans under the New Facility, the Company agreed with its lenders to file its Annual Report on Form 10-K for the year ended December 31, 2005 by May 31, 2006 and its Quarterly Report on Form 10-Q for the fiscal quarter ended March 31, 2006 by June 30, 2006. Concurrently, the Company’s lenders agreed to certain technical amendments to the New Facility clarifying Permitted Investments which can be utilized in determining the Company’s restricted cash and investments (which until the Company files its Quarterly Report on Form 10-Q for the fiscal quarter ended March 31, 2006 and demonstrates compliance with the financial covenants in the New Facility, must be at least $45 million), allowing the Company to deliver to the lenders under the New Facility the Company’s 2006 annual budget by June 30, 2006 and allowing the Company to calculate, for financial covenant purposes, consolidated EBITDA without giving effect to that portion of the Company’s initial $5 million payment to Medigene that the Company classified as an expense in accordance with GAAP. The Company’s lenders acknowledged that provided the Company file its Annual Report on Form 10-K for the year ended December 31, 2005 with the SEC by May 31, 2006, the Company would not be required to pay default interest under the New Facility; otherwise, default interest would be payable on a retroactive basis beginning May 1, 2006. The Company filed its Annual Report on Form 10-K for the year ended December 31, 2005 with the SEC on May 19, 2006.

As of May 31, 2006, the Company has $76 million in borrowings under the New Facility’s term loan outstanding, no amounts under the New Facility’s revolving line of credit outstanding and approximately $70 million in cash and cash equivalents, short-term investments and restricted cash and investments.

As result of the refinancing on November 14, 2005 and the waiver of the defaults on January 26, 2006 and May 15, 2006, the Company has classified as long-term liability $66 million that would have otherwise been shown as current as a result of the default.

Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations

The following discussion of our financial condition and results of operations should be read in conjunction with the financial statements and notes ~~thereto~~ included elsewhere in this Form 10-Q and our audited consolidated financial statements and related notes included in our Annual Report on Form 10-K for the year ended December 31, ~~2005~~ 2006. The following discussion and analysis contains forward-looking statements regarding our future performance and business strategy. All forward-looking information is inherently uncertain and actual results may differ materially from the assumptions, estimates or expectations reflected or contained in the forward-looking statements. See “Forward-Looking Statements” and “Risk Factors” included in our Form 10-K for the year ended December 31, ~~2005~~2006 and elsewhere in this Form 10-Q.

Forward-Looking Statements

Some of the statements under the captions “Risk Factors” included in our Annual Report on Form 10-K for the year ended December 31, ~~2005~~2006 or in this Form 10-Q under Part II, Item 1A, “Management’s Discussion and Analysis of Financial Condition and Results of Operations” or otherwise contained ~~or incorporated by reference~~ in this Form 10-Q constitute “forward-looking statements” within the meaning of the Private Securities Litigation Reform Act of 1995. These forward-looking statements include statements that address activities, events or developments that we expect, believe or anticipate will or may occur in the future, including:

• our plans to ~~execute~~in-license, ~~our~~develop ~~Acquire,~~and ~~Enhance~~launch new and enhanced products with long-term intellectual property protection or other significant barriers to market entry, ~~Grow~~such ~~strategy~~as VEREGEN™ and ELESTRIN™;

• ~~market~~our ~~acceptance~~ability to maintain or increase sales and launch VEREGEN™ at the end of ~~our~~2007 ~~products~~and ELESTRIN™ at the end of the Second Quarter of 2007;

• our ~~plans~~ability to ~~launch~~compete ~~new~~in ~~and~~the ~~enhanced~~marketplace against generic or therapeutically equivalent products;

• our ability to ~~maintain~~estimate orfor ~~increase~~charges against sales, including returns, chargebacks and rebates;

• our ability to ~~adequately~~continue ~~estimate~~to ~~for~~develop ~~charges~~products ~~against~~organically ~~sales,~~with ~~including~~longer ~~returns,~~lifecycles ~~chargebacks~~ and ~~rebates~~to extend indications for our current product portfolio;

• our ability to successfully implement life cycle management techniques;

•

our ability to secure regulatory consents and approvals, if necessary, for new products;

~~• our ability to obtain new distributors and market approvals in new countries;~~29

• our ability to ~~react~~expand ~~favorably~~existing topartnerships ~~changes~~and injoint ~~governmental~~venture ~~regulations~~relationships ~~affecting~~with ~~products~~biotechnology wecompanies ~~market~~and foster new strategic alliances designed to deliver a stronger product portfolio;

• our ~~plans~~reliance toon ~~pursue~~third ~~patents~~party manufacturers and suppliers;

• our ability to ~~successfully~~react ~~compete~~to changes in ~~the~~governmental ~~marketplace~~regulations affecting products we market;

• our plans to ~~maintain or~~ expand the size of our sales force in anticipation of new product launches;

31• our estimates of future financial condition and results of operations;

• our earnings estimates and future financial condition and results of operations;

•

our ability to favorably resolve the SEC’s informal inquiry;

• our ability to favorably resolve state and federal shareholder derivative, and federal securities class action, lawsuits;

• our ability to ~~file~~maintain ~~our~~adequate ~~required~~inventory ~~reports with the SEC in a timely manner~~levels;

• our ability to remediate our material weaknesses in our internal controls;

• the adequacy of our cash, cash equivalents and cash generated from operations to meet our working capital requirements for the next twelve months;

•

our ability to satisfy the covenants contained in our senior credit facility;

•

our ability to obtain new distributors and market approvals in new countries;

•

our ability to access the capital markets on attractive terms or at all;

• our ability to ~~refinance~~achieve ~~indebtedness,~~our ifinitiatives ~~required, and~~ to ~~comply~~enhance ~~with~~corporate ~~the~~governance ~~terms~~ and ~~conditions~~long-term ofstockholder ~~our debt instruments~~value; ~~and~~

•

our ability to refinance indebtedness, if required;

•

our ability to implement the returns and inventory optimization plan timely, if at all;

•

our ability to reduce product returns; and

•

the impact of the changes in the accounting rules discussed in this Form 10-Q.

In some cases, you can also identify forward-looking statements by terminology such as “may,” “should,” “could,” “would,” “predicts,” “potential,” “continue,” “expects,” “anticipates,” “future,” “intends,” “plans,” “believes,” “estimates” and similar expressions. All forward-looking statements are based on assumptions that we have made based on our experience and perception of historical trends, perception of current conditions, expected future developments and other factors we believe are appropriate under the circumstances. These statements are subject to numerous risks and uncertainties, many of which are beyond our control, including the statements set forth ~~under~~ ~~“Risk Factors” included in our Annual Report on Form 10-K for the year ended December 31, 2005.~~

No forward-looking statement can be guaranteed, and actual results may differ materially from those projected. We undertake no obligation to publicly update any forward-looking statement, whether as a result of new information, future events or otherwise. 30

under “Risk Factors” included in our Annual Report on Form 10-K for the year ended December 31, 2006 and in Item 1A of Part II of this Form 10-Q.

No forward-looking statement can be guaranteed, and actual results may differ materially from those projected. Except as required by law, we undertake no obligation to publicly update any forward-looking statement, whether as a result of new information, future events or otherwise.

Overview

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

~~Doak Dermatologics~~• ~~promotes~~in-licensing ~~our~~phase ~~branded~~II ~~dermatologic~~ and ~~podiatric~~phase ~~products, including~~III ~~our~~drugs ~~ADOXA®,~~and ~~SOLARAZE®,~~developing ~~KERALAC™, ZODERM®, LIDAMANTLE®, ROSULA®, ZONALON®~~ and ~~SELSEB®~~bringing ~~product lines,~~ to ~~dermatologists~~ ~~and~~market ~~podiatrists in the United States through its dedicated sales force of 132 representatives as of May 1, 2006. Kenwood Therapeutics promotes our branded gastrointestinal~~ products, ~~including~~with ~~ANAMANTLE®HC, PAMINE®, PAMINE® FORTE and FLORA~~long-Q®term tointellectual ~~gastroenterologists~~property ~~and~~protection ~~colon~~or ~~and~~other ~~rectal~~significant ~~surgeons~~barriers ~~in the~~to ~~United~~market ~~States through its~~ entry;

•

commercializing brands that fill unmet patient and physician needs;

•

expanding existing partnerships and joint venture relationships with biotechnology and specialty pharmaceutical companies and fostering new strategic alliances designed to deliver a stronger product portfolio; and

•

increasing our focus on research and development activities to continue to develop products organically with longer lifecycles and to extend indications for our current product portfolio.

We have two primary business segments, our Doak Dermatologics subsidiary, specializing in therapies for dermatology and podiatry, and our Kenwood Therapeutics division, providing gastroenterology, women’s health, respiratory and other internal medicine brands. To a lesser extent, Kenwood Therapeutics also markets nutritional supplements and respiratory products. At April 30, 2007, Doak Dermatologics had a dedicated sales force of 128 professional sales representatives, while Kenwood Therapeutics had a dedicated sales force of 46 professional sales representatives. We also launched our A. Aarons subsidiary in 2006, which is focused on marketing authorized generic versions of Doak’s and Kenwood’s products, in an effort to maintain market share when our products encounter generic competition.

As part of our business strategy of in-licensing and bringing to market products with long-term intellectual property protection or other significant barriers to market entry we entered into agreements in 2006 with MediGene AG (“MediGene”) to commercialize VEREGEN™, a new drug indicated for the treatment of external genital and perianal warts, and with BioSante Pharmaceuticals to commercialize ELESTRIN™, an estradiol transdermal gel indicated for the treatment of moderate-to-severe “hot flashes” in menopausal women and available at several dosage levels. VEREGEN™ is

patented through 2017 and ELESTRIN™ is patented through 2022 (additional pending patent applications may extend the patent life of both or either product) giving both these products significant intellectual property protection. We expect to launch ELESTRIN™ at the end of the Second Quarter of 2007 and VEREGEN™ at the end of 2007. VEREGEN™ will be promoted to physicians by both our Doak Dermatologics and Kenwood Therapeutics sales forces. ELESTRIN™ will be promoted to physicians by our Kenwood Therapeutics sales force. In connection with the launch of these products, we anticipate hiring approximately 20 additional Kenwood Therapeutics sales representatives during 2007 and incurring a corresponding amount of additional sales, marketing and related expenses. Our net sales and profitability would be adversely affected if, for any reason, we were unable to launch VEREGEN™ and ELESTRIN™ on a timely basis.

We derive a majority of our net sales from our core branded products: ADOXA^®, KERALAC^®/ KEROL™, SOLARAZE^®, ZODERM^®, LIDAMANTLE^®, ROSULA^®, PAMINE^®, ANAMANTLE^®HC and FLORA-Q^®. These core branded products accounted for a total of approximately 81% and 87% of our net sales in the first quarter of 2007 and for fiscal year 2006, respectively. Currently, only SOLARAZE^®, KEROL™ and FLORA-Q^® do not face some sort of competition from generic or therapeutically equivalent products.

With the exception of SOLARAZE^®, which is patented through at least 2014, and potential products expected to be launched in the future including VEREGEN™, which is patented through at least 2017, and ELESTRIN™, which is patented through at least 2022, there is no meaningful intellectual property or proprietary protection for our other material branded pharmaceutical products, including ADOXA^®, and competing generic or therapeutically equivalent versions for most of these other products are sold by other pharmaceutical companies. In addition, governmental and other pressure to reduce pharmaceutical costs may result in physicians prescribing products for which there are generic or therapeutically equivalent products. Since 2004, our net sales have been negatively impacted by the onset and increase in generic or therapeutically equivalent products competing on price with our brands. Increased competition from the sale of generic or therapeutically equivalent products may cause a further decrease in sales that would have an adverse effect on our business, financial condition and results of operations. As a result of increased generic competition, the execution of Distribution Service Agreements (DSAs) with three of our wholesale customers, two of whom are our two largest customers, and a change in these customers’ market dynamics, we have also experienced an increase in product returns. Our branded products for which there are no generic or therapeutically equivalent forms may also face competition from different therapeutic treatments used for the same indications for which our branded products are used.

Critical Accounting Policies

~~dedicated~~contingent ~~sales~~assets ~~force~~and ofliabilities 47at ~~representatives~~the asdate of ~~May~~the 1,financial ~~2006~~statements and revenues and expenses for the relevant reporting period. ToActual aresults ~~lesser~~could ~~extent,~~differ ~~Kenwood~~from ~~Therapeutics~~those ~~also~~estimates. ~~markets~~We believe that the following ~~nutritional~~critical ~~supplements~~accounting policies affect our more significant estimates used in the preparation of financial statements. Management has discussed the development and selection ~~respiratory~~of ~~products~~the critical accounting estimates discussed below with our audit committee, and our audit committee has reviewed our disclosures relating to these estimates.

WeRevenue ~~derive~~recognition. aRevenue ~~majority~~from ofproduct ~~our~~sales, net ~~sales~~of ~~from~~estimated ~~our~~provisions, ~~core~~is ~~branded~~recognized ~~products: ADOXA®,~~when ~~KERALAC™,~~the ~~SOLARAZE®,~~merchandise ~~ZODERM®,~~is ~~LIDAMANTLE®~~shipped to and/or received by an unrelated third party, as provided in ~~ROSULA®,~~SAB ~~SELSEB®,~~No. ~~ZONALON®~~104, ~~PAMINE®~~“Revenue Recognition in Financial Statements.” Accordingly, revenue is ~~ANAMANTLE®HC,~~recognized ~~FLORA-Q®~~when ~~and~~all ~~GLUTOFAC®-ZX.~~four of the following criteria are met:

~~We have~~• ~~experienced~~persuasive anevidence ~~increase~~that in generic competition occurring in the Fourth Quarter 2004 and during 2005 against many of our products, including some ADOXA®, KERALAC™, ZODERM®, LIDAMANTLE®, ROSULA®, and ANAMANTLE®HC products. As a result of generic competition, the execution of Distribution and Service Agreements with two wholesale customers in 2005 and a change in these customers’ market dynamics, we experienced an ~~increase~~arrangement ~~in product returns from our customers.~~ exists;

~~In December~~• ~~2004,~~delivery ~~we were advised by the staff~~ of the ~~SEC~~products ~~that it is conducting an informal inquiry to determine whether there have been violations of the federal securities laws. In connection with the inquiry, the SEC staff~~ has requested that we provide it with certain information and documents, including with respect to revenue recognition and capitalization of certain payments. We are cooperating with this inquiry, however, we are unable at this point to predict the final scope or outcome of the inquiry. We are also party to a federal securities class action lawsuit and federal and state shareholder derivative lawsuits which have arisen as a consequence of the SEC inquiry and restatement of our financial results for the quarter ended September 30, 2004. occurred;

~~On January~~• ~~30, 2006, we entered into a Collaboration and License Agreement with MediGene AG. Under~~ the ~~Agreement,~~selling ~~MediGene~~price ~~has~~is ~~granted~~both usfixed ~~the exclusive license, or sublicense in certain instances, to certain patents, trademarks~~ and other intellectual property for our use in the commercialization, in the United States, as a prescription product, of any ointment or other topical formulation containing green tea catechins, developed pursuant to our agreement with MediGene, for the treatment of dermatological diseases in humans, including but not limited to external genital warts, perianal warts and actinic keratosis. In the First Quarter 2006, the Company paid to MediGene $5,000,000 in consideration for development and registration activities undertaken prior to the date of the Agreement. The Company expensed the $5 million research and development payment during the First Quarter 2006. determinable;

~~Recent~~• ~~Developments~~ collectability is reasonably probable.

WeOur customers ~~received~~consist aprimarily ~~letter,~~of ~~dated~~large ~~June~~pharmaceutical 15wholesalers who sell directly into the retail channel. Provisions for returns, ~~2006~~rebates, ~~from~~chargebacks aand ~~holder~~discounts ofare ~~approximately~~established ~~9.1%~~as a reduction of ~~our~~product ~~outstanding~~sales ~~common~~revenues ~~stock,~~at ~~which~~the ~~letter~~time ~~made~~revenues ~~certain~~are recognized, ~~assertions~~based ~~concerning~~on ~~federal~~historical ~~securities~~experience ~~laws~~adjusted ~~and~~to ~~state~~reflect ~~corporate~~known ~~laws~~changes in ~~connection~~ ~~with~~ the ~~timing~~factors ofthat impact ~~our~~these ~~2006~~reserves. ~~Annual~~These ~~Meeting~~revenue ~~and~~reductions ~~the~~are ~~election~~generally ofreflected either as a ~~directors~~direct atreduction ~~that~~to ~~meeting.~~accounts receivable through an allowance or as an addition to accrued expenses.

~~While~~We do wenot ~~disagree~~provide ~~with~~any ~~the~~forms ~~assertions~~of ~~set~~price ~~forth~~protection into ~~the~~wholesale ~~letter,~~customers inother anthan a ~~effort~~contractual right to ~~avoid~~three ~~the~~wholesale ~~cost~~customers ~~and~~(who ~~burden~~together ofaccounted ~~litigation,~~for we80% ~~have~~of ~~rescheduled~~ our ~~Annual~~gross ~~Meeting~~sales ~~originally~~in ~~scheduled to occur on July 18, 2006. We have also reduced~~ the ~~number~~First Quarter of ~~directors~~2007) ~~constituting~~that our ~~Board~~price ofincreases ~~Directors~~and ~~from~~product ~~nine to~~purchase ~~eight~~discounts ~~members,~~offered ~~effective~~during asa ofspecified ~~the~~twelve-month ~~date~~period ofwill ~~the~~allow ~~rescheduled~~for ~~Annual~~inventory ~~Meeting. At the rescheduled Annual Meeting, the holders~~ of our ~~common stock voting~~ ~~separately~~products asthen aheld ~~class~~by ~~will~~these bewholesalers ~~entitled~~ to ~~elect~~appreciate ~~three~~in ~~directors and~~ the ~~holders of~~aggregate. ~~our~~We ~~Class~~do Bnot, however, ~~common~~guarantee ~~stock~~that ~~voting~~our ~~separately~~wholesale ascustomers ~~a class~~ will besell ~~entitled to elect five directors, consistent with~~ our ~~Certificate~~products ofat ~~Incorporation~~a ~~and By-Laws~~profit.

OnA. Aarons ~~June~~first ~~21,~~began selling products during the Third Quarter of 2006,. ~~this~~We ~~shareholder~~did ~~filed~~not recognize arevenue ~~complaint~~for ~~against~~A. usAarons during 2006 or in the First Quarter of 2007 because we ~~United~~did ~~States~~not ~~District~~have ~~Court~~sufficient historical data in accordance with SFAS No. 48, “Revenue Recognition When Right of Return Exists,” in order for ~~the~~us ~~District~~to accrue and reserve for returns of ~~Massachusetts~~A. ~~The~~Aarons’ ~~complaint~~products. In addition, the prescription data did not support ~~seeks~~sufficient resales to the ~~relief~~end ~~described~~user and ~~requested~~we did not have sufficient customer payments for product shipped. During 2006 and in the ~~shareholder's~~First ~~June~~Quarter 15of 2007, ~~2006~~A. Aarons shipped ~~letter~~approximately $268,000 and $2,022,000, respectively, of products at each product’s respective gross selling price. The Company has recorded in accrued expenses deferred revenue of $590,000 from these sales at March 31, 2007, which represent the payments received from customers through that date.

We believe the complaint is moot in light of the actions we have taken described above.

Shareholders who wish to submit proposals to be considered at the rescheduled 2006 Annual Meeting or to nominate directors must submit their proposals to us at our offices located at 383 Route 46 West, Fairfield, New Jersey on or before July 24, 2006.

Results of Operations

Percentage of Net Sales

The following table sets forth certain data as a percentage of net sales for the periods indicated:

	Three Months Ended March 31,
	2006		2005
Net sales	100	%	100	%
Gross profit	85.6	%	84.8	%
Operating expenses	79.7	%	70.3	%
Operating income	5.9	%	14.5	%
Interest income	1.2	%	1.1	%
Interest expense	8.9	%	4.9	%
Income tax expense (benefit)	(0.7	)%	4.2	%
Net income (loss)	(1.0	)%	6.5	%

During the Third Quarter of 2006, we began shipping our products to certain of our wholesale customers under FOB Destination shipping terms. Under FOB Destination shipping terms, we cannot record the shipment as a sale until the customer receives the shipment at its designated location. These wholesalers required that we enter into agreements with them to change our shipping terms to FOB Destination in order for our business practice with them to conform to their standard operating procedures. For a discussion of the quantitative effect of this change in our shipping terms for the quarter ended March 31, 2007, see “Results of Operations-Quarter ended March 31, 2007 compared to quarter ended March 31, 2006”.

~~Quarter~~ Allowances for ~~ended~~returns. ~~March~~In the pharmaceutical industry, customers are normally granted the right to 31return product for a refund if the product has not been used by its expiration date, which ~~2006~~is ~~compared~~typically two to ~~quarter~~three ~~ended~~years ~~March~~from 31the date of manufacture. Our return policy typically allows product returns for products within an eighteen-month window from six months prior to the expiration date to up to twelve months after the expiration date. Our return policy conforms to industry standard practices. Management is required to estimate the level of sales that will ultimately be returned pursuant to our return policy and to record a related reserve at the time of sale. These amounts are deducted from our gross sales to determine our net sales. We believe that we have sufficient data to estimate future returns at the time of sale. Management periodically reviews the allowances for returns and adjusts them based on actual experience. If we over or under estimate the level of sales that will ultimately be returned, ~~2005~~there may be a material impact to our financial statements.

~~NET~~During ~~SALES~~March ~~for~~2005, ~~the~~we ~~three~~entered ~~months~~into ~~ended~~a ~~March~~DSA 31with Cardinal Health, ~~2006~~having ~~were~~an ~~$34~~effective date of July 2004; during September 2005,~~753~~ we entered into a DSA with McKesson having an effective date of October 2004; and during September 2006,~~000,~~ ~~representing~~we entered into a DSA with Kinray having an ~~increase~~effective date of $1August 2006. Under the terms of each of these DSAs,~~551~~ we have agreed to pay,~~000~~ under certain circumstances, ora ~~approximately~~fee 4in exchange for certain product distribution, inventory management, and administrative services.7% The terms of our DSAs are consistent with the industry’s movement toward fee-for-service. These agreements have, ~~from~~among ~~$33~~other things,~~203,000~~ improved our knowledge of demand for our products, reduced the ~~three~~level ~~months~~of wholesale ~~ended~~inventories ~~March~~of ~~31,~~our ~~2005.~~products ~~The~~and ~~following~~improved ~~table~~channel ~~sets~~transparency ~~forth~~as ~~certain~~the ~~net~~wholesalers ~~sales~~provide us ~~data~~with ~~for~~periodic reports of inventory and demand levels of our products under the terms ~~periods~~of ~~indicated~~the DSAs.

	Quarter Ended March 31,
Therapeutic Category by Company	2006	2005	Increase/(Decrease)
Dermatology & Podiatry *
Doak Dermatologics *
Keratolytic	$ 5,935,252	$ 5,896,947	$ 38,305
Acne/Roseaca *	15,396,365	17,240,040	(1,843,675	)
Actinic Keratoses *	4,106,572	1,628,650	2,477,922
Anesthetics *	1,412,735	1,133,742	278,993
Scalp	391,910	288,790	103,120
Cosmeceuticals *	1,138,016	1,257,115	(119,099	)
Authorized Generic *	966,171	—	966,171
Other	55,800	28,202	27,598
Total Doak Dermatologics (Total Dermatology & Podiatry)	29,402,821	27,473,486	1,929,335
Kenwood Therapeutics
Gastrointestinal	4,712,119	4,047,042	665,077
Respiratory	290,300	1,048,092	(757,792	)
Nutritional	300,068	573,841	(273,773	)
Other	48,050	60,340	(12,290	)
Total Kenwood Therapeutics	5,350,537	5,729,315	(378,778	)
Total Bradley Pharmaceuticals, Inc.	$34,753,358	$33,202,801	$ 1,550,557

Prior to entering our first DSA in the first quarter of 2005, we followed the practice of offering customers pricing incentives to ensure that supplies in the distribution channel would be sufficient to avoid lack of stock. Although these promotions caused wholesaler buying spikes, we believe the channel was not inflated. Based upon our review of the wholesaler inventory that is available to us, we believe the level of product in the channel at March 31, 2007 is approximately 1.5 months for the primary wholesale customers and 0.6 months for all other locations compared to 1.7 and 0.6 months, respectively, at December 31, 2006. Subsequent to entering the DSAs, we only offer customary new product launch incentives. When we launch new products we disclose those sales under “Results of Operations.” We record our incentive sales in the period in which the related products are shipped or delivered, net of applicable allowances.

* Includes Bioglan Pharmaceuticals Corp.

~~For~~At ~~the three months ended~~ March 31, ~~2006,~~2007 ~~Doak~~our ~~Dermatologics’~~return ~~Net~~reserve ~~Sales~~was ~~were~~ $2926,~~403~~112,000~~, representing~~. anIn ~~increase~~order ofto ~~$1,929,000,~~reasonably orestimate ~~approximately 7%, from $27,473,000 for the~~future ~~three months ended March 31~~returns, ~~2005.~~we ~~The~~analyze ~~increase~~both inquantitative ~~Net Sales was led by the actinic keratoses line of products of $2,478,000~~ and ~~authorized~~qualitative ~~generics~~information ~~of $966~~including,~~000,~~ ~~which~~but ~~were~~not ~~partially~~limited ~~offset by a decline in the acne/rosacea line of products of $1~~to,~~844,000.~~ ~~The actinic~~actual ~~keratoses~~return ~~products’~~rates ~~increase was solely led~~ by ~~an increase in SOLARAZE® of $2~~product,~~478,000~~ ~~and~~ the ~~authorized~~level ~~generics’ increase~~ of ~~$966,000~~product ~~was from our authorized generic agreement with Par Pharmaceuticals, Inc. The acne/rosacea decrease was led by a decline~~ in ~~ADOXA®~~the ~~50mg, 75mg and 100mg tablets, due to generic~~distribution ~~competition~~channel, ofexpected ~~$5,695,000,~~shelf ~~ROSULA®~~life ~~AQUEOUS GEL~~ of $1the product,~~017,000~~ ~~and~~product ~~ZODERM® of $328~~demand,~~000,~~ ~~which was partially offset by an increase in ADOXA® 150mg tablets (launched in~~ the ~~Fourth~~introduction ~~Quarter 2005)~~ of competitive ~~$5,436,000.~~or ~~The~~generic ~~keratolytic line of~~ products ~~had~~that amay ~~decrease~~erode incurrent ~~CARMOL®~~demand, ~~products~~our ofnew ~~$1,267,000,~~product ~~KERALAC® Cream~~launches ofand ~~$690,000,~~general ~~KERALAC®~~economic ~~Lotion of $1,077,000~~ and ~~KERALAC®~~industry ~~GEL of~~wide ~~$1,160,000~~indicators. ~~The~~Certain ~~decrease~~specifics inregarding ~~the keratolytic line was offset by increases in KERALAC® NAILSTICK~~these ~~(launched~~analyses inare ~~the~~as ~~Third~~follows: ~~Quarter 2005) of $2,409,000 and KERALAC® Ointment (launched in the Fourth Quarter 2005) of $1,839,000.~~

~~For the~~• ~~three~~Actual ~~months~~return ~~ended~~rates ~~March~~– ~~31,~~We ~~2006,~~track ~~Kenwood~~actual ~~Therapeutics’~~returns ~~Net~~by ~~Sales were $5,351,000, representing a decrease of $379,000, or approximately 7%, from $5,729,000 for the three months ended March 31, 2005~~product. ~~The~~We ~~decrease~~determine ~~in Net Sales was led by~~ the ~~respiratory~~provision ~~line~~for ~~of products~~our ofcurrent ~~$758,000,~~sales ~~which~~using ~~was~~actual ~~partially~~return ~~offset by an increase in the gastroenterology line of products of $665,000~~rates. ~~The~~Our ~~respiratory~~actual ~~products’~~returns ~~decrease was led~~ by ~~declines~~therapeutic ~~in DECONAMINE®~~category offor ~~$503,000~~three ~~and~~months ~~TYZINE®~~ended ofMarch ~~$202~~31,~~000.~~ ~~The increase~~2007 in the gastroenterology line was led by an increase in ANAMANTLE® HC FORTE (launched in the Third Quarter 2005) of $1,886,000, which was partially offset by a decline in ANAMANTLE® HC 14 of $507,000, ANAMANTLE® HC CREAM KIT of $610,000 and ~~PAMINE®~~2006 ofare ~~$465,000.~~detailed below.

~~Net Sales~~• ~~during~~Level of product in the ~~First~~distribution ~~Quarter~~channel ~~2006~~– ~~were~~We ~~negatively~~analyze ~~impacted~~and ~~primarily~~utilize bywholesale aninventory ~~increase~~reports ~~in generic~~provided orto ~~therapeutically~~us ~~equivalent~~by ~~products~~our ~~competing~~largest onwholesale ~~price~~customers. In particular, the ~~First~~ ~~Quarter~~wholesale ~~2006~~inventory ~~was~~reports ~~negatively~~provide ~~impacted~~us the current wholesaler demand by product and actual product inventory held by the ~~introduction~~same ofwholesaler. ~~generic~~We ~~competition~~also ~~for CARMOL®40~~estimate ~~(Fourth~~the ~~Quarter~~level ~~2003),~~of ~~ANAMANTLE®~~product HCin 14the ~~(Fourth Quarter~~distribution ~~2004),~~channel ~~LIDAMANTLE®~~held by small wholesale customers and ~~LIDAMANTLE®HC~~retail ~~(Fourth Quarter~~chains ~~2004),~~that ~~ANAMANTLE®~~do HCnot ~~CREAM~~provide ~~KIT~~us ~~(First~~inventory ~~Quarter~~reports ~~2005),~~based ~~KERALAC™~~upon ~~GEL and~~discussions ~~LOTION~~with ~~(First~~them ~~Quarter~~and ~~2005),~~our ~~ZODERM®~~actual ~~(Second~~sales ~~Quarter~~to ~~2005),~~these ~~ROSULA®~~locations. ~~AQUEOUS GEL~~Based ~~and~~upon ~~ROSULA®~~gathering ~~AQUEOUS~~the ~~CLEANSER~~information ~~(Second~~of ~~Quarter~~the ~~2005)~~non-reporting inventory locations, ~~KERLAC®~~we ~~CREAM (Third~~estimate ~~Quarter~~the ~~2005),~~additional ~~ADOXA®~~weeks ~~50mg~~of ~~and~~product ~~100mg~~at ~~tablets~~these ~~(Fourth~~locations. ~~Quarter~~If ~~2005) and~~our estimate for the ~~recently~~non-reporting ~~announced~~locations, ~~threat~~a component of ~~generic~~our ~~competition~~allowance for ~~ADOXA~~returns, ®were ~~75mg~~different ~~tablets~~by one week of demand, our return reserve at March 31, 2007 would increase or decrease by approximately $1,181,000. AsWe believe a ~~result~~difference of one week of demand for the ~~generic~~non-reporting ~~competition~~locations ~~noted~~is ~~above,~~not wereasonably ~~expect~~likely ~~our~~but ~~future sales~~is possible due to the subjective nature of this estimate. The estimate for the ~~above~~non-reporting ~~products~~locations tois bebased ~~negatively~~upon ~~impacted~~oral bycommunications ~~generic~~we orhave ~~therapeutically equivalent~~had ~~products.~~with some of our retail chain customers.

~~As noted~~• ~~above~~We also estimate product returns in-transit that are not included in the wholesale inventory reports and not received by us for processing based upon discussions we have with our return processor and our customers. For the March 31, ~~some~~2007 ofallowance for returns, we used actual subsequent returns and estimated the ~~increases~~time between when the customer removes our product from their inventory and the time we record the return credit. If our estimate for product returns in-transit, based upon actual subsequent returns, is different by one week, our ~~Net~~return ~~Sales~~reserve at March 31, 2007 would increase or decrease by approximately $338,000. We believe a difference of one week for the ~~First~~returns ~~Quarter~~in-transit ~~2006~~is ~~were~~not reasonably likely but is possible due to the ~~result~~ ofsubjective ~~new~~nature ~~product~~of ~~launches~~this estimate. ~~Further,~~The estimate for the returns in-transit is based upon oral communications we have had with some of our larger wholesale customers, wholesale customers’ return processing centers and our outsourced return processing center. The level of product in the ~~new~~distribution channel is used to determine the maximum return exposure and is compared against the product ~~sales~~return ~~were~~reserve created by utilizing the actual return rate trends. The estimated

~~result~~return value at March 31, 2007 of ~~initial~~all ~~stocking~~our ~~sales~~products in the distribution channel was approximately $33, ~~which~~243,000 ~~historically~~compared to $36,400,000 ~~have~~at ~~resulted~~December 31, 2006. Our estimated return value of all our products in ~~reduced~~the ~~product~~distribution ~~sales~~channel and our related allowance for ~~subsequent~~returns ~~quarters.~~at March 31, 2007 by therapeutic categories is below.

~~As of~~• ~~March~~Estimated ~~31,~~shelf ~~2006,~~life we– ~~had~~We ~~$323,000~~track ofour ~~orders~~returns onby ~~backorder~~lot asnumbers aand ~~result~~compare ofthe uslot ~~being~~numbers ~~out~~to when a range of ~~stock,~~ ~~which~~sales ~~were~~may ~~subsequently~~have ~~shipped~~occurred ~~and~~to ~~recognized~~determine inan ~~the~~estimated ~~Second~~average ~~Quarter~~shelf ~~2006~~life. We use this historical average as part of our overall process of estimating future returns.

~~Our gross~~• ~~prescription~~Current ~~demand,~~and ~~based~~projected ~~upon~~demand ~~information~~– ~~received~~We ~~from~~utilize ~~Wolters~~prescription ~~Kluwer,~~demand ~~for~~data ~~the First~~provided ~~Quarter~~by ~~2006,~~Wolters ~~was approximately $48 million. Our gross prescription sales~~Kluwer, ~~which~~an ~~do not~~industry ~~include~~standard ~~charges~~third ~~for~~party ~~discounts~~source, ~~returns, chargebacks~~ and ~~rebates,~~wholesale ~~for~~inventory ~~the~~reports ~~First Quarter~~provided ~~2006,~~by ~~were approximately $45 million. The approximate $3 million difference between gross prescription demand and~~ our ~~gross~~wholesale ~~prescription sales was primarily due to timing of customer purchases and Wolters Kluwer’s gross prescription demand was calculated based upon retail sale values~~customers.

~~The following~~• ~~table~~Competitive ~~summarizes~~or ~~the~~generic ~~changes~~products inthat ~~the~~may ~~return~~erode ~~reserve~~current ~~during~~demand ~~the~~– ~~three~~For ~~months ended~~competitive ~~March~~product ~~31:~~launches, including generics, we utilize our historical experience of competitive product/ generic intrusion to estimate our return reserve allowance.

	2006		2005
Return reserve at January 1,	$ 24,934,082		$ 24,074,511
Product returns	(6,022,757	)	(3,231,665	)
Provision	8,638,981		4,740,114
Return reserve at March 31,	$ 27,550,306		$ 25,582,960

•

New product launches – For our new product launches, we utilize our historical experience of new product sales in comparison to the same new product returns to estimate our return reserve allowance.

AsOur ofactual ~~March~~returns ~~31,~~by ~~2006,~~therapeutic ~~based~~category ~~upon~~for ~~wholesale inventory reports and discussions with retail chains and wholesalers, we estimate~~ the ~~total~~three ~~monthly inventory of our products at the wholesalers and retailers to be 2.4~~ months. ~~After~~ended ~~applying the~~ March 31, ~~2006~~2007 ~~return reserve,~~and ~~we estimate the unreserved monthly inventory of our products at the wholesalers~~2006 ~~and~~are ~~retailers~~as tofollows: ~~be 0.6 months.~~

There is no proprietary protection for most of our products, and therefore our products face competition from generic or comparable products that are sold by other pharmaceutical companies. Increased competition from the sale of generic or comparable products may cause a decrease in Net Sales from our products. If Net Sales of KERALAC™, ADOXA®, SOLARAZE®, ZODERM®, ROSULA®, ANAMANTLE®HC, PAMINE® or other Company products decline, as a result of increased competition, government regulations, wholesaler buying patterns, returns, physicians prescribing habits or for any other reason and we fail to replace those Net Sales, our Net Sales and profitability would decrease.

Therapeutic Category by Company	Three Months Ended		Range of Expiration Periods (in years) March 31, 2007
Therapeutic Category by Company	March 31, 2007	March 31, 2006	Range of Expiration Periods (in years) March 31, 2007
Doak Dermatologics, Inc.
Keratolytic	$1,220,000	$1,969,000	2
Acne/Rosacea	4,286,000	1,765,000	1.5 - 2
Actinic Keratoses	271,000	431,000	2 - 2.5
Anesthetics	318,000	742,000	2 - 3
Scalp	230,000	94,000	2
Cosmeceuticals/ Other	38,000	43,000	2-3

Total	$6,363,000	$5,044,000

Kenwood Therapeutics
Gastrointestinal	$ 623,000	$ 727,000	2
Respiratory	140,000	215,000	2 - 5
Nutritional	28,000	37,000	2 - 3

Total	$ 791,000	$ 979,000

TOTAL	$7,154,000	$6,023,000

COST OF SALES for the three months ended March 31, 2006 were $5,006,000, representing a decrease of $36,000, or approximately 0.7%, from $5,041,000 for the three months ended March 31, 2005. The gross profit percentage for the three months ended March 31, 2006 of approximately 86% was relatively flat in comparison to the same period of the prior year.

~~SELLING,~~* ~~GENERAL~~Based ~~AND~~upon ~~ADMINISTRATIVE~~date ~~EXPENSES for the three months ended March 31, 2006 were $19,893,000, representing a decrease~~ of ~~$728,000,~~manufacture ~~or 3.5%, compared~~ to labeled ~~$20,621,000~~expiration ~~for the same period in the prior year~~date. The decrease in selling, general and administrative expenses reflects decreased spending on advertising and promotional costs, and professional fees primarily related to the SEC inquiry and the restatement of the Company’s Quarterly Report on Form 10-Q for the quarter ended September 30, 2004. The decrease was partially offset by a share-based compensation expense of $927,000 related to the adoption of SFAS No. 123R. The following table sets forth the increase (decrease) in certain expenditures:

	Change from the Three Months Ended March 31, 2006 in Comparison to March 31, 2005
Advertising and Promotional Costs	(1,788,000	)
Professional Fees	(1,273,000	)
Share-Based Compensation Expense	927,000
Other	1,406,000

The increase in the actual returns during the first quarter 2007, in comparison to the same period of the prior year, is attributable to decrease in demand for many of our products as a result of increased generic competition (for a listing of products that have generic competition, see “Results of Operations”).

~~During~~Our actual ~~the~~return ~~three~~credits ~~months~~issued ~~ended March 31, 2005, the Company expensed $1,433,000 in professional fees relating~~ to ~~the~~our ~~SEC~~customers ~~inquiry and the restatement of the Company's Quarterly Report on Form 10-Q~~ for the ~~quarter ended September 30, 2004. Selling, general and administrative expenses as a percentage of Net Sales were 57.2% for the~~ three months ended March 31, ~~2006, representing a decrease of 4.9% compared to 62.1% for the same period the prior year. The decrease in the percentage was primarily a result of decreased spending on sales~~ 2007 and ~~marketing~~2006 ~~and~~are ~~professional~~as ~~fees~~follows: ~~without the proportionate decrease in Net Sales.~~

DEPRECIATION AND AMORTIZATION EXPENSES for the three months ended March 31, 2006 were $2,550,000, representing an increase of $78,000 from $2,472,000 for the three months ended March 31, 2005.

	Three Months Ended
Customer	March 31, 2007	March 31, 2006
AmerisourceBergen Corp.	$ 527,000	$ 528,000
Cardinal Health, Inc.	3,172,000	3,515,000
McKesson Corporation	3,210,000	1,756,000
Quality King	6,000	—
Others	239,000	224,000

TOTAL	$7,154,000	$6,023,000

~~RESEARCH~~Our ~~AND~~estimate ~~DEVELOPMENT~~of ~~EXPENSES~~all ~~for~~our ~~the~~products ~~three~~in ~~months~~the ~~ended~~distribution ~~March~~channel ~~31,~~at ~~2006 were $5,263,000, representing~~ an ~~increase~~estimated ofreturn ~~$5,006,000,~~value orand our ~~1,948.5%,~~related ~~compared~~allowance ~~to $257,000~~ for ~~the~~returns ~~same period~~at inMarch ~~the~~31, ~~prior~~2007 ~~year. The increase in research~~ and ~~development~~December ~~expenses primarily relates to a $5~~31,~~000,000~~ ~~payment~~2006 ~~made~~by ~~to MediGene AG under a Collaboration and License~~therapeutic ~~Agreement,~~categories ~~dated~~is ~~January~~as ~~30,~~follows: ~~2006.~~

Therapeutic Category by Company	March 31, 2007		% of Total
Therapeutic Category by Company	Estimated Product in the Distribution Channel	Allowance for Returns	% of Total
Doak Dermatologics, Inc.
Keratolytic	$ 4,719,000	$ 4,237,000	90	%
Acne/Rosacea	16,524,000	12,435,000	75	%
Actinic Keratoses	4,036,000	3,084,000	76	%
Anesthetics	1,908,000	1,292,000	68	%
Scalp	509,000	363,000	71	%
Cosmeceuticals/Other	175,000	145,000	83	%

Total	$27,871,000	$21,556,000	77	%

Kenwood Therapeutics
Gastrointestinal	$ 4,740,000	$ 4,028,000	85	%
Respiratory	523,000	449,000	86	%
Nutritional/Other	109,000	79,000	72	%

Total	$ 5,372,000	$ 4,556,000	85	%

TOTAL	$33,243,000	$26,112,000	79	%

LOSS ON INVESTMENT for the three months ended March 31, 2006 was zero, in comparison to $2,000 in the same period of the prior year.

	December 31, 2006
Therapeutic Category by Company	Estimated Product in the Distribution Channel	Allowance for Returns	% of Total
Doak Dermatologics, Inc.
Keratolytic	$ 5,459,000	$ 4,537,000	83	%
Acne/Rosacea	17,317,000	11,956,000	69	%
Actinic Keratoses	3,584,000	2,682,000	75	%
Anesthetics	2,065,000	1,071,000	52	%
Scalp	551,000	484,000	88	%
Cosmeceuticals/Other	183,000	163,000	89	%

Total	$29,159,000	$20,893,000	72	%

Kenwood Therapeutics
Gastrointestinal	$ 6,064,000	$ 4,414,000	73	%
Respiratory	880,000	833,000	95	%
Nutritional/Other	303,000	208,000	69	%

Total	$ 7,247,000	$ 5,455,000	75	%

TOTAL	$36,406,000	$26,348,000	72	%

~~INTEREST~~Without ~~INCOME~~utilizing ~~for~~assumptions, we cannot currently specify when actual returns relate to a current period or prior period due to the ~~three~~nature ~~months~~of ~~ended~~the ~~March~~sales 31process. Therefore, ~~2006~~we ~~was~~use a ~~$427~~number of assumptions when calculating our reserve estimates based upon the following circumstances. We primarily sell our products to wholesalers. The wholesalers maintain inventory of products consistent with their industry practices and perceived business interests. The wholesalers resell their inventory of products to pharmacies,~~000,~~ ~~representing~~which may also maintain an ~~increase~~ inventory of ~~$50~~product. Thus,~~000~~ the date on which we sell the product to the wholesaler may be different from the ~~three~~date of sale to the end-user. We produce our product in quantity “lots” that we believe best optimize our purchasing power in light of estimated demand. We retain lot information on product delivered to our customers. Each lot produced fills a number of customer orders, often spanning a number of months ~~ended~~that may ~~March~~not 31coincide with our financial reporting periods. When our customers return product, they ~~2005~~do not usually specify the original sales date, but we can see and track the respective product lots. We make assumptions in filling orders at the wholesalers. We know the quantity sold from each lot and apply this historical lot information on product sales to determine future potential returns. We also apply third party prescription data and information from our largest wholesalers; and we make adjustments for estimated product in the return channels in order to provide consistent cut-off periods with the reports received from our largest wholesalers. Using this information, we estimate returns on a quarterly basis.

~~INTEREST~~Our ~~EXPENSE~~roll-forward ~~for the three months ended March 31, 2006 was $3,077,000, representing an increase~~ of ~~$1,428,000 from~~ the ~~three~~allowances ~~months~~for ~~ended~~returns ~~March~~is ~~31,~~included ~~2005. The increase~~ in ~~the interest~~“Results ~~expense was a result~~ of ~~our entering into the $110 million New Facility in November 2005, which has a higher interest rate than our previous credit facility~~Operations.”

INCOME TAX EXPENSE (BENEFIT) for the three months ended March 31, 2006 was ($256,000), representing a decrease of $1,639,000 from $1,383,000 for the three months ended March 31, 2005. The decrease in income tax expense was due to a decrease in income before income tax expense. The effective tax rate used to calculate the income tax expense for the three months ended March 31, 2006 was approximately 42%. The effective tax rate used to calculate the income tax expense for the three months ended March 31, 2005 was approximately 39%. The increase in the effective tax rate was due to the adoption of SFAS No. 123R, which results in a permanent tax difference when expensing qualified (incentive) stock options.

NET INCOME (LOSS) for the three months ended March 31, 2006 was ($353,000), representing a decrease of $2,507,000, or 116.4%, from $2,154,000 for the three months ended March 31, 2005. Net income (loss) as a percentage of Net Sales for the three months ended March 31, 2006 was (1.0)%, representing a decrease of 7.5% compared to 6.5% for the three months ended March 31, 2005. The decrease in net income (loss) in the aggregate was principally due to a $5,000,000 payment made to MediGene AG under a Collaboration and License Agreement, dated January 30, 2006 and an increase in our interest expense, partially offset by an increase in Net Sales and a decrease in selling, general and administrative expenses.

Doak’s net loss for the three months ended March 31, 2006 was ($164,000), representing a decrease of $2,598,000, from net income of $2,434,000 for the three months ended March 31, 2005. Kenwood’s net loss for the three months ended March 31, 2006 was ($189,000), representing an increase of $91,000, from a net loss of ($280,000) for the three months ended March 31, 2005.

Off Balance Sheet Arrangements

As of March 31, 2006, we did not have any off balance sheet arrangements.

Recent Accounting Pronouncements

In November 2004, the Financial Accounting Standards Board (“FASB”) issued Statement 151, “Inventory Costs.” The standard clarifies that abnormal amounts of idle

~~facility expense, freight, handling~~ The ~~costs,~~estimated ~~and~~product ~~wasted~~in ~~materials~~the ~~should~~distribution bechannel ~~recognized~~for asthe ~~current-period~~Company’s ~~charges~~two ~~and~~largest ~~requires~~wholesalers, ~~the~~Cardinal ~~allocation~~and ofMcKesson, ~~fixed~~in ~~production~~the ~~overheads~~aggregate toat ~~inventory~~March ~~based~~31, on2007 ~~the~~was ~~normal~~$16,942,000 ~~capacity~~compared ofto ~~the~~$20,512,000 ~~production~~at ~~facilities~~December 31, 2006. The ~~standard~~estimated isproduct ~~effective~~in ~~for~~the ~~inventory~~distribution ~~costs~~channel (including ~~incurred~~returns ~~during fiscal~~in ~~years~~transit) ~~beginning~~for ~~after~~Quality ~~June~~King ~~15,~~and ~~2005.~~the ~~The~~non-reporting ~~adoption~~wholesalers ofand retailers ~~SFAS~~was ~~No.~~$55,000 ~~151~~and ~~did~~$16,245,000, ~~not~~respectively, ~~have~~at ~~a material~~March ~~impact~~31, on2007 ~~our~~compared ~~financial~~to $225,000 ~~position~~and or$15,670,000, ~~results~~respectively, ofat ~~operations~~December 31, 2006.

In ~~December~~April ~~2004~~2007, ~~the~~we ~~FASB~~adopted ~~issued~~a ~~Statement~~returns 153, “Exchanges of Nonmonetary Assets, an amendment of APB Opinion No. 29.” The standard is based on the principle that exchanges of nonmonetary assets should be measured based on the fair value of the assets exchanged and ~~eliminates~~inventory ~~the~~optimization ~~exception~~plan ~~under~~in ~~ABP Opinion No. 29 for~~ an ~~exchange~~attempt ~~of similar~~to ~~productive assets and replaces it with an exception for exchanges of nonmonetary~~reduce ~~assets~~future ~~that do not have commercial substance~~returns. The ~~standard~~plan ~~is effective for nonmonetary exchanges occurring in fiscal periods beginning after June 15, 2005. The adoption~~ of ~~SFAS No.~~action ~~153~~includes ~~did~~the ~~not~~following: ~~have a material impact on our financial position or results of operations.~~

~~In December~~• ~~2004,~~Reducing ~~the~~wholesaler ~~FASB~~inventory ~~issued~~to ~~SFAS~~six ~~No.~~weeks ~~123R~~by ~~(revised~~June ~~2004)~~30, ~~Share-Based~~2007 ~~Payment (“SFAS No. 123R”). SFAS No. 123R replaced SFAS No. 123, Accounting for Stock-Based Compensation (“SFAS No. 123”),~~ and ~~superseded~~four ~~Accounting~~weeks ~~Principles~~by ~~Board Opinion~~December ~~No. 25~~31, ~~Accounting for Stock Issued to Employees (“APB 25”)~~2007. In ~~March 2005~~addition, ~~the~~reduce ~~U.S.~~wholesaler ~~Securities~~inventory ~~and~~levels Exchange Commission (“SEC”) issued Staff Accounting Bulletin No. 107, which expresses views of the SEC staff regarding the interaction between SFAS No. 123R and certain SEC rules and regulations, and provides the staff’s views regarding the valuation of share-based payment arrangements for ~~public companies.~~products ~~SFAS~~that ~~No.~~have 123R will require compensation cost related to share-based payment transactions to be recognized in the financial statements. SFAS No. 123R required public companies to apply SFAS No. 123R in the first interim or annual reporting period beginning after June 15, 2005. In April 2005, the SEC approved a ~~new~~greater ~~rule~~risk ~~that delayed the effective date, requiring public companies to apply SFAS No. 123R in their next fiscal year, instead~~ of ~~the~~encountering ~~next~~generic ~~interim reporting period~~competition, ~~beginning~~which ~~after~~includes ~~June~~ADOXA® 15150mg, ~~2005. As permitted by SFAS No. 123, the Company elected~~ to ~~follow~~three ~~the guidance of APB 25, which allowed companies~~ to ~~use~~four the intrinsic value method of accounting to value their share-based payment transactions with employees. SFAS No. 123R requires measurement of the cost of share-based payment transactions to employees at the fair value of the award on the grant date and recognition of expense over the requisite service or vesting period. SFAS No. 123R allows implementation using a modified version of prospective applicationweeks, ~~under~~ which ~~compensation~~we ~~expense~~expect ~~of the unvested portion of previously granted awards and all new awards will be recognized on or after the date of adoption. SFAS No. 123R also allows companies~~ to ~~adopt~~accomplish ~~SFAS No. 123R~~ by ~~restating~~May ~~previously issued statements~~31, ~~basing the amounts on the expense previously calculated and reported in their pro forma footnote disclosures required under SFAS No~~2007. ~~123. We have adopted SFAS No. 123R in the first interim period of fiscal 2006 using the modified prospective method, see Note L to the Consolidated Financial Statements.~~

•

Implement revised minimum shelf-life shipping requirements. The current plan is to ship up to 10 months prior to expiration for product that is manufactured with 18 month expiration dates, 12 to 15 months prior to expiration for product that is manufactured with 24 month expiration dates and 18 months prior to expiration for product that is manufactured with 30 to 60 expiration dates. As a result of this plan, we increased our inventory reserves by approximately $886,000 at March 31, 2007.

•

Optimizing product production planning to increase effective dating on manufactured products. We plan to conduct a cost/benefit analysis of our product production schedules in order to analyze the potential benefit of producing small size batches.

The actions described above are an attempt to lower our future returns. We cannot, however, provide assurance that these actions will be successful in reducing future product returns or that they will not result in an increase in the Company’s out of stock position on any products.

Allowance for rebates. At March 31, 2007, our rebate reserve was $5,044,000. Our contracts with Medicaid, other government agencies and managed care organizations commit us to providing those organizations with favorable pricing. This ensures that our products remain eligible for purchase or reimbursement under these programs. Based upon our contracts and the most recent experience with respect to sales through each of these channels and the amount of product in the distribution channel net of the return reserve, we provide an allowance for rebates. We monitor the rebate trends and adjust the rebate accrual to reflect the most recent rebate experience. If our estimate for the amount of product in the distribution channel net of the return reserve were different by one week of demand, our rebate reserve at March 31, 2007 would increase or decrease by approximately $203,000.

InThe ~~May~~Company’s ~~2005,~~reserve ~~the~~for ~~FASB~~rebates ~~issued~~at ~~Statement~~March ~~of Financial Accounting Standards No. 154~~31, ~~Accounting Changes~~2007 ~~and~~was ~~Error~~higher ~~Corrections~~than ~~(“SFAS~~the ~~No.~~balance ~~154”).~~at ~~SFAS~~March ~~No. 154 requires~~31, ~~retrospective application to prior-period financial statements of changes in accounting principles~~2006, ~~unless~~primarily itdue ~~is impracticable~~ to ~~determine either~~ the ~~period-specific~~timing ~~effects or the cumulative effect~~ of ~~the~~Medicaid ~~change.~~rebate ~~SFAS No~~payments. ~~154~~Our ~~also~~provision ~~redefines~~for ~~“restatement” as~~rebates ~~the~~as ~~revising~~a percent of ~~previously~~gross ~~issued~~sales ~~financial~~was ~~statements~~5% ~~to reflect the correction~~ of ~~an error.~~gross ~~This~~sales ~~statement is effective~~ for ~~accounting~~the ~~changes~~three ~~and~~month ~~corrections~~period ofended ~~errors made~~March ~~in fiscal years beginning after December 15~~31, ~~2005.~~2007 ~~The~~compared ~~adoption~~to of4% ~~SFAS~~in ~~No.~~the ~~154~~corresponding ~~did~~period ~~not have~~last ~~a material impact on our financial position or results of operations~~year.

~~Liquidity~~ Without utilizing ~~and~~assumptions, ~~Capital~~we cannot currently specify when actual credits relating to ~~Resources~~ rebates relate to a current period or prior period. The requests for rebates do not provide the product lot number, which is our only method of relating product sales to a specific time period. For rebates, we apply specific percentages based on trailing historical experience.

Our ~~cash and cash equivalents, short~~roll-~~term~~forward ~~investments~~of ~~and~~the ~~restricted~~allowances ~~cash~~for ~~and~~rebates ~~investments were $61,671,000 at March 31, 2006 and $64,799,000 at December 31, 2005. Cash used in operating activities~~ for the three months ended March 31, ~~2006~~2007 ~~was $740,000. The uses of cash primarily resulted from net loss of $353,000 (including a $5,000,000 research~~ and development payment to Medigene) plus a decrease in the rebate reserve of $1,798,000, primarily attributable to a shift of patient medical coverage from Medicaid to Medicare Part D, effective January 1, 2006, ~~which~~are ~~has~~as afollows: lower rebate; a decrease in the inventory valuation reserve of $49,000; a decrease of deferred tax assets of $230,000; an increase in accounts receivable of $1,904,000; an increase in inventories of $566,000; an increase in prepaid expenses and other of $677,000; a decrease in accounts payable of $2,146,000 due to timing of vendor payments; an increase in prepaid income taxes of $210,000; and a decrease in accrued expenses of $142,000. The uses of cash were partially offset by non-cash charges for depreciation and amortization of $2,550,000; non-cash charges for amortization of deferred financing costs of $325,000; non-cash share based compensation expense of $927,000; an increase in allowance for doubtful accounts of $713,000, primarily due to an increase in customer short payments; an increase in the return reserve of $2,616,000, primarily due to applying the current product historic return rate to First Quarter 2006 gross sales and the recently announced potential generic competition for ADOXA® 75mg tablets; and the accruing of $205,000 for fee-for-service under a DSA relating to the First Quarter 2006.

Cash used in investing activities for the three months ended March 31, 2006 was $12,000, primarily from the purchase of property and equipment.

	2007		2006
Allowance at January 1,*	$ 3,087,000		$ 5,032,000
Rebates processed in current period relating
to sales made in prior period	(538,000	)	(3,529,000	)

Current provision for rebates relating to
sales made in current period	2,495,000		1,731,000

Allowance at March 31,*	$ 5,044,000		$ 3,234,000

~~Cash used~~* inShown ~~financing~~within ~~activities~~accrued for the three months ended March 31, 2006 was $2,377,000, resulting from the payment of the scheduled $110 million New Facility’s term note of $2,000,000; payment of notes payable of $4,000; and payment of deferred financing costs associated with the $110 million New Facility of $520,000; partially offset by proceeds from the exercise of stock options of $54,000 and a tax benefit due to exercise of non-qualified options of $94,000expenses.

OnAllowance ~~November~~for ~~14,~~Chargebacks. ~~2005~~At March 31, we2007 ~~entered~~our ~~into~~chargeback areserve ~~new~~was $~~110~~105,000. ~~million~~Chargebacks ~~credit~~are based ~~facility~~on (the ~~“New~~difference between the prices at which we sell our products to wholesalers ~~Facility”)~~and ~~with~~the asales ~~syndicate~~price ofultimately ~~lenders~~paid ~~led~~under fixed price contracts by ~~Wachovia~~third ~~Bank~~party payers, who are often governmental agencies. ~~Our~~Based ~~New~~upon ~~Facility~~our iscontracts and the most recent ~~comprised~~experience with respect to sales through this channel and the amount of product in the distribution channel net of the return reserve, we provide an ~~$80~~allowance ~~million~~for ~~term~~chargebacks. We ~~loan~~monitor the chargeback trends and aadjust ~~$30~~the ~~million~~chargeback ~~revolving~~accrual ~~line~~to reflect the most recent chargeback experience. If our estimate for the amount of ~~credit~~product in the distribution channel net of the return reserve were different by one week of demand, our chargeback reserve at March 31, 2007 would increase or decrease by approximately $53,000. ~~The~~

Without utilizing assumptions, we cannot currently specify when actual credits relating to chargebacks relate to a current period or prior period. The requests for chargebacks do not provide the product lot number, which is our only method of relating product sales to a specific time period. For chargebacks, we apply a specific percentages based on the trailing historical experience.

~~New Facility’s term loan and~~ Our ~~revolver~~roll-forward ~~both~~of ~~mature~~the onallowances ~~November~~for ~~14,~~chargebacks ~~2010~~for ~~and~~the ~~are~~three ~~secured~~months byended aMarch ~~lien upon substantially all of our assets~~31, ~~including those of our subsidiaries,~~ 2007 and 2006 is ~~guaranteed~~as byfollows: ~~our domestic subsidiaries.~~

As of March 31, 2006, we had $30 million unused under the New Facility’s revolving line of credit, $76 million under the New Facility’s term loan was outstanding and no amounts under the revolving line of credit were outstanding. As of May 31, 2006, we have $76 million in borrowings under the New Facility’s term loan outstanding, no amounts under the New Facility’s revolving line of credit outstanding and no defaults under the New Facility. In addition, as of May 31, 2006, we had approximately $70 million in cash and cash equivalents, short-term investments and restricted cash and investments. Amounts outstanding under the New Facility accrue interest at our choice from time to time of either (i) the alternate base rate (which is equal to the greater of the applicable prime rate or the federal funds effective rate plus 1/2 of 1%) plus 3%; or (ii) a rate equal to the sum of the applicable LIBOR rate plus 4%. In addition, the lenders under the New Facility are entitled to customary facility fees based on unused commitments under the New Facility and outstanding letters of credit.

	2007		2006
Allowance at January 1,*	$ 135,000		$ 135,000
Chargebacks processed in current period relating
to sales made in current period (a)	(667,000	)	(504,000	)

Chargebacks processed in current period relating
to sales made in prior period (a)	(183,000	)	(162,000	)
Current provision for chargebacks relating to
sales made in current period	820,000		657,000

Allowance at March 31,*	$ 105,000		$ 126,000

~~The financial~~* ~~covenants~~Shown ~~under~~within ~~the~~accounts ~~New Facility require that we maintain (i) a leverage ratio (which is a ratio of funded debt of us and our subsidiaries to consolidated EBITDA) less than or equal to 2~~receivable.50 to 1.00; (ii) a fixed charge coverage ratio (which is a ratio of (A) consolidated EBITDA minus consolidated capital expenditures made in cash to (B) the sum of consolidated interest expense made in cash, scheduled funded debt payments, total federal, state, local and foreign income, value added and similar taxes paid or payable in cash, and certain restricted payments) greater than or equal to 1.50 to 1.00; and (iii) not less than $25 million of unrestricted cash and cash equivalents on our balance sheet at all times. Further, the New Facility limits our ability to declare and pay cash dividends.

As (a) ~~result~~Based ofupon ~~our~~receipt ~~failure~~date ~~to file our Annual Report on Form 10-K for the year ended December 31, 2005 by April 30, 2006, we triggered a default under the New Facility. On May 15, 2006, we received a waiver~~ of ~~this~~chargeback default from our lenders under the New Facility. In connection with this waiver, which also allowed us to continue outstanding LIBOR Rate Loans under the New Facility, we agreed with our lenders to file our Annual Report on Form 10-K for the year ended December 31, 2005 by May 31, 2006 and ~~our Quarterly Report on Form 10-Q for~~ the ~~fiscal~~estimated ~~quarter~~level ended March 31, 2006 by June 30, 2006. Concurrently, our lenders agreed to certain technical amendments to the New Facility clarifying Permitted Investments which can be utilized in determining our restricted cash and investments (which until we file our Quarterly Report on Form 10-Q for the fiscal quarter ended March 31, 2006 and demonstrate compliance with the financial covenants in the New Facility, must be at least $45 million), allowing us to deliver to the lenders under the New Facility our 2006 annual budget by June 30, 2006 and allowing us to calculate, for financial covenant purposes, consolidated EBITDA without giving effect to that portion of ~~our~~inventory ~~initial $5 million payment to Medigene that we classified as an expense~~ in ~~accordance with GAAP. Our lenders acknowledged that provided we file our Annual Report on Form 10-K for~~ the ~~year~~distribution ~~ended December 31, 2005 with the SEC by May 31, 2006, we would not be required to pay default interest under the New Facility; otherwise, default interest would be payable on a retroactive basis~~ channel.

Goodwill and Intangible assets. We have made acquisitions of products and businesses that include goodwill, license agreements, product rights and other identifiable intangible assets. We determine the estimated fair values of goodwill and certain intangible assets with definitive lives based on valuations performed by us at the time of acquisition in accordance with SFAS No. 142, “Goodwill and Other Intangible Assets” (“SFAS No. 142”). In addition, the fair value of certain amounts paid to third parties relating to product acquisitions or license agreements are recorded as intangible assets when we determine that technical feasibility for the acquired or licensed product has been established, which, for us, historically has been after the FDA has approved the product for commercialization.

Under SFAS No. 142, which eliminated the amortization of purchased goodwill, goodwill is tested for impairment at least annually and more frequently if an event occurs that indicates the goodwill may be impaired. We performed the test at December 31, 2006 and noted that no impairment existed.

Our intangible assets with definitive lives, also tested periodically for impairment, are capitalized and amortized over their estimated useful lives. The Company evaluates long-lived assets, including intangible assets with definitive lives, in accordance with SFAS No. 144, “Accounting for the Impairment or Disposal of Long-Lived Assets” (“SFAS No. 144”). SFAS No. 144 states that an impairment loss shall be recognized only if the carrying amount of a long-lived asset is no longer recoverable.

We assess the impairment of identifiable intangibles, including goodwill, when events or changes in circumstances indicate that the carrying value may not be recoverable. Some factors we consider important which could trigger an impairment review include:

beginning May 1, 2006. We filed our Annual Report on Form 10-K for the year ended December 31, 2005 with the SEC on May 19, 2006.

As of March 31, 2006, we had the following contractual obligations and commitments:

Period	Operating Leases	Capital Leases(a)	$110 million Senior Credit Facility	Other Debt	Minimum Inventory Purchases(b)
April 1, 2006 to
December 31, 2006	$1,438,054	$ 10,999	$ 7,000,000	$ 60,085	$1,146,733
Fiscal 2007	1,708,494	6,608	13,000,000	—	1,000,000
Fiscal 2008	1,341,139	5,925	17,000,000	—	1,100,000
Fiscal 2009	814,043	—	21,000,000	—	—
Fiscal 2010	41,983	—	18,000,000	—	—
Thereafter	—	—	—	—	—
	$5,343,713	$ 23,532	$76,000,000	$ 60,085	$3,246,733

(a) Lease amounts include interest and minimum lease payments.

(b) For more information on minimum inventory purchases, see “Contract Manufacturing Agreement” in Note I.5 of the notes to our consolidated financial statements included in our Annual Report on Form 10-K for the year ended 2005.

We believe that our cash and cash equivalents and cash generated from operations will be adequate to fund our current working capital requirements for at least the next twelve months. However, if we make or anticipate significant acquisitions, we may need to raise additional funds through additional borrowings or the issuance of debt or equity securities.

Critical Accounting Policies

In preparing financial statements in conformity with accounting principles generally accepted in the United States, we are required to make estimates and assumptions that affect the reported amounts of assets and liabilities and the disclosure of contingent assets and liabilities at the date of the financial statements and revenues and expenses for the relevant reporting period. Actual results could differ from those estimates. We believe that the following critical accounting policies affect our more significant estimates used in the preparation of financial statements. Management has discussed the development and selection of the critical accounting estimates discussed below with our audit committee, and our audit committee has reviewed our disclosures relating to these estimates.

Revenue recognition. Revenue from product sales, net of estimated provisions, is recognized when the merchandise is shipped to an unrelated third party, as provided in

Staff Accounting: Bulletin No. 104, “Revenue Recognition in Financial Statements.” Accordingly, revenue is recognized when all four of the following criteria are met:

• persuasive evidence that an arrangement exists;

• delivery of the products has occurred;

• the selling price is both fixed and determinable;

• collectibility is reasonably probable.

Our customers consist primarily of large pharmaceutical wholesalers who sell directly into the retail channel. Provisions for sales discounts, and estimates for chargebacks, rebates, damaged product returns and exchanges for expired products, are established as a reduction of product sales revenues at the time revenues are recognized, based on historical experience adjusted to reflect known changes in the factors that impact these reserves. These revenue reductions are generally reflected either as a direct reduction to accounts receivable through an allowance or as an addition to accrued expenses if the payment is due to a party other than the wholesale or retail customer.

We do not provide any forms of price protection to wholesale customers other than a contractual right to two wholesale customers that our price increases and product purchase discounts offered during each twelve-month period will allow for inventory of our products then held by these wholesalers to appreciate in the aggregate. We do not, however, guarantee that our wholesale customers will sell our products at a profit.

Chargebacks and rebates are based on the difference between the prices at which we sell our products to wholesalers and the sales price ultimately paid under fixed price contracts by third party payors, who are often governmental agencies and managed care buying groups. We record an estimate of the amount either to be charged back to us, or rebated to the end user, at the time of sale to the wholesaler. We have recorded reserves for chargebacks and rebates based upon various factors, including current contract prices, historical trends and our future expectations. The amount of actual chargebacks and rebates claimed could be either higher or lower than the amounts we accrued. Changes in our estimates would be recorded in the income statement in the period of the change.

Product returns. In the pharmaceutical industry, customers are normally granted the right to return product for a refund if the product has not been used around its expiration date, which is typically two to three years from the date of manufacture. Our return policy typically allows product returns for products within an eighteen-month window from six months prior to the expiration date and up to twelve months after the expiration date. Our return policy conforms to industry standard practices. We believe that we have sufficient data to estimate future returns at the time of sale. Management is required to estimate the level of sales, which will ultimately be returned pursuant to our return policy, and record a related reserve at the time of sale. These amounts are deducted from our gross sales to determine our net sales. Our estimates take into consideration historical returns of a given product, product specific information provided by our customers and information obtained regarding the levels of inventory being held by our customers, as

well as overall purchasing patterns by our customers. Management periodically reviews the reserves established for returns and adjusts them based on actual experience, including executing the DSAs in 2005 (but effective as of 2004), obtaining customer inventory data for our largest customers, changing market dynamics of these customers, having subsequent return visibility, and having increased generic competition. If we over or under estimate the level of sales, that will ultimately be returned, there may be a material impact to our financial statements.

Intangible assets. We have made acquisitions of products and businesses that include goodwill, license agreements, product rights and other identifiable intangible assets. We assess the impairment of identifiable intangibles, including goodwill, when events or changes in circumstances indicate that the carrying value may not be recoverable. Some factors we consider important which could trigger an impairment review include:

•

significant underperformance compared to expected historical or projected future operating results;

• significant changes in our use of the acquired assets or the strategy for our overall business; and

•

significant negative industry or economic trends.

When we determine that the carrying value of intangible assets may not be recoverable based upon the existence of one or more of these factors, we first perform an assessment of the asset’s recoverability based on expected undiscounted future net cash flow, and if ~~the~~ the amount is less than the asset’s value, we measure any impairment based on a ~~projected~~ projected discounted cash flow method using a discount rate determined by our management to be commensurate with the risk inherent in our current business model. If the estimated undiscounted future cash flows from the use of an asset were less than the carrying value, a write-down would be recorded to reduce the related asset to its estimated fair value.

AsDetermining ofthe ~~January~~fair 1,value ~~2002,~~of weintangible ~~adopted~~assets ~~Statement~~and ofestimating ~~Financial~~useful ~~Accounting~~lives ~~Standards~~is ~~No.~~inherently ~~142, “Goodwill~~uncertain and ~~Other~~subject ~~Intangible~~to ~~Assets”~~significant ~~(“SFAS~~risks ~~No.~~and ~~142”)~~uncertainties, ~~which~~and ~~eliminated~~may ~~the amortization~~be ofdependent, ~~purchased~~in ~~goodwill.~~significant part, ~~Adoption~~on ofthe ~~this~~success ~~standard~~of ~~did not have a material effect on~~ our ~~financial~~plans ~~statements.~~to ~~Under~~launch ~~SFAS~~new ~~No. 142~~products, ~~goodwill~~as ~~will~~well beas ~~tested for~~successfully ~~impairment~~continue atto ~~least~~promote ~~annually~~existing ~~and more frequently if an event occurs that indicates the goodwill may be impaired~~products. ~~We performed the test at December 31, 2005 and noted that no impairment existed.~~

AsDeferred ofincome ~~January~~taxes 1,are ~~2002,~~provided wefor ~~also~~the ~~adopted~~future ~~SFAS~~tax ~~No.~~consequences ~~144,~~attributable ~~“Accounting~~to ~~for~~the differences between the ~~Impairment~~carrying ~~or Disposal~~amounts of ~~Long-lived~~assets ~~Assets,”~~and ~~which~~liabilities ~~supersedes~~and ~~SFAS~~their Norespective tax bases. Deferred ~~121~~tax assets are reduced by a valuation allowance when, ~~“Accounting~~in ~~for~~our opinion, it is more likely than not that some portion of the ~~Impairment~~deferred tax assets will not be realized. As of March ~~Long-lived~~31, ~~Assets~~2007 and ~~for~~December ~~Long-lived~~31, ~~Assets~~2006, towe bedetermined ~~Disposed~~that ~~of.”~~no ~~The~~deferred tax asset valuation ~~adoption~~allowance was necessary. We believe that our projections of ~~SFAS~~future ~~No.~~taxable ~~144~~income ~~had~~make noit more ~~effect~~likely onthan ~~our~~not ~~financial~~that ~~statements~~these deferred tax assets will be realized. If our projections of future taxable income change in the future, we may be required to reduce deferred tax assets by a valuation allowance.

OnInventory ~~August~~valuation 10reserve. At March 31, ~~2004~~2007 our inventory valuation reserve was $1,828,000. weWe provide ~~purchased~~valuation ~~certain~~reserves ~~assets~~for estimated obsolescence or unmarketable inventory in an amount equal to the difference between the cost of ~~Bioglan~~inventory ~~Pharmaceuticals~~and the estimated market value based upon assumptions about future demand and market conditions. AsThe ~~part~~reserve for estimated inventory obsolescence was calculated based upon specific review of the ~~transaction,~~inventory weexpiration ~~acquired~~dates ~~certain~~and ~~intellectual~~the ~~property,~~quantity ~~regulatory~~on-hand ~~filings~~at March 31, ~~and~~2007 ~~other assets~~in ~~relating~~comparison to our ~~SOLARAZE®,~~expected ainventory ~~topical~~usage. ~~treatment~~The ~~indicated~~amount ~~for~~of actual inventory obsolescence and unmarketable inventory could differ (either higher or lower) in the near term from the ~~treatment~~amounts ofaccrued. ~~actinic~~Changes ~~keratosis;~~in ~~ADOXA®,~~our anestimates ~~oral~~would ~~antibiotic~~be ~~indicated~~recorded ~~for~~in the income statement in the ~~treatment~~period of ~~acne;~~the change.

Allowance for bad debts. At March 31, 2007, our allowance for bad debts was $2,035,000. Based upon specific analysis of our accounts receivable, including review of older account balances and account balances resulting in customer short pays, we

maintain a reserve. The amount of actual customer defaults could differ (either higher or lower) in the near term from the amounts accrued. Changes in our estimates would be recorded in the income statement in the period of the change.

Results of Operations

Percentage of Net Sales

The following table sets forth certain data as a percentage of net sales for the periods indicated:

	Three Months Ended
	March 31, 2007		March 31, 2006
Net sales	100	%	100	%
Gross profit	82.3	%	85.6	%
Operating expenses	65.9	%	79.7	%
Operating income	16.4	%	5.9	%
Interest income	1.5	%	1.2	%
Interest expense	6.0	%	6.1	%
Income tax expense	5.2	%	0.4	%

Net income	6.7	%	0.6	%

Quarter ended March 31, 2007 compared to quarter ended March 31, 2006

NET SALES for the three months ended March 31, 2007 were $37,803,000, representing an increase of $3,050,000, or approximately 9%, from $34,753,000 for the three months ended March 31, 2006. The following table sets forth certain net sales data for the periods indicated.

Therapeutic Category by Company Doak Dermatologics Dermatology & Podiatry	Three Months Ended
	March 31, 2007	March 31, 2006	Increase/ (Decrease)		% Change
Keratolytic	$ 4,868,000	$ 5,935,000	$(1,067,000	)	(18	)%
Acne/Rosacea	14,427,000	15,396,000	(969,000	)	(6	)%
Actinic Keratoses	5,334,000	4,107,000	1,227,000		30	%
Anesthetics	1,638,000	1,413,000	225,000		16	%
Scalp	283,000	392,000	(109,000	)	(28	)%
Cosmeceuticals	1,424,000	1,138,000	286,000		25	%
Authorized Generic	269,000	966,000	(697,000	)	(72	)%
Other	95,000	56,000	39,000		70	%

Total Doak Dermatologics	28,338,000	29,403,000	(1,065,000	)	(4	)%

Kenwood Therapeutics
Gastrointestinal	6,553,000	4,712,000	1,841,000		39	%

Respiratory	2,513,000	290,000	2,223,000	767	%
Nutritional	344,000	300,000	44,000	15	%
Other	55,000	48,000	7,000	15	%

Total Kenwood Therapeutics	9,465,000	5,350,000	4,115,000	77	%


Total Bradley Pharmaceuticals, Inc.	$37,803,000	$34,753,000	$ 3,050,000	9	%

Doak Dermatologics’ Net Sales for the three months ended March 31, 2007, were $28,338,000, representing a decrease of $1,065,000, or approximately 4%, from $29,403,000 for the three months ended March 31, 2006. Net Sales declines in the keratolytic and acne/rosacea lines of products of $1,067,000 and $969,000, respectively, were partially offset by increases in the actinic keratoses line of products of $1,227,000 due to higher sales of SOLARAZE^®. In the keratolytic line of products, a decrease in sales of the KERALAC^® products of $2,246,000 was partially offset by higher sales of the CARMOL^® products of $1,178,000. The acne/rosacea decrease included an aggregate decline in ADOXA^® product sales of $3,036,000, as decreased sales of the 50mg, 75mg and 100mg tablets were partially offset by increased sales of the 150mg tablets (launched in the Fourth Quarter 2005). Partially offsetting these decreases were higher sales of the ZODERM^® products of $1,132,000 and the ROSULA^® products of $935,000. An aggregate increase in our other product lines of $441,000 was more than offset by lower revenue of $697,000 from authorized generics’, recorded pursuant to our authorized generic agreement with Par Pharmaceutical Companies, Inc.

For the three months ended March 31, 2007, Kenwood Therapeutics’ Net Sales were $9,465,000, representing an increase of $4,115,000, or approximately 77%, from $5,350,000 for the three months ended March 31, 2006. The increase in Net Sales was primarily due to increases in both the respiratory and gastrointestinal lines of products of $2,223,000 and $1,841,000, respectively. The increase in the gastrointestinal line was led by an increase in ANAMANTLE^® HC GEL (launched in the Second Quarter of 2006) of $2,362,000. The respiratory products’ increase was led by higher sales of the DECONAMINE^® products of $1,755,000 which experienced increase market demand due to the loss of a competitor.

A. Aarons first began selling products during the Third Quarter of 2006 and as discussed above the Company has recorded deferred revenue from these sales of $590,000 in accrued expenses at March 31, 2007, which represents the payments received from customers through that date. During 2006 and in the First Quarter of 2007, A. Aarons shipped approximately $268,000 and $2,022,000, respectively, of products at each product’s respective gross selling price. A. Aarons currently does not have an internal sales force and its selling activity is being conducted with the assistance of consultants.

Historically, net sales have been negatively impacted by an increase in generic or therapeutically equivalent products competing on price. During the First Quarter of 2007, the Company experienced generic competition for the first time on ROSULA^® NS and ZODERM^® Redi-Pads. In addition, the Company has learned through industry

~~ZONALON®,~~intelligence athat ~~topical treatment indicated for pruritus; Tx Systems~~ANAMANTLE®, ~~a line of advanced topical~~HC ~~treatments~~GEL ~~used~~has ~~during~~experienced ~~in-office~~generic ~~procedures~~competition, ~~and~~which ~~certain~~commenced ~~other~~during ~~dermatologic~~April ~~products~~2007. The ~~total~~ ~~consideration was approximately $191 million, including acquisition costs. With the~~Company’s ~~assistance~~other ofproducts ~~valuation~~which ~~experts,~~have webeen ~~allocated~~negatively ~~the~~impacted ~~purchase~~by ~~price to~~ the ~~fair~~introduction ~~value~~ of ~~the~~generic ~~various~~competition ~~intangible~~are ~~assets~~CARMOL®40 ~~which~~(Fourth weQuarter ~~acquired as part of the transaction. In addition~~2003), ~~we assigned~~ANAMANTLE® ~~useful~~HC ~~lives~~14 to(Fourth ~~acquired intangible assets which are not deemed to have an~~Quarter ~~indefinite~~2004), ~~life.~~LIDAMANTLE® ~~Intangible~~and ~~assets~~LIDAMANTLE®HC ~~are~~(Fourth ~~amortized~~Quarter on2004), aANAMANTLE® ~~straight~~HC ~~line~~CREAM ~~basis over their~~KIT ~~respective~~(First ~~useful~~Quarter ~~lives.~~2005), ~~The~~KERALAC® ~~intangible~~GEL ~~assets~~and ~~recorded~~KERALAC® inLOTION ~~connection~~(First ~~with~~Quarter ~~the~~2005), ~~acquisition~~ZODERM® ~~are~~(Second ~~being~~Quarter ~~amortized~~2005), ~~over~~ROSULA® ~~periods~~AQUEOUS ~~ranging~~GEL ~~from~~and 10ROSULA® toAQUEOUS ~~20 years with a weighted~~CLEANSER ~~average~~(Second ~~amortization~~Quarter ~~period~~2005), ofKERALAC® 19CREAM ~~years.~~(Third InQuarter ~~light of our experience of promoting and selling dermatologic brands~~2005), weADOXA® ~~carefully~~50mg ~~evaluated the useful lives assigned to the intangible assets acquired~~ and ~~whether or not any impairment of any such assets was~~100mg ~~indicated.~~tablets ~~Our~~(Fourth ~~best~~Quarter ~~estimate~~2005), isADOXA® ~~that~~75mg ~~the~~tablets ~~useful~~(Third ~~lives~~Quarter ~~assigned~~2006), ~~to the intangible assets~~ANAMANTLE® ~~remain~~HC ~~appropriate.~~FORTE ~~Our~~(Third ~~estimate~~Quarter of2006), ~~such~~KERALAC® ~~useful~~NAILSTIK ~~lives~~(Third isQuarter ~~subject~~2006), ~~to significant risks and~~KERALAC® ~~uncertainties.~~OINTMENT ~~Among~~(Third ~~these~~Quarter ~~risks and uncertainties is our ability to develop one or more new versions of the product~~2006), ~~obtain~~PAMINE® ~~approval~~2.5mg ~~from the FDA to market~~ and ~~sell~~PAMINE® ~~such~~Forte ~~newly developed~~(Fourth ~~product.~~Quarter ~~SFAS No~~2006). ~~144 “Accounting for the Impairment or Disposal of~~ ~~Long-Lived~~We ~~Assets”~~expect ~~states~~our ~~that an impairment loss shall be recognized only if the carrying amount of a long-lived asset is not recoverable and exceeds its fair value. The undiscounted~~ future ~~cash~~sales ~~flows~~ of the ~~Bioglan~~above ~~acquisition~~products ~~was estimated by us over the remaining useful life of the product~~ to ~~exceed~~continue ~~the carrying amount of the asset and therefore the carrying amount is estimated~~ to be ~~recoverable.~~negatively ~~However,~~impacted ~~the amount~~by ~~recorded~~generic ~~as intangible assets on our balance sheet for the acquired Bioglan assets may be more~~ or ~~less~~therapeutically ~~than~~equivalent ~~the fair value of such assets~~products. ~~Determining the fair value of the intangible asset is inherently uncertain, and may be dependent in significant part on the success of our revised plans to promote the Bioglan brands.~~

~~Deferred~~As ~~income~~noted ~~taxes~~above, ~~are~~increases ~~provided~~in our Net Sales for the ~~future~~First ~~tax~~Quarter ~~consequences~~2007 ~~attributable~~were tosubstantially the ~~differences~~ ~~between~~result ~~the~~of ~~carrying~~increased ~~amounts~~sales of ~~assets~~products ~~and~~which ~~liabilities~~have ~~and~~no ~~their~~generic ~~respective~~competition, ~~tax~~such ~~base.~~as ~~Deferred~~SOLARAZE® ~~tax~~and ~~assets~~products ~~are~~which ~~reduced~~have byonly arecently ~~valuation~~experienced ~~allowance~~generic ~~when~~competition, ~~in our opinion, it is more~~such ~~likely~~as ~~than~~ANAMANTLE® ~~not~~HC ~~that~~GEL, ~~some~~ROSULA® ~~portion~~NS ofand ~~the~~ZODERM® ~~deferred tax assets will not be realized~~Redi-Pads. As ~~of March~~with ~~31,~~all ~~2006~~products ~~and~~that experience ~~December~~generic 31competition, ~~2005,~~the weCompany ~~determined~~expects that nosales ~~deferred tax asset valuation allowance was necessary. We believe that our projections~~ of ~~future~~ANAMANTLE® ~~taxable~~HC ~~income makes~~GEL, itROSULA® ~~more~~NS ~~likely~~and ~~than~~ZODERM® ~~not~~Redi-Pads ~~that these deferred tax assets~~ will be ~~realized.~~negatively Ifimpacted ~~our projections of future taxable income changes~~ in ~~the~~ future, ~~we may be required to reduce deferred tax assets by a valuation allowance~~periods.

First Quarter of 2007 net sales included $1,290,000 of product that was shipped at the end of the Fourth Quarter 2006 resulting from certain of our wholesalers having FOB Destination shipping terms. As of March 31, 2007, we had $3,960,000 of orders on backorder as a result of our being out of stock.

Our gross prescription demand for the First Quarter 2007, based upon information received from Wolters Kluwer, was approximately $54,761,000. Our gross prescription sales, which do not include charges for discounts, returns, chargebacks and rebates, for the First Quarter 2007, were approximately $44,811,000. The approximate $9,950,000 difference between gross prescription demand and our gross prescription sales was primarily due to timing of customer purchases and Wolters Kluwer’s projected gross prescription demand being calculated based upon retail sale values.

As stated under “Critical Accounting Policies,” we cannot currently specify exactly when actual returns or credits relate to a current period or prior period, and therefore, we cannot currently specify without utilizing assumptions how much of the provision recorded relates to sales made in the prior periods. However, we believe the appropriate data is available that allows us to reasonably estimate the level of product returns expected from current sales activities, including quantitative and qualitative information such as actual return rates by product, the level of product in the distribution channel, expected shelf life of the product, product demand, the introduction of competitive or generic products that may erode current demand, our new product launches and general economic and industry wide indicators. To determine a reasonable basis for when a returned product may have been sold, we track our returns by lot

numbers and compare the lot numbers to when a range of sales may have occurred to determine an estimated average shelf life. We use this historical average as part of our overall process of estimating future returns. We also believe the appropriate data is available that allows us to reasonably estimate the level of credits associated with rebates or chargebacks expected from current sales activities, including quantitative and qualitative information such as the level of product in the distribution channel, the allowance for returns, and historical rebates and chargebacks. To determine a reasonable basis for when a related product rebate or chargeback may have been sold by us, we track our historical rebates or chargebacks by the managed care organizations’ usage period or our receipt date.

The following table summarizes the changes in the return reserve during the three months ended March 31, 2007 and 2006:

	2007		2006
Return reserve at January 1,	$ 26,348,000		$ 24,934,000
Product returns processed in the current
period related to prior period sales (a)	(6,796,000	)	(5,722,000	)
Product returns processed in the current
period related to current period sales (a)	(358,000	)	(301,000	)
Provision for returns relating to current
period sales	6,918,000		8,639,000

Return reserve at March 31,	$ 26,112,000		$ 27,550,000

(a)

Based upon our Returns Good Policy and our review of the average time between the sold product lot numbers and return product lot numbers.

In the First Quarter of 2007 and 2006, we experienced increased actual product returns primarily as a result of increased competition from generic and therapeutically equivalent products that competed against our brands on price. The Company’s reserve for product returns at March 31, 2007 was lower than the balance at March 31, 2006 and its provision for returns as a percent of gross sales has decreased to 14% of gross sales for the three month period ended March 31, 2007 from 18% in the corresponding period last year, primarily due to a reduction in the need to record a provision for current sales due to a pre-established returns reserve in comparison to the estimated inventory in the channel. In addition to plans to introduce new, patent-protected products, the Company has began initiatives which include lowering customer inventory in the channel and optimizing product production planning to increase effective dating on manufactured products in order to ship products with increased shelf-life to wholesalers (see - Critical Accounting Policies-Allowance for Returns). The lowering of customer inventory may reduce sales in subsequent quarters or while the initiatives are being implemented.

As of March 31, 2007, based upon wholesale inventory reports and discussions with retail chains and wholesalers, we estimate the total monthly inventory of our products to be approximately 1.5 months for the primary wholesale customers and 0.6 months for all other locations compared to 1.7 and 0.6 months, respectively, at December 31, 2006. After applying the March 31, 2007 return reserve, we estimate the unreserved monthly inventory of our products at the wholesalers and retailers to be 0.5 months.

There is no proprietary protection for most of our products, and therefore our products face competition from generic or comparable products that are sold by other pharmaceutical companies. Increased competition from the sale of generic or comparable products may cause a decrease in Net Sales from our products. If Net Sales of KERALAC™, ADOXA^®, SOLARAZE^®, ZODERM^®, ROSULA^®, ANAMANTLE^®HC, PAMINE^® or other Company products decline, as a result of increased competition, government regulations, wholesaler buying patterns, returns, physicians prescribing habits or for any other reason and we fail to replace those Net Sales, our Net Sales and profitability would decrease. Further, our net sales and profitability would be adversely affected if, for any reason, we were unable to launch VEREGEN™ or ELESTRIN™ during 2007.

COST OF SALES, which is comprised primarily of product costs and royalties and excludes amortization of intangible assets related to acquired products, were $6,682,000 for the First Quarter of 2007, representing an increase of $1,676,000, or approximately 33%, from $5,006,000 for 2006. The increase in cost of sales was primarily due to the higher net sales and an increase in inventory reserves of $886,000, primarily the result of the Company’s returns and inventory optimization initiatives, including shipping products with increased shelf-life to its customers. Primarily due to the increase in inventory reserves, the gross profit percentage for the three months ended March 31, 2007 decreased to approximately 82% from 86% in the corresponding period of 2006.

SELLING, GENERAL AND ADMINISTRATIVE EXPENSES for the three months ended March 31, 2007 were $21,296,000, representing an increase of $1,403,000, or 7%, compared to $19,893,000 for the same period in the prior year. The increase in selling, general and administrative expenses reflects higher spending on salary and salary related expenses, primarily in the sales area, and higher professional fees related to the Company’s ongoing litigations. The increased costs were partially offset by decreased spending on advertising and promotion on the existing product lines in response to increased competition from generic and therapeutically equivalent products. In selling general and administrative expenses, the Company has recorded non-cash compensation expense of $833,000 and $927,000, respectively, for the three month periods ended March 31, 2007 and 2006 related to its adoption of SFAS No. 123R, “Stock-Based Compensation” on January 1, 2006. The following table sets forth the increase (decrease) in certain expenditures:

	Change from the Three Months Ended March 31, 2007 in Comparison to March 31, 2006
Professional Fees	$ 1,036,000
Salary and Salary Related Expenses	790,000
Advertising and Promotional Costs	(744,000	)
Other	321,000

Selling, general and administrative expenses as a percentage of Net Sales were approximately 56% and 57%, respectively, for the three months ended March 31, 2007 and 2006. The percentages remained comparable despite increased spending on salary and salary related expenses and professional fees due to a proportionate increase in Net Sales.

The lower advertising and promotional costs were partially offset by the start of promotional spending on ELESTRIN™ which is expected to increase in subsequent quarter along with promotional spending on VEREGEN™ as the Company prepares for the potential launch of these products later in the year. In connection with the launch of these products, we anticipate hiring approximately 20 additional Kenwood Therapeutics sales representatives during 2007 and incurring a corresponding amount of additional sales, marketing and related expenses.

DEPRECIATION AND AMORTIZATION EXPENSES for the three months ended March 31, 2007 were $2,928,000, representing an increase of $378,000, or 15% from $2,550,000 for the three months ended March 31, 2006 primarily due to additional amortization expense from intangibles recorded in the Fourth Quarter of 2006 pursuant to the BioSante and MediGene Agreements.

RESEARCH AND DEVELOPMENT EXPENSES for the three months ended March 31, 2007 were $680,000, representing a decrease of $4,583,000, or 87%, compared to $5,263,000 for the same period in the prior year. The decrease in research and development expenses relates to a $5,000,000 payment made to MediGene under the MediGene Agreement in consideration for development and registration activities

undertaken prior to the date of the Agreement. The Company expensed the $5,000,000 as a research and development payment during the First Quarter of 2006 since there was no FDA approval at the time of the payment.

INTEREST INCOME for the three months ended March 31, 2007 was $554,000, representing an increase of $127,000 from $427,000 for the three months ended March 31, 2006, primarily due to higher cash balances and higher interest rates.

INTEREST EXPENSE for the three months ended March 31, 2007 was $2,266,000, representing an increase of $152,000 from $2,114,000 for the three months ended March 31, 2006.

INCOME TAX EXPENSE for the three months ended March 31, 2007 was $1,979,000, representing an increase of $1,830,000 from $149,000 for the three months ended March 31, 2006. The increase in income tax expense was due to an increase in income before income tax expense. The effective tax rates used to calculate the income tax expense for the three months ended March 31, 2007 and 2006 were approximately 44% and 42%, respectively. The higher rate in the most recent quarter reflects the Company’s adoption of FIN 48 on January 1, 2007.

NET INCOME for the three months ended March 31, 2007 was $2,525,000, representing an increase of $2,320,000, or 1,132%, from $205,000 for the three months ended March 31, 2006. Net income as a percentage of Net Sales for the three months ended March 31, 2007 was 7%, representing an increase of approximately 6% compared to 1% for the three months ended March 31, 2006. The increase in net income in the aggregate was principally due to lower operating expenses of $2,802,000, which included a decrease in research and development expenses related to a payment of $5,000,000 made to pursuant to the MediGene Agreement and expensed in the First Quarter of 2006, partially offset by higher selling, general and administrative expenses and amortization costs as described above. In addition, the Net Sales increase over the prior period led to an increased gross margin contribution of $1,373,000.

Doak’s net income for the three months ended March 31, 2007 was $962,000, representing an increase of $657,000, from net income of $305,000 for the three months ended March 31, 2006. Kenwood’s net income for the three months ended March 31, 2007 was $1,600,000, representing additional net income of $1,700,000, from a net loss of $100,000 for the three months ended March 31, 2006. A.Aarons, which began operations in the Third Quarter of 2006, had a net loss of $37,000 for the three months ended March 31, 2007.

Off Balance Sheet Arrangements

As of March 31, 2007, we did not have any off balance sheet arrangements.

Adoption of New Accounting Standards

In July 2006, the FASB issued Interpretation No. 48, “Accounting for Uncertainty in Income Taxes-an Interpretation of FASB Statement No. 109” (“FIN 48”), which clarifies the accounting for uncertainty in tax positions. This Interpretation requires that the Company recognize in its financial statements the impact of a tax position, if that position is more likely than not of being sustained on audit, based on the technical merits of the position. This interpretation is effective for fiscal years beginning after December 15, 2006, with the cumulative effect of the change in accounting principle recorded as an adjustment to opening retained earnings. On January 1, 2007, the Company’s adoption of FIN 48 resulted in an opening retained earnings adjustment of $3,500,000.

In June 2006, the EITF issued EITF Issue 06-3, “How Taxes Collected from Customers and Remitted to Governmental Authorities Should Be Presented in the Income Statement (That Is, Gross versus Net Presentation).” EITF Issue 06-3 provides guidance related to the presentation in financial statements of any tax assessed by a governmental authority that is directly imposed on a revenue-producing transaction between a seller and a customer, including, but not limited to, sales, use, value added, and some excise taxes. The EITF concluded that the presentation of taxes within the scope of EITF Issue 06-3 on either a gross (included in revenues and costs) or a net (excluded from revenues) basis is an accounting policy decision that should be disclosed. In addition, the aggregate amount of any such taxes that are reported on a gross basis should be disclosed in interim and annual financial statements. The guidance in EITF Issue 06-3 is effective for interim and annual reporting periods beginning after December 15, 2006. The adoption of EITF Issue 06-3 did not have a material impact on the Company’s consolidated financial statements.

New Accounting Standards

In February 2007, the FASB issued SFAS No. 159, “The Fair Value Option for Financial Assets and Financial Liabilities” (“SFAS No. 159”) which permits entities to choose to measure many financial instruments and certain other items at fair value that are not currently required to be measured at fair value. SFAS No. 159 will be effective for the Company on January 1, 2008. The Company is currently evaluating the impact of adopting SFAS No. 159 on its financial position, cash flows, and results of operations.

In September 2006, the FASB issued SFAS No. 157, “Fair Value Measurements.” SFAS No. 157 clarifies the principle that fair value should be based on the assumptions market participants would use when pricing an asset or liability and establishes a fair value hierarchy that prioritizes the information used to develop those assumptions. Under the standard, fair value measurements would be separately disclosed by level within the fair value hierarchy. SFAS No. 157 is effective for financial statements issued for fiscal years beginning after November 15, 2007, and interim periods within those fiscal years, with early adoption permitted. The Company has not yet determined the impact, if any, that the implementation of SFAS No. 157 will have on its results of operations or financial condition.

Liquidity and Capital Resources

Our cash and cash equivalents, short-term investments and restricted cash and investments increased to $77,860,000 at March 31, 2007 from $71,693,000 at December 31, 2006. Cash provided by operating activities for the three months ended March 31, 2007 was $11,512,000. The sources of cash primarily resulted from net income of $2,525,000 plus non-cash charges for depreciation and amortization of $2,928,000; a decrease in accounts receivable of $4,582,000; a decrease in prepaid income taxes of $2,041,000; an increase in the rebate reserve of $1,957,000; non-cash share based compensation expense of $833,000; an increase in the inventory valuation reserve $886,000; an increase in accounts payable of $785,000, due to timing of vendor payments; non-cash charges for amortization of deferred financing costs of $464,000; an increase in allowance for doubtful accounts of $33,000; and an increase in the fee-for-service accrual under DSAs of $21,000. The sources of cash were partially offset by an increase of deferred tax assets of $1,611,000; a decrease in accrued expenses of $2,116,000; an increase in inventories of $1,274,000; an increase in prepaid expenses and other of $306,000; and a decrease in the return reserve of $236,000.

Cash provided by investing activities for the three months ended March 31, 2007 was $681,000. The cash provided by investing activities was from sales of short-term investments-net of $709,000 partially offset by the purchase of property and equipment of $28,000.

Cash used in financing activities or the three months ended March 31, 2007 was $5,316,000, due to a decrease in milestones payable of $6,863,000, recorded using an imputed interest rate of 7.35% to determine the principal owed to the Company, resulting from the March 2007 payment of $7,000,000 due BioSante for ELESTRIN™ and scheduled payments of $3,660,000 under our Facility’s (as described below) term note. These uses of cash were partially offset by proceeds from the exercise of stock options of $4,433,000 and a tax benefit due to exercise of non-qualified options of $774,000.

The Company has a $110,000,000 credit facility, which we entered into on November 14, 2005, with a syndicate of lenders led by Wachovia Bank. Our Facility, which has been amended from time to time, is comprised of an $80,000,000 term loan and a $30,000,000 revolving line of credit. The Facility’s term loan and revolver both mature on November 14, 2010 and are secured by a lien upon substantially all of our assets, including those of our subsidiaries, and is guaranteed by our domestic subsidiaries.

As of March 31, 2007, we had $65,340,000 million in borrowings under the Facility’s term loan outstanding and no amounts outstanding under the Facility’s revolving line of credit. Amounts outstanding under the Facility accrue interest at our choice from time to time of either (i) the alternate base rate (which is equal to the greater of the applicable prime rate or the federal funds effective rate plus 1/2 of 1%) plus 3%; or (ii) a rate equal to the sum of the applicable LIBOR rate plus 4%. In addition, the lenders under the Facility are entitled to customary facility fees based on unused commitments under the Facility and outstanding letters of credit. At March 31, 2007, the effective interest rate accrued by us under the Facility was 9.32%.

The financial covenants under the Facility require that we maintain (i) a leverage ratio (which is a ratio of funded debt of us and our subsidiaries to consolidated EBITDA) less than or equal to 2.50 to 1.00; (ii) a fixed charge coverage ratio (which is a ratio of (A) consolidated EBITDA minus consolidated capital expenditures made in cash to (B) the sum of consolidated interest expense made in cash, scheduled funded debt payments, total federal, state, local and foreign income, value added and similar taxes paid or payable in cash, and certain restricted payments) greater than or equal to 1.50 to 1.00; and (iii) not less than $25 million of unrestricted cash and cash equivalents on our balance sheet at all times. Further, the Facility limits our ability to declare and pay cash dividends. As of March 31, 2007, the Company is in compliance with the financial covenants under the Facility.

As a result of our classifying $10,500,000 of regulatory milestone payments we owed BioSante during 2007, $7,000,000 of which was paid in March 2007, as milestones payable at December 31, 2006, we triggered a technical default under the Facility. On March 9, 2007, we received a waiver of this default from our lenders under the Facility. Concurrently, our lenders agreed to, among other things, modify the definition of Consolidated EBITDA to add back the initial $3,500,000 payment made by the Company on account of ELESTRIN™ under the BioSante License during the Fourth Quarter of 2006 that the Company classified as an expense in accordance with U.S. GAAP, and further modify the definitions of Excess Cash Flow to exclude cash payments made with respect to Permitted Acquisitions and Permitted Acquisition and Scheduled Funded Debt Payments to permit the payment by the Company of its other obligations under the BioSante License. Further, pursuant to the March 9, 2007 waiver, the lenders had the option of not requiring the Excess Cash Flow principal prepayment due by March 31, 2007. The principal prepayment, which could have been up to $2,600,000, was included in current maturities of long-term debt at December 31, 2006. In March 2007, the lenders required and the Company paid $660,000 of this principal prepayment.

As result of the waivers by our lenders of defaults under the Facility during 2006 and 2007, we have classified as a long-term liability $51,480,000 at March 31, 2007 that would have otherwise been shown as current as a result of the defaults. Based upon our current projections, we expect to be in default under the Fixed Coverage Charge Ratio set forth in the Facility beginning in the Third Quarter of 2007. As a result of the projected default, the desire to reduce the interest rates charged under the Facility and to provide us increased flexibility to potentially enter into future licensing, acquisition or other similar transactions, we currently expect to enter into a new credit facility prior to the Third Quarter of 2007.

As a result of the FDA approving, in the Fourth Quarter of 2006, the marketing of ELESTRIN™ for the treatment of moderate to severe vasomotor symptoms, especially hot flashes, associated with menopause, we paid BioSante and its licensor a regulatory milestone payment of $7,000,000 in March 2007 and are required to pay an additional $3,500,000 in December 2007. At March 31, 2007, the remaining $3,500,000 regulatory milestone payment is non-interest bearing and classified as milestones payable of $3,252,000 utilizing an imputed interest rate of 7.35% to determine the principal owed. We utilized the same imputed interest rate to determine the principal owed of

$10,115,000 at December 31, 2006, which was recorded as milestones payable and a corresponding intangible asset during December 2006. We will commercialize ELESTRIN™ in the United States and expect to launch ELESTRIN™ during 2007. We have also agreed to pay BioSante a royalty on net sales and sales-based milestones.

As of March 31, 2007, we had the following contractual obligations and commitments:

Period	Operating Leases	ELESTRIN™ Payments	Senior Credit Facility (a)	Other Debt	Minimum Inventory Purchases (b)	Total Obligations and Commitments
April 1, 2007 to
Dec. 31, 2007	$1,540,000	$3,500,000	$14,264,000	$60,000	$ 2,339,000	$21,703,000
Fiscal 2008	1,827,000	—	21,449,000	—	3,872,000	27,148,000
Fiscal 2009	1,476,000	—	23,702,000	—	2,772,000	27,950,000
Fiscal 2010	962,000	—	18,715,000	—	1,253,000	20,930,000
Fiscal 2011	791,000	—	—	—	—	791,000
Thereafter	926,000	—	—	—	—	926,000

	$7,522,000	$3,500,000	$78,130,000	$60,000	$10,236,000	$99,448,000

(a)

Senior Credit Facility includes estimated interest expense based upon an estimated interest rate of 9.32%. The Senior Credit Facility bears interest at a variable rate (see Note P of the notes to our consolidated financial statements). For the purpose of estimating the future interest expense included above, we used the interest rate that was in effect at March 31, 2007.

(b)

For more information on minimum inventory purchases, see “Manufacturing and Supply Agreements” in Note K.5 of the notes to our consolidated financial statements included in our Annual Report on Form 10-K for the year ended 2006.

We believe that our cash and cash equivalents and cash generated from operations together with funds available under the Facility and the expected new credit facility will be adequate to fund our current working capital requirements for at least the next twelve months, including the costs and expenses associated with our anticipated launches of VEREGEN™ and ELESTRIN™. However, if we make or anticipate significant acquisitions, or are unable to enter into a new credit facility, or are unable to obtain a waiver for the expected default under the fixed charge coverage ratio in the Third Quarter of 2007, we may need to raise additional funds through additional borrowings, by other means or the issuance of debt or equity securities.

Impact of Inflation

We have experienced only moderate price increases under our agreements with third-party manufacturers as a result of raw material and labor price increases. We have passed these price increases along to our customers. However, there can be no assurance that possible future inflation would not impact our operations.

Item 3. Quantitative and Qualitative Disclosures About Market Risk

During the period from our fiscal year end, December 31, ~~2005~~2006, to the end of our first fiscal quarter, March 31, ~~2006~~2007, there have been no material changes in the information previously provided under “Part II, Item 7A: Qualitative and Quantitative ~~Disclosures~~ Disclosures About Market Risk” set forth in our Annual Report on Form 10-K for the year ended December 31, ~~2005~~2006.

Item 4. Controls and Procedures

The Audit Committee of the Board of Directors of the Company has reviewed this Quarterly Report on Form 10-Q.

Evaluation of Disclosure Controls and Procedures

The Company is required to maintain disclosure controls and procedures that are designed to ensure that information required to be disclosed in its reports under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in the SEC’s rules and forms, and that such information is accumulated and communicated to management, including the Company’s Chief Executive Officer (“CEO”) and Chief Financial Officer (“CFO”) as appropriate, to allow timely decisions regarding required disclosure.

In connection with the preparation of the Form 10-Q for the period ended March 31, ~~2006~~2007, management, under the supervision of the CEO and CFO, conducted an evaluation of disclosure controls and procedures~~. Based on that evaluation~~, ~~the~~as ~~CEO~~such ~~and~~term ~~CFO~~is ~~concluded that~~defined ~~the~~in ~~Company’s~~Rules ~~disclosure~~13a-15(e) ~~controls~~ and ~~procedures were not effective as of March~~ ~~31,~~15d-15(e) ~~2006~~under ~~due to~~ the ~~material~~Securities ~~weaknesses~~Exchange ~~described~~Act inof ~~the~~1934 ~~Company’s~~as ~~management~~amended ~~report on internal control over financial reporting included in Item 9A to its 2005 Form 10-K~~ (the “~~2005~~Exchange ~~Form 10-K~~Act”) ~~and outlined below~~. ~~To date, the material weaknesses~~ ~~identified~~Based inon ~~the~~that ~~2005 Form 10-K have not been fully remediated. Additionally~~evaluation, ~~since~~ the ~~material~~ ~~weaknesses described below have not been fully remediated, the~~ CEO and CFO ~~continue~~ toconcluded ~~conclude~~ that the Company’s disclosure controls and procedures ~~are~~were ~~not~~ effective as of ~~the~~March ~~filing~~31, ~~date of this Form 10-Q~~2007.

As disclosed in the 2005 Form 10-K, management identified the following material weaknesses in connection with its assessment of the effectiveness of the Company’s internal control over financial reporting as of December 31, 2005:

• Information Technology Controls. Management’s evaluation of the effectiveness of our internal control over financial reporting as of December 31, 2004 revealed a material weakness relating to our information technology controls. As such evaluation was completed in 2006, management’s evaluation of the effectiveness of our internal control over financial reporting as of December 31, 2005 also found a material weakness in this area. The material weakness as of December 31, 2005 related to inadequate controls over information technology used in our core business

and financial reporting. These areas included logical access security controls to financial applications and change management procedures.

• Financial Closing Process. During 2006, management also concluded that we did not adequately implement certain controls relating to our review and verification of internally prepared reports and analyses utilized in the financial closing process. As such, management has identified a material weakness in our internal control over financial reporting relating to our financial closing process.

Remediation Steps to Address Material Weaknesses

As described below, through March 31, 2006, we have implemented, or plan to implement, the following measures to remediate the material weaknesses described above and in our 2005 Form 10-K.

Information Technology Controls

• Implement controls, policies and procedures within our information technology department over the monitoring and management of computer systems access rights, as well as documentation and approvals of programming change requests and approval of the programming changes.

Financial Closing Process

• Creating and filling a new Director of Finance position. The Director of Finance is responsible for overseeing the financial closing process;

• Recruitment of additional personnel with accounting and finance backgrounds;

• Changes in assigned roles and responsibilities within the accounting department to complement the hiring of additional accounting personnel and enhance our segregation of duties within the Company.

Changes in Internal Control Over Financial Reporting

NoThere ~~other~~were ~~change~~no changes in our internal control over financial reporting (as defined in Rules 13a-15(f) and 15d-15(f) under the Exchange Act) that occurred during the fiscal quarter ~~ended~~ ended March 31, ~~2006~~2007 that ~~has~~ materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.

4754

PART II - OTHER INFORMATION

Item 1. Legal Proceedings

Contract ~~Dispute~~Disputes

In 2004, wethe ~~were~~Company was named in a Complaint as a defendant in a civil action filed in the ~~Superior~~ Superior Court of New Jersey alleging breach of contract by usthe Company and seeking unspecified monetary damages. During 2005, wethe Company filed an Answer and Counterclaim with respect to this matter, seeking monetary relief offor ~~our~~the ~~own~~Company. ~~Discovery~~A June 11, 2007 trial date has been set with respect to this dispute. ~~has~~The ~~not~~Company ~~yet~~believes that it has ~~been~~meritorious ~~scheduled~~defenses byto the ~~Court~~plaintiff’s allegations and valid bases to assert the Company’s counterclaims and demand for monetary damages. WeWhile ~~believe~~the ~~that~~Company webelieves ~~have~~that it has meritorious defenses to the plaintiff’s allegations and valid bases to assert ~~our~~ its counterclaims and demand for monetary damages, the Company accrued $500,000 as a probable settlement for this matter in the Fourth Quarter 2004.

Shareholder Lawsuits

~~We,~~The Company, along with certain of ~~our~~its officers and directors, were named defendants in ~~thirteen~~ thirteen federal securities lawsuits that were consolidated on May 5, 2005 in the United ~~States~~ States District Court of New Jersey. In the amended consolidated complaint, filed on June 20, 2005, the plaintiffs allege violations of Sections 10(b) and 20(a) of the Securities Exchange Act of 1934 and Rule 10b-5 promulgated thereunder, arising out of disclosures that plaintiffs allege were materially false and misleading. Plaintiffs also allege that wethe Company and the individual defendants falsely recognized revenue. Plaintiffs sought an an unspecified amount of compensatory damages in an amount to be proven at trial. WeThe Company and the individual defendants filed ~~our~~its initial response on July 20, 2005 seeking to dismiss the amended consolidated complaint in its entirety with prejudice. On March 23, ~~2005~~2006, the Court issued an order denying ~~our~~the Company’s motion to dismiss the federal securities class action lawsuit. WeThe ~~continue~~Company continues to dispute the allegations set forth in the class action lawsuit and ~~intend~~ intends to vigorously defend ~~ourself~~itself. ~~Discovery~~Pursuant to a June 28, 2006 Scheduling Conference with the Court and the Court’s Pretrial Scheduling Order of that date, discovery in the federal securities class action lawsuit has ~~not~~begun. Plaintiffs ~~yet~~filed ~~been~~a ~~scheduled~~motion for class certification on January 15, 2007. Defendants filed their response on April 2, 2007. On April 20, 2007, the court issued an order staying further deadlines in this matter pending the completion of mediation between the parties.

Additionally, two related New Jersey state court shareholder derivative actions were filed on April 29, 2005 and May 11, 2005 against certain of our officers and directors alleging breach of fiduciary duty and other claims arising out of substantially the same allegations made in the federal securities class action lawsuit. Plaintiffs seek an unspecified amount of damages in addition to attorneys’ fees. On the parties’ agreement, these two related state shareholder derivative actions were consolidated on July 19, 2005 in the Superior Court of New Jersey and stayed in their entirety pending a decision on the motion to dismiss the consolidated federal securities class action lawsuit. Plaintiffs in the state shareholder derivative actions filed a consolidated amended derivative complaint on May 12, 2006. We dispute the allegations in the state shareholder derivative lawsuit and intend to move to dismiss the consolidated amended derivative complaint in its entirety. 55

~~Further~~Additionally, atwo ~~federal~~related New Jersey state court shareholder derivative ~~action~~actions ~~was~~were filed on April 29, 2005 and May 11, 2005 against certain of the Company’s officers and directors alleging breach of fiduciary duty and other claims arising out of substantially the same allegations made in the ~~United~~federal ~~States~~securities ~~District~~class ~~Court~~action lawsuit. Plaintiffs seek an unspecified amount of damages in addition to attorneys’ fees. On the parties’ agreement, these two related state shareholder derivative actions were consolidated on July 19, 2005 in the Superior Court of New Jersey. ~~against~~Plaintiffs usin the state shareholder derivative actions filed a consolidated amended derivative complaint on May 12, 2006. The Company and ~~certain~~the individual defendants filed its initial response on July 17, 2006 seeking to dismiss the alleged derivative complaint in its entirety with prejudice. On October 30, 2006, the court granted the defendants’ motion to dismiss and dismissed the derivative complaint with prejudice. Plaintiffs filed a notice of ~~our~~appeal ~~officers~~on December 14, 2006 and their ~~directors~~appeal papers on April 27, 2007. ~~Service~~ Defendants’ response is due on June 11, 2007.

48 Further, a federal shareholder derivative action was filed in the United States District Court of New Jersey against the Company and certain of its officers and directors. Service of process in this matter was accepted by the Company and the other defendants on April 26, 2006. After the Company and the other defendants filed on June 16, 2006 a motion to dismiss the derivative claim in this action, the shareholder filed an amended complaint on July 14, 2006 alleging a sole count for breach of fiduciary duties arising out of substantially the same allegations made in the federal securities class action lawsuit. The Company and the individual defendants have filed a motion to dismiss the alleged derivative complaint in its entirety with prejudice.

~~of process in this matter was~~ The ~~accepted~~Company byexpects usto ~~and~~incur ~~the~~additional ~~other~~substantial ~~defendants~~defense oncosts ~~April~~regardless ~~26, 2006. This action alleges breach~~ of ~~fiduciary~~ ~~duties arising out of~~ the ~~SEC inquiry and the restatement of our financial~~outcome ~~results for the quarter ended September 30, 2004 and violations~~ of ~~Delaware~~these ~~law regarding annual meetings~~lawsuits. Plaintiffs seek an unspecified amount of damages and attorneys’ fees and an order compelling us to schedule an Annual Meeting of Stockholders. We and the other defendants filed a motion to dismiss the derivative claim in this action on June 16Likewise, ~~2006.~~such ~~After~~events ~~we sent a notice to stockholders that we~~ have ~~scheduled our 2006 Annual Meeting of Stockholders for July 18~~caused, ~~2006~~and ~~(which~~will ~~Annual~~likely ~~Meeting,~~continue ~~the Company~~to ~~announced~~cause, ~~has been rescheduled), plaintiff in this~~ ~~lawsuit~~a ~~consented~~diversion ~~to the dismissal without prejudice~~ of ~~its claim under Delaware law relating to~~ the ~~failure~~Company’s tomanagement’s ~~hold~~time anand ~~annual meeting~~attention. ~~The parties filed a stipulation on June 15, 2006 requesting that the Court enter the order of dismissal.~~

We expect to incur additional substantial defense costs regardless of the outcome of these lawsuits. Likewise, such events have caused, and will likely continue to cause, a diversion of our management’s time and attention.

SEC Inquiry

In December 2004, wethe ~~were~~Company was advised by the staff of the SEC that it is conducting an ~~informal~~ informal inquiry relating to usthe Company to determine whether there have been violations of the federal securities laws. In connection with the inquiry, the SEC staff has requested that we the Company provide it with certain information and documents, including with respect to revenue recognition and capitalization of certain payments. WeThe ~~are~~Company is cooperating with this inquiry, however, wethe ~~are~~Company is unable at this point to predict the final scope or outcome of the inquiry, and it is possible the inquiry could result in civil, injunctive or criminal proceedings, the imposition of fines and penalties, and/or other remedies and sanctions. The conduct of these proceedings could negatively impact the ~~our~~Company’s stock price. Since wethe Company cannot predict the outcome of this matter and its impact on usthe Company, wethe ~~have~~Company has made no provision relating to this matter in ~~our~~its financial statements. In addition, wethe ~~expect~~Company expects to continue to incur expenses associated with the SEC inquiry and itits repercussions, regardless of the ~~outcome~~ outcome of the SEC inquiry, and the inquiry may divert the efforts and attention of ~~our~~the Company’s management team from normal business operations. During the Second Quarter 2006, the Audit Committee completed its previously announced internal review

~~Shareholders Initiatives~~ 56

~~We received~~related ato ~~letter,~~the ~~dated~~SEC’s ~~June 15, 2006, from a holder of approximately 9~~informal inquiry.1% ofThe ~~our outstanding~~Audit ~~common~~Committee ~~stock,~~conducted ~~which~~its ~~letter~~review ~~made~~with ~~certain~~the ~~assertions~~assistance ~~concerning~~of ~~federal~~independent ~~securities~~counsel. ~~laws~~The ~~and~~Audit ~~state~~Committee’s ~~corporate~~conclusions ~~laws~~were indelivered ~~connection~~to ~~with~~ the ~~timing~~full Board of ~~our 2006 Annual~~Directors, ~~Meeting~~the SEC and the ~~election~~Company’s ofindependent ~~directors at that meeting~~accountants.

~~While~~In weresponse ~~disagree~~to ~~with~~a ~~the~~resignation ~~assertions set forth in the~~ letter, insent ~~an effort~~ to ~~avoid~~members of the ~~cost and~~Board ~~burden~~ of ~~litigation,~~Directors weon ~~have~~April ~~rescheduled~~13, 2007, ~~our~~from ~~Annual~~an ~~Meeting~~employee ~~originally~~of ~~scheduled~~the ~~to occur~~Company, onthe ~~July~~Audit 18Committee, ~~2006.~~with ~~We have also reduced~~ the ~~number~~assistance of ~~directors constituting our~~its ~~Board~~outside ofcounsel, ~~Directors~~conducted ~~from~~an ~~nine~~internal toreview ~~eight~~of ~~members,~~the ~~effective~~matters asset offorth in the ~~date~~letter. ~~of the~~The ~~rescheduled~~Audit ~~Annual~~Committee’s ~~Meeting.~~review Atwas ~~the~~completed ~~rescheduled~~on ~~Annual~~May ~~Meeting~~8, 2007, and the ~~holders~~results of ~~our~~that ~~common~~review ~~stock~~were ~~voting~~reported ~~separately~~to asthe afull ~~class~~Board ~~will~~of beDirectors, ~~entitled~~the toSEC ~~elect three directors~~ and the ~~holders~~ ofCompany’s ~~our~~independent accountants. ~~Class~~No Bmatters ~~common~~from ~~stock~~the ~~voting~~review ~~separately~~affected asthe afinancial ~~class~~statements ~~will~~or bebooks ~~entitled to~~and ~~elect~~records ~~five directors, consistent with our Certificate~~ of ~~Incorporation~~the ~~and By-Laws~~Company.

On June 21, 2006, this shareholder filed a complaint against us in the United States District Court for the District of Massachusetts. The complaint seeks the relief described and requested in the shareholder’s June 15, 2006 letter.

We believe the complaint is moot in light of the actions we have taken described above.

Shareholders who wish to submit proposals to be considered, or to nominate Directors, at the rescheduled 2006 Annual Meeting must submit their proposals to us at our offices located at 383 Route 46 West, Fairfield, New Jersey on or before July 24, 2006.

General Litigation

WeThe Company and ~~our~~its operating subsidiaries are parties to other routine actions and ~~proceedings~~ proceedings incidental to ~~our~~the Company’s business. There can be no assurance that an adverse determination on any such action or proceeding would not have a material adverse effect on ~~our~~the Company’s business, financial condition or results of operations. WeThe Company ~~disclose~~discloses ~~the~~material ~~amount~~amounts or ~~range~~ranges of reasonably possible losses in excess of recorded amounts.

4957

Item 1A. Risk Factors

~~Controversies~~ There orwere ~~proceedings~~no ~~arising~~material ~~out~~changes ofin ~~proposed~~the ~~shareholder~~information ~~initiatives~~previously ~~could~~provided ~~cause~~under us“Part toI, ~~incur~~Item 1A: ~~substantial~~Risk ~~costs~~Factors” ~~and~~set ~~divert~~forth ~~management’s~~in ~~attention~~our ~~and~~Annual ~~resources~~Report on Form 10-K for the year ended December 31, 2006. Refer to that section for disclosures regarding the risks and uncertainties related to the Company’s business.

We received a letter from a holder of approximately 9.1% of our outstanding common stock, which letter made certain assertions concerning federal securities laws and state corporate laws in connection with the timing of our 2006 Annual Meeting and the election of directors at that meeting. In addition, on June 21, 2006, that shareholder also filed a complaint against us in the United States District Court for the District of Massachusetts. The complaint seeks the relief described and requested in its June 15, 2006 letter.

We have retained the services of various professionals to advise us on this matter, the costs of which may impact our future financial results. In addition, the uncertainty created by this or similar shareholder action could be disruptive to our operations, distract management, negatively impact our ability to attract and retain customers and could have a material adverse affect on our business, financial condition and results of operations.

We believe any related risk of not having three years of audited financial statements that incorporate the results of operations of Bioglan Pharmaceuticals Corp. is now not material.

As a result of our filing with the SEC of our Annual Report on Form 10-K for the year ended December 31, 2005, we now have three years of audited financial statements that incorporate the results of operations of Bioglan Pharmaceuticals Corp. Therefore, we currently believe any related risk of not having three years of audited financial statements that incorporate the results of operations of Bioglan Pharmaceuticals Corp. stated in our Annual Report on Form 10-K for the year ended December 31, 2005 is now not material.

In addition to the other information set forth in this report, you should carefully consider the factors discussed in “Part I, Item 1A: Risk Factors” in our Annual Report on Form 10-K for the year ended December 31, 2005, all of which could materially affect our business, financial condition or future results. These described risks are not the only risks facing us. Additional risks and uncertainties not currently known to us or that we currently deem to be immaterial also may adversely affect our business, financial condition and/or operating results.

Item 2. Unregistered Sales of Equity Securities and Use of Proceeds

On October 27, 2004, the Company’s Board of Directors approved a program to repurchase up to $8,000,000 of the Company’s outstanding common stock, which program expired on October 26, 2006. During 2005 and 2004, the Company repurchased under the October 2004 approved program 14,000 and 22,000 shares at a cost of $209,000 and $414,000, respectively. During September 2004, the Company’s previously announced program to repurchase up to $4,000,000 of outstanding common stock expired. During 2004, prior to the plan’s expiration, the Company repurchased 20,000 shares at a cost of $418,000. The ~~following~~Facility ~~table~~permits ~~summarizes~~the ~~our~~Company ~~repurchases~~to repurchase up to $18,000,000 of ~~our~~its outstanding common stock ~~since~~through ~~January~~March 131, ~~20051:~~2007, and up to $3,000,000 of its outstanding common stock during the remainder of the term of the Facility. The Company has not established a new repurchase program.

Period	Total Number of Shares Repurchased	Average Price Paid per Share	Total Number of Shares Repurchased as Part of Publicly Announced Plan	Maximum Dollar Value of Shares that May Yet Be Repurchased Under the Plan
January 1, 2005 to
January 31, 2005	14,000	$14.91	36,000	$7,377,290
February 1, 2005 to
March 31, 2006	—	N/A	—	$7,377,290

1 During September 2004, our previously announced program to repurchase up to $4 million of outstanding common stock expired. On October 27, 2004, we announced the approval by our Board of Directors of a program to repurchase up to $8 million of our common stock, which program expires on October 26, 2006. However, under the terms of our $110 million credit facility, aggregate repurchases of stock by us are limited to $3 million during the term of the facility, unless waived or amended. Stock repurchases under this program may be made from time to time, on the open market, in block transactions or otherwise, at the discretion of our management.

Item 3. Defaults Upon Senior Securities

As ~~a result~~ of ~~our~~March ~~failure to file our Annual Report on Form 10-K for the year ended December~~ 31, ~~2005 by April 30~~2007, ~~2006, we triggered a default under~~ the ~~$110~~Company ~~million~~is ~~New Facility.~~in Oncompliance ~~May 15, 2006, we received a waiver of this default from our lenders under our New Facility. In connection~~ with ~~this~~the ~~waiver,~~financial ~~which~~covenants ~~also allowed us to continue outstanding LIBOR Rate Loans~~ under the ~~New Facility, we agreed with our lenders to file~~ ~~our Annual Report on Form 10-K for the year ended December 31, 2005 by May 31, 2006 and our Quarterly Report on Form 10-Q for the fiscal quarter ended March 31, 2006 by June 30, 2006~~Facility. Concurrently, our lenders agreed to certain technical amendments to the New Facility clarifying Permitted Investments which can be utilized in determining our minimum cash balance (which, until we file our Quarterly Report on

Form 10-Q for the fiscal quarter ended March 31, 2006 and demonstrate compliance with the financial covenants in the New Facility, must be at least $45 million), allowing us to deliver to the lenders our 2006 annual budget by June 30, 2006 and allowing us to calculate, for financial covenant purposes, consolidated EBITDA without giving effect to that portion of our initial $5 million payment to MediGene that we classify as an expense in accordance with GAAP. Our lenders acknowledged that provided we file our Annual Report on Form 10-K for the year ended December 31, 2005 with the SEC by May 31, 2006, we would not be required to pay default interest under the New Facility; otherwise, default interest would be payable on a retroactive basis beginning on May 1, 2006. The Company filed its Annual Report on Form 10-K for the year ended December 31, 2005 with the SEC on May 19, 2006.

As of May 31, 2006, the Company has $76 million in borrowings under the New Facility’s term loan outstanding and no amounts under the New Facility’s revolving line of credit outstanding.

Item 4. Submission of Matters to a Vote of Security Holders

None.

Item 5. Other Information

None.

Item 6. Exhibits

(a) Exhibits.

Exhibit No.	Description
31.1	Rule 13a-14(a) Certification of Chief Executive Officer Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002
31.2	Rule 13a-14(a) Certification of Chief Financial Officer Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002
32.1	Certification pursuant to 18 U.S.C. Section 1350 by the Chief Executive Officer, as adopted, pursuant to Section 906 of the Sarbanes-Oxley Act of 2002
32.2	Certification pursuant to 18 U.S.C. Section 1350 by the Chief Financial Officer, as adopted, pursuant to Section 906 of the Sarbanes-Oxley Act of 2002

Exhibit
No.

Description

5131.1 Rule 13a-14(a) Certification of Chief Executive Officer Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002

31.2

Rule 13a-14(a) Certification of Chief Financial Officer Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002

32.1

Certification pursuant to 18 U.S.C. Section 1350 by the Chief Executive Officer, as adopted, pursuant to Section 906 of the Sarbanes-Oxley Act of 2002

32.2

Certification pursuant to 18 U.S.C. Section 1350 by the Chief Financial Officer, as adopted, pursuant to Section 906 of the Sarbanes-Oxley Act of 2002

SIGNATURES

Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.

BRADLEY PHARMACEUTICALS, INC. (REGISTRANT)

	BRADLEY PHARMACEUTICALS, INC. (REGISTRANT)
Date: May 10, 2007		/s/ Daniel Glassman Daniel Glassman President and Chief Executive Officer (Principal Executive Officer)

Date: May 10, 2007		/s/ R. Brent Lenczycki, CPA R. Brent Lenczycki, CPA Vice President and Chief Financial Officer (Principal Financial and Accounting Officer)

Date: June 23, 2006	/s/ Daniel Glassman Daniel Glassman Chairman of the Board, President and Chief Executive Officer (Principal Executive Officer)
Date: June 23, 2006	/s/ R. Brent Lenczycki, CPA R. Brent Lenczycki, CPA Vice President and Chief Financial Officer (Principal Financial and Accounting Officer)

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