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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, DC 20549

FORM 10-Q

For the quarterly period ended September 30, 2004

OR

For the transition period from                to                
Commission file number 0-18881

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

383 Route 46 West
Fairfield, NJ 07004

(973) 882-1505

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 an accelerated filer (as defined in Exchange Act Rule 12b-2) YES |X|   NO |_|

Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of the latest practicable date.

BRADLEY PHARMACEUTICALS, INC.

Table of Contents

Part I. Financial Information

Item 1. Financial Statements

BRADLEY PHARMACEUTICALS, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS

See accompanying notes to consolidated financial statements.

BRADLEY PHARMACEUTICALS, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS

See accompanying notes to consolidated financial statements.

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

See accompanying notes to consolidated financial statements

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

(Continued)

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

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 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 interim financial information. Accordingly, they do not include all of the 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 September 30, 2004, and its results of operations for the three and nine months ended September 30, 2004 and 2003 and cash flows for the nine months ended September 30, 2004 and 2003.

        The accounting policies followed by the Company are set forth in Note A of the Company’s consolidated financial statements as contained in the Form 10-K for the year ended December 31, 2003 filed with the Securities and Exchange Commission. These financial statements should be read in conjunction with the financial statements and notes thereto included in the Company’s Form 10-K for the year ended December 31, 2003.

        The results reported for the three and nine months ended September 30, 2004 are not necessarily indicative of the results of operations that may be expected for a full year.

NOTE B — Stock Based Compensation

        The Company’s 1990 Stock Option Plan and its 1999 Incentive and Non-Qualified Stock Option Plan are described more fully in Note I.2 of the Company’s Form 10-K for the period ended December 31, 2003. The Company accounts for those plans under the recognition and measurement principles of Accounting Principles Board, or APB Opinion No. 25, “Accounting for Stock Issuedto Employees,” and related interpretations. No stock-based employee compensation cost is reflected in net income, as all options granted under those plans had an exercise price equal or above the market value of the underlying common stock on the date of grant. The following table illustrates the effect on net income and net income per share if the Company had applied the fair value recognition provisions of Statement of Financial Accounting Standards (“SFAS”) No. 123, “Accounting for Stock-Based Compensation,”using the assumptions described in Note K.

NOTE C — Net Income Per Common Share

        Basic net income per common share is determined by dividing net income by the weighted average number of shares of common stock outstanding. Diluted net income per common share is determined by dividing net income plus applicable after-tax interest expense and related offsets from convertible notes by the weighted number of shares outstanding and 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:

        In addition to stock options and warrants included in the above computation, options and warrants to purchase 180,000 and 123,500 shares of common stock at prices ranging from $24.25 to $26.68 and $24.85 to $26.68 per share were outstanding for purpose of calculating per share amounts for the three and nine months ending September 30, 2004, respectively. Further, options and warrants to purchase 32,500 shares of common stock at prices ranging from $18.70 to $20.18 per share were outstanding for purposes of calculating per share amounts for the nine months ending September 30, 2003. These were not included in the computation of diluted income per share because their exercise price was greater than the average market price of the Company’s common stock and, therefore, the effect would be anti-dilutive.

Note D – Comprehensive Income

        SFAS No. 130, Reporting Comprehensive Income, requires that items defined as other comprehensive income, such as net income and unrealized gains and losses on available-for-sale securities, be reported separately in the financial statements. The components of comprehensive income for the three and nine months ended September 30, 2004 and 2003 are as follows:

Note E – Business Segment Information

        The Company’s three reportable segments are Doak Dermatologics, Inc. (dermatology and podiatry), Bioglan Pharmaceuticals Corp. (dermatology) and Kenwood Therapeutics (gastrointestinal, respiratory, nutritional and other). Each segment has been identified by the Company to be distinct operating units distributing different pharmaceutical products. Doak Dermatologics’ products are marketed, promoted and distributed primarily to physicians practicing in the fields of dermatology and podiatry; Bioglan Pharmaceuticals’ products are marketed, promoted and distributed primarily to physicians practicing in the field of dermatology; and Kenwood Therapeutics’ products are marketed, promoted and distributed primarily to physicians practicing in the field of internal medicine. On August 10, 2004 the Company, through its wholly-owned subsidiary Bioglan Pharmaceuticals Corp (formerly BDY Acquisition Corp.), acquired certain assets constituting the “Bioglan business” from Bioglan Pharmaceuticals Company and certain of its affiliated companies. The Bioglan business is currently operated as a separate subsidiary but may, upon completion of the integration of the Bioglan business with the Company’s other dermatology operations, be combined into one reportable segment with Doak.

        The accounting policies used to develop segment information correspond to those described in the summary of significant accounting policies in the notes to the financial statements in the Company’s Form 10-K for the year ended December 31, 2003. The reportable segments are distinct business units operating in different market segments with no intersegment sales. The following information about the three segments are for the

three and nine months ended September 30, 2004 and 2003.

        The basis of accounting that is used by the Company to record business segments’ sales have been recorded and allocated by each business segment’s identifiable products.

The basis of accounting that is used by the Company to allocate expenses that relate to all segments are based upon the proportionate quarterly net sales of each segment. Accordingly, the allocation percentage used can differ between quarters and 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, based upon, the Company’s investment guidelines and market conditions.

        The Company invests primarily in money market funds, short-term commercial paper, short-term municipal bonds, treasury bills and treasury notes. The Company’s policy is to invest primarily in high-grade investments.

        The following is a summary of available-for-sale securities for September 30, 2004:

        During the three and nine months ended September 30, 2004, the Company had gross realized gain on investment of $3,952 and $35,328, respectively. During the three and nine months ended September 30, 2003, the Company had a gross realized gain on investment securities of $64,136. The net adjustment to unrealized gain or loss during the three and nine months ended September 30, 2004 on available-for-sale securities included in stockholders’ equity totaled a gain of $484,809 for the three months ended September 30, 2004 and a loss of $30,517 for the nine months September 30, 2004 and the net adjustment to unrealized income during three and nine months ended September 30, 2003 on available-for-sale securities included in stockholders’ equity totaled a gain of $129,181 and $233,874, respectively. The Company views its available-for-sale securities as available for current operations.

        The Company’s held-to-maturity investments represents investments with financial institutions that have an original maturity of more than three months and a remaining maturity of less than one year, when purchased. Securities classified as held-to-maturity, which consist of securities that management has the ability and intent to hold to maturity, are carried at cost.

        The composition of the Company’s held-to-maturity investments at September 30, 2004 is as follows:

Note G – 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 88% of gross accounts receivable at September 30, 2004. On September 30, 2004, Cardinal Health, Inc. owed 42% of gross accounts receivable to the Company, McKesson Corporation owed 32% of gross accounts receivable to the Company and Quality King, Inc. owed 14% of gross accounts receivable to the Company.

        In addition, the Company’s four largest customers accounted for 87% of the gross sales for the three and nine months ended September 30, 2004 and 83% and 81% of gross sales for the three and nine months ended September 30, 2003, respectively. The following table presents a summary of sales to these customers, who are wholesalers, during the nine months ended September 30, 2004 and 2003 as a percentage of the Company’s total gross sales:

        Accounts receivable balances at September 30, 2004 and December 31, 2003 are as follows:

        Included in the accounts receivable other is $1,936,411 owed by Quintiles Transnational Corp. due to a post-closing adjustment based upon the working capital of the Bioglan business as of the closing date of its acquisition by the Company from affiliates of Quintiles.

Note H – 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 September 30, 2004 and December 31, 2003 are as follows:

Note I – Accrued Expenses

        Accrued expenses balances at September 30, 2004 and December 31, 2003 are as follows:

        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 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.

Note J – 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 September 30, 2004 and December 31, 2003, the Company determined that no deferred tax asset valuation allowance is 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 projection of future taxable income changes in the future, the Company may be required to reduce deferred tax assets by a valuation allowance.

Note K – Incentive and Non-Qualified Stock Option Plan

        During the nine months ended September 30, 2004, the Company granted 150,700 options at exercise prices ranging from $21.05 to $25.75 to employees and directors, canceled 23,833 options, and exercised 344,977 options and warrants, generating proceeds to the Company of $1,133,412 and a tax benefit of $361,653.

        During the nine months ended September 30, 2003, the Company granted a consultant options to purchase 1,800 shares of common stock at a price of $13.90, the market value on the date of grant, which is exercisable immediately, nonforfeitable, and will expire 3 years from its initial exercise date. During the nine months ended September 30, 2003, the Company expensed $11,041 for these services using a Black-Scholes method to value such options.

        All options issued during the nine months ended September 30, 2004 were at or above the market price on the date of grant.

        The Company applies the fair value recognition provisions of FASB Statement No. 123, “Accounting for Stock-Based Compensation,” using the following assumptions for grants during the periods ending September 30, 2004 and 2003: no dividend yield; expected volatility of 60%; risk-free interest rate of 5%; and expected life of four years for directors and officers and two years for others.

Note L – Related Party Transactions

Transactions With Shareholders and Officers

        During January 2004, the Company issued 5,236 restricted, fully vested and nonforfeitable shares of common stock to certain officers of the Company for being a member of a new officer committee, which is responsible for identifying and implementing the Company’s strategic plans. The committee was formed in the First Quarter 2004 and as a result of the issuance of the restricted stock, the Company expensed $125,036 during the First Quarter 2004.

        The Company leases approximately 32,000 square feet of office space at 383 Route 46 West, Fairfield, New Jersey, under a lease that expires on January 31, 2008, with a limited liability company that is controlled by Daniel Glassman, the Company’s Chairman of the Board of Directors, Chief Executive Officer and President, and Iris Glassman, an executive officer, a member of the Company’s Board of Directors and spouse of Daniel Glassman. At the Company’s option, the Company can extend the term of the lease for an additional 5 years beyond expiration. The lease agreement contractually obligates the Company to pay a 3% increase in annual lease payments per year. Rent expense, including the Company’s proportionate share of real estate taxes, was approximately $492,000 and $445,000 for the nine months ended September 30, 2004 and 2003, respectively.

Transactions With an Affiliated Company

        Daniel and Iris Glassman are majority owners of Medimetrik Inc., a privately held entity that was principally engaged in the business of market research services and ceased providing services to the Company in June 2004. During the nine months ended September 30, 2004 (services ceased in June 2004) and 2003, the Company incurred expenses for administrative support services (consisting principally of mailing, copying, financial services, data processing and other office services) from Medimetrik Inc. in the amount of approximately $29,000 and $31,000, respectively.

Note M – Recent Accounting Pronouncements

        In December 2003, the FASB issued FASB Interpretation No. 46(R), “Consolidation of Variable Interest Entities” (“FIN 46(R)”). FIN 46(R) clarifies the application of Accounting Research Bulletin 51, “Consolidated Financial Statements,” for certain entities that do not have sufficient equity at risk for the entity to finance its activities without additional subordinated financial support from other parties or in which equity investors do not have the characteristics of a controlling financial interest (“variable interest entities”). Variable interest entities within the scope of FIN 46(R) will be required to be consolidated by their primary beneficiary. The primary beneficiary of a variable interest entity is determined to be the party that absorbs a majority of the entity’s expected losses, receives a majority of its expected returns, or both. FIN 46(R) applies

immediately to variable interest entities created after January 31, 2003, and to variable interest entities in which an enterprise obtains an interest after that date. It applies to the Company in the first fiscal year or interim period ending after December 15, 2003, to variable interest entities in which an enterprise holds a variable interest that it acquired before February 1, 2003. The Company adopted FIN 46(R) in December 2003. Adoption of FIN 46(R) did not have a material effect on the Company’s financial position or results of operations.

        In March 2004, the EITF reached a consensus opinion on EITF 03-6, “Participating Securities and the Two-Class Method under FASB Statement No. 128, Earnings per Share.” The EITF reached several consensuses on the definition of a participating security and when and how to apply the two-class method when an entity has any type of participating security. EITF 03-6 is effective in periods beginning after March 31, 2004. Adoption of EITF 03-6 did not have an effect.

        In March 2004, the Emerging Issues Task Force (“EITF”) reached a consensus on Issue No. 03-1, “The Meaning of Other-Than-Temporary Impairment and Its Application to Certain Investments.” This consensus clarifies the meaning of other-than-temporary impairment and its application to investments classified as either available-for-sale or held-to-maturity under SFAS No. 115, “Accounting for Certain Investments in Debt and Equity Securities,” and investments accounted for under the cost method or the equity method. The application of this guidance should be used to determine when an investment is considered impaired, whether an impairment is other than temporary, and the measurement of an impairment loss. The guidance also includes accounting considerations subsequent to the recognition of an other-than-temporary impairment and requires certain disclosures about unrealized losses that have not been recognized as other-than-temporary impairments. The guidance for evaluating whether an investment is other-than-temporarily impaired is effective for evaluations made in reporting periods beginning after June 15, 2004. Adoption of EITF 03-1 did not have an effect.

        In March 2004 the FASB issued a proposed standard entitled “Share-Based Payment—An Amendment of FAS Nos. 123 and 95.” The proposed rules will eliminate the disclosure-only election under FAS 123 and require the recognition of compensation expense for stock options and other forms of equity compensation based on the fair value of the instruments on the date of grant. The FASB currently expects the final standard to be effective for during 2005 for the Company. See Note B for the quarterly disclosures of the pro forma dilutive impact on net income and earnings per share of expensing stock options based on the Black-Scholes model. The FASB’s proposal advocates using a binomial (lattice-based) option pricing model rather than the Black-Scholes model the company currently uses to determine grant date fair value. The Company has not yet determined what, if any, impact using the recommended binomial model will have on the company’s estimated net income and earnings per share dilution compared to the Black-Scholes model.

        On July 1, 2004, the Emerging Issues Task Force (the “EITF”) of the FASB reached a tentative conclusion that would require all shares that are contingently issuable

under outstanding convertible notes to be considered outstanding for its diluted earnings per share computations, if dilutive, using the “if converted” method of accounting from the date of issuance. Currently these shares are only included in the diluted earnings per share computation if the common stock price has reached certain conversion trigger prices. If approved, this EITF statement (“EITF 04-8“) would also require retroactively restate prior periods diluted earnings per share. If adopted, the Company believes EITF 04-8 will not have a material impact on the Company’s diluted earnings per share.

Note N – Commitments & Contingencies

Dermik/Aventis Litigation

        The Company entered into a settlement agreement with Dermik, dated as of June 30, 2004, in which the parties agreed to settle all legal proceedings between them involving patents owned by the Company relating to dermatologic compositions with approximately 21% to 40% urea and their therapeutic uses.

DPT Lakewood Litigation

        On February 25, 2003, the Company filed an action in the United States District Court for the District of New Jersey against DPT Lakewood, Inc., an affiliate of DPT Laboratories Ltd. In this lawsuit, the Company alleged, among other things, that DPT Lakewood breached a confidentiality agreement and misappropriated the Company’s trade secrets relating to CARMOL^®40 CREAM. During 1999, the Company provided, in accordance with a confidentiality agreement entered into for the possible manufacture of our CARMOL^®40 CREAM, substantial trade secret information to a company of which the Company believes DPT Lakewood is a successor, including processing methods and formulations essential to the manufacture of CARMOL^®40 CREAM. DPT Lakewood currently manufactures a 40% urea cream for Dermik and Aventis. Among other things, the Company sought damages from DPT Lakewood for misappropriation of the Company’s trade secrets. DPT Lakewood counterclaimed against the Company seeking a declaration of invalidity and non-infringement of the patents in question and making a claim for interference with contract and prospective economic advantage. The patent claims and counterclaims were recently dismissed with the consent of both parties. This dismissal led to the successful application to have remaining state law based claims and counterclaims dismissed without prejudice for lack of subject matter jurisdiction.

        On June 3, 2004, DPT Lakewood instituted a New Jersey state court action against the Company asserting the common law defamation and tortious interference claims that were recently dismissed by the federal court for lack of subject matter jurisdiction. The Company’s response to the complaint (a motion to dismiss) was recently denied, however, the appellate court has returned this matter to the trial court for reconsideration.

        On March 6, 2003, DPT Laboratories, Ltd., filed a lawsuit against the Company alleging defamation arising from the Company’s press release announcing commencement of the litigation against DPT Lakewood. On July 11, 2003, the District Court for the Western District of Texas denied the Company’s motion to dismiss. DPT Laboratories recently designated an expert opining that it has suffered over $1 million in damages as a result of the Company’s allegedly defamatory comment in a press release regarding the New Jersey patent infringement litigation. The Company has subsequently identified an expert witness in the case calling into serious question both the methodology and the facts upon which DPT Laboratories’ expert based that opinion.

        The Company and DPT Laboratories are actively engaged in negotiations to resolve their dispute, but there can be no assurance that an amicable resolution, on favorable terms, will be obtained.

General Litigation

        The Company and its operating subsidiaries are parties to other routine actions and proceedings incidental to its business. There can be no assurance that an adverse determination on any such action or proceeding would not have a material adverse effect on the Company’s business, financial condition or results of operations.

        The Company accounts for legal fees as their services are incurred.

Securities Transferred to 401(k) Plan

        From 1997 through January 2004, the Company failed to register, in compliance with applicable securities laws, shares of the Company’s common stock transferred to participants in its 401(k) plan and the interests of those participants in that plan, which may also be deemed securities requiring registration. The Company may offer a right of rescission to those participants who received shares of its common stock in violation of applicable securities laws during the two years preceding the date of the rescission offer, the statute of limitations period that the Company believes may apply to claims for rescission under applicable state laws, or possibly a longer or shorter period. Under that rescission offer, the participants could require the Company to repurchase those shares at the price per share of the Company’s common stock when the shares were transferred to the participant’s account, plus interest at a rate to be determined.

        Based upon the Company’s preliminary investigation, the Company currently believes that approximately 22,000 shares of its common stock were transferred to 401(k) plan participants since January 1, 2002 in violation of applicable securities laws and, if subject to its rescission offer, would have an aggregate repurchase price of approximately $301,000, plus interest. The Company may also face fines or other penalties for its violation of applicable securities laws, and may be required to offer rescission to participants who received shares of the Company’s common stock prior to the two-year period preceding our possible rescission offer.

        In addition, applicable securities laws do not expressly provide that the Company’s rescission offer would terminate a participant’s right to rescind a sale of stock that was not properly registered. Accordingly, even if the rescission offer is made the Company may continue to have a contingent liability relating to the shares transferred to participants who do not accept the rescission offer, based upon the price per share of the Company’s common stock when the shares were transferred to the participant’s account.

Supply Agreement

        On December 4, 2003, the Company contracted with a manufacturer to produce the product FLORA-Q™, a probiotic product, for exclusive distribution within the United States, Canada and Mexico. The initial term of the agreement is for three years and may only be terminated if the other party commits a material breach of its obligations or has increased its price as described below. The Company is required to purchase at least $375,000 of the product per contract year. The manufacturer cannot change the price per manufactured product unless the product production cost increases greater than 10 percent during any given contract year. If the manufacturer increases the price per product, the Company can terminate the agreement without any liability to the manufacturer, within 30 days after receipt of notice of any price increase from the manufacturer. After the initial term, the supply agreement will be renewed for consecutive periods of one year, unless the Company or the manufacturer gives notice to the other not less than 180 days prior to the end of the initial term or any such renewal term. The contract year is the twelve consecutive month period commencing from December 1^st through November 30^th.

International Distribution Agreement

        On June 30, 2004, the Company entered into a distribution agreement with Dermik Laboratories, a division of Aventis Pharmaceuticals, Inc., a wholly owned subsidiary of Aventis Pharma AG, to acquire exclusive distribution and marketing rights in selected international markets to the prescription acne and rosacea products Benzamycin^®, Klaron^®and Noritate^®, and three additional products, Hytone, Sulfacet R and Zetar Shampoo. Pursuant to this agreement, the Company will have exclusive distribution and marketing rights to these products for eight years in Australia, Japan, the countries comprising the former Soviet Union, Saudi Arabia, the United Arab Emirates, Kuwait and Egypt in the Middle East, and Vietnam, Thailand and Cambodia in Southeast Asia. The Company will be responsible for securing the necessary approvals to market these products in these countries. The Company has agreed to pay Dermik not less than $3.2 million in aggregate acquisition fees and royalties against the Company’s net sales of these products, of which the Company has paid approximately $2.6 million in distribution rights included in intangible assets and $120,000 in advanced royalties.

Note O – Purchase of Bioglan Pharmaceuticals Company

        On August 10, 2004, the Company, through its wholly-owned subsidiary BDY Acquisition Corp., acquired certain assets constituting the “Bioglan business” from Bioglan Pharmaceuticals Company, Quintiles Bermuda Ltd. and Quintiles Ireland Limited, each a subsidiary of Quintiles Transnational Corp. (“Quintiles”). The purchase price of approximately $190 million, including acquisition costs, was paid in cash.

        The assets acquired include certain intellectual property, regulatory filings, and other assets relating to SOLARAZE^® (diclofenac sodium), a topical treatment indicated for the treatment of actinic keratosis; ADOXA^® (doxycycline monohydrate), an oral antibiotic indicated for the treatment of acne; ZONALON^® (doxepin hydrochloride), a topical treatment indicated for pruritus; TxSystems^®, a line of advanced topical treatments used during in-office procedures; and certain other dermatologic products.

        In connection with the acquisition, the Company hired certain sales representatives and other personnel of Bioglan and entered into a $50 million bridge loan, which replaced the Company’s existing credit facility. The Company funded the purchase price for the acquisition through the proceeds of the bridge loan and working capital. On September 28, 2004, the Company replaced the bridge loan with a $125 million credit facility, consisting of a $75 million term loan and $50 million revolver.

        The Food and Drug Agency (“FDA”) approved ADOXA^® in 2001 as an Abbreviated New Drug Application (“ANDA”). Though the Company is currently unaware of any product currently available that is bioequivalent to ADOXA^®, ADOXA^®is not patent protected and is subject to possible generic competition. Under a Distribution Agreement with Par Pharmaceuticals, the Company holds the distribution rights for ADOXA^® in the United States and related territories. Under a royalty agreement with Par, the Company may use the ANDA owned by Par and must pay Par royalties through 2010 of 5% of sales for the 100mg and 50mg and 7.5% for the 75mg product. After 2010, the Company has the option to purchase the ANDA for $10. In addition, the Company has a manufacturing agreement with Par for ADOXA^® also through 2010.

        The FDA approved SOLARAZE^® Gel in October 2000, and the related U.S. patent expires in 2014. The Company has a license agreement with Jagotec AG for SOLARAZE^® in the United States, Canada and Mexico. The Company also holds the New Drug Application (“NDA”) for the United States and the New Drug Submission for Canada. Under the terms of the license agreement, the Company currently pays royalties of 15% of sales to Jagotec AG. The Company also has a manufacturing agreement with Patheon for the production of SOLARAZE^® Gel through February 2006.

        ZONALON^® is an FDA-approved product that is off-patent. The Company holds the NDA for ZONALON^® in the United States. The Company is attempting to maintain a manufacturing agreement with DPT for the production of ZONALON^® through October 2005.

        The Company holds the license in the United States for TxSystems^® and Cardinal Health supplies the product. The manufacturing agreement with Cardinal Health is renewed annually, with a required ninety-day notice for termination.

        The acquisition was accounted for as a purchase business combination in accordance with SFAS No. 141, and accordingly, the results of Bioglan’s operations are included in the Company’s consolidated results from the date of purchase. The amounts are preliminary and are subject to adjustment:

* Certain reclassifications have been made to the amounts above, in comparison to Bioglan’s Balance Sheet as of August 10, 2004 on the Form 8-K/A filed with the SEC on October 22, 2004, in order to conform to the Company’s current presentation.

        Assets, excluding intangible assets, and liabilities have been recorded at their net book value, which approximates their fair market value at the date of purchase.

        The amount paid in excess of the fair value of the net tangible assets has been allocated to separately identified intangible assets based upon an independent valuation analysis.

        In accordance with SFAS No. 142, goodwill related to this purchase will not be amortized but will be subject to periodic impairment tests. To the extent the Company is required to pay additional amounts such as acquisition costs, the amount of goodwill that will be subject to periodic impairment assessments will increase. The intangible assets that do have definite lives are being amortized over estimated useful lives ranging from 10 to 20 years.

        The following unaudited pro forma data sets forth the combined consolidated results of operations for the three and nine month periods ended September 30, 2004 and September 30, 2003 as if the purchase had taken place on January 1, 2003. The pro forma data gives effect to actual operating results prior to the purchase, with adjustments for interest income, interest expense, intangible amortization expense, foreign currency gain or losses and income taxes. No effect has been given to cost reductions or operating synergies in this presentation.

        The unaudited pro forma results are provided for information purposes only and do not purport to represent what the results of operations would actually have been had the transaction in fact occurred as of the dates indicated, or to project the results of operations for any future period.

        As stated in the Company’s Form 8-K filed with the SEC on August 12, 2004, statements of income and cash flows for the Bioglan business for any period prior to March 22, 2002, the date on which the Bioglan business was acquired by Quintiles, were not available or able to be produced by Quintiles. Accordingly, the Company filed by amendment to the Form 8-K on October 22, 2004, audited balance sheets of the Bioglan business as of December 31, 2003 and 2002 and audited statements of operations, entity equity and cash flows for the periods from March 22, 2002 through December 31, 2002 and January 1, 2003 through December 31, 2003 in addition to the required June 30, 2003 and 2004 unaudited financial statements. Further, the Company filed audited financial statements of the Bioglan business for the period from January 1, 2004 through the closing, which provided more current information than, but are not a substitute for, the omitted statements of income and cash flows for the pre-March 22, 2002 periods.

        Due to the significance of this acquisition to the Company, among other factors, the Company was unable to obtain a waiver from the SEC of the requirement to include the pre-March 22, 2002 statements of income and cash flows. However, the Company believes that those omitted financial statements would not be particularly meaningful to an understanding of the current and future operations of the Company and the Bioglan business because, among other reasons, it understands that the Bioglan business was part of an insolvent organization prior to its acquisition by Quintiles and not operated in the ordinary course of business during the period that would be covered by those financial statements. Once the Company has filed audited financial statements that include the operations of the Bioglan business for an appropriate post-closing period, the Company intends to again seek a waiver from the SEC concerning its omission of those financial statements, which would allow the Company to have future registration statements for its securities declared effective by the SEC, though the Company cannot assure whether or when that waiver may be granted. Until the Company is able to have registration statements for public offerings of its securities declared effective by the SEC, the Company would need to pursue additional borrowings or private placements of securities if it desires to conduct a financing, which could result in increased costs or other less favorable terms compared to public offerings.

Note P – Credit Facility

        The Company’s previous loan agreement with respect to a $5 million revolving asset-based credit facility and a $10 million acquisition facility was replaced on August 10, 2004 with a $50 million bridge loan from Wachovia Bank. The $50 million bridge loan was replaced on September 28, 2004 with $125 million credit facility with a syndicate of banks led by Wachovia.

        The $125 million credit facility is comprised of a $75 million term loan and a $50 million revolving line of credit. The credit facility expires and becomes due upon the earlier to occur of (i) September 28, 2009; and (ii) May 15, 2008 if, after giving effect to a redemption of the Company’s outstanding $37 million of convertible senior subordinated notes due 2013 that may be compelled by the noteholders on June 15, 2008, the Company would fail to meet certain financial ratios described in the credit agreement.

The credit facility is secured by a lien upon substantially all of the Company’s assets, including those of its subsidiaries, and is guaranteed by the Company’s operating subsidiaries. The Company intends to use the credit facility for general corporate purposes, including potential acquisitions and the repayment the Company made of the former bridge credit facility.

        Amounts outstanding under the credit facility accrue interest at the Company’s choice from time to time of either (i) the base rate (which is equal to the greater of the applicable prime rate or the federal funds rate plus 1/2 of 1%) plus 1.00% to 1.75%, depending upon the Company’s leverage ratio; or (ii) a rate equal to the sum of the applicable LIBOR rate plus 2.00% to 2.75%, depending upon the Company’s leverage ratio. In addition, the lenders under the credit facility are entitled to customary facility fees based on unused commitments under the facility and outstanding letters of credit.

        The financial covenants under the credit facility require that the Company maintain (i) a senior funded debt to EBITDA ratio less than or equal to 2.50 to 1.00 prior to June 20, 2005, 2.25 to 1.00 from July 1, 2005 through June 30, 2006 and 2.00 to 1.00 from July 1, 2006 through maturity; (ii) a funded debt to EBITDA ratio less than or equal to 3.00 to 1.00 prior to June 30, 2005, 2.75 to 1.00 from July 1, 2005 through June 30, 2006 and 2.50 to 1.00 from July 1, 2006 through maturity; and (iii) a fixed charge coverage ratio (which is a ratio of (A) EBITDA minus consolidated capital expenditures to (B) the sum of consolidated interest expenses, funded debt payments, cash taxes paid and certain restricted payments) greater than or equal to 1.20 to 1.00. As of the date of this report, the Company is in compliance with those covenants, the entire $75 million term loan is outstanding and no amounts are outstanding under the revolving credit facility. As of September 30, 2004, the Company has incurred $3,347,397 of deferred financing costs associated with this credit facility.

Note Q – Stock Repurchase Plan

        During September 2004, the Company’s previously announced program to repurchase up to $4 million of outstanding common stock expired. During September 2004, prior to the plan’s expiration, the Company repurchased 20,000 shares at a cost of $418,077. The Company had repurchased, from the plan’s inception during September 2002, a total of 117,713 shares at a cost of $1,474,102.

        On October 27, 2004, the Company’s Board of Directors approved a program to repurchase up to $8 million of the Company’s outstanding common stock. Repurchases are currently subject, however, to a restriction under the Company’s recently established $125 million credit facility, which limits the aggregate repurchases of stock by the Company 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 management of the Company.

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 the financial statements and notes included in our Form 10-K for the year ended December 31, 2003. The following discussion and analysis contains forward-looking statements regarding our future performance. 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, 2003.

Forward-Looking Statements

        Some of the statements under the captions “Risk Factors” included in our Form 10-K for the year ended December 31, 2003, “Management’s Discussion and Analysis of Financial Condition and Results of Operations” or 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:

        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, current conditions, expected future developments and other factors we believe are appropriate. 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 Form 10-K for the year ended December 31, 2003.

        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.

Overview

        We are a specialty pharmaceutical company that acquires, develops and markets prescription and over-the-counter products within the dermatologic, podiatric and gastrointestinal markets. We have experienced substantial growth in Net Sales and net income through increased sales of existing products and new product sales, recognizing Net Sales for the nine months ended September 30, 2004 of $76,519,000 representing an increase of $25,270,000, or approximately 49% from $51,248,000 for the nine months ended September 30, 2003.

        We market and sell our products in the highly competitive pharmaceutical industry primarily through our full-time sales personnel and wholesalers. We seek to expand our market reach through promotion of our products in new geographic regions and for wider application in existing regions, and will continue expansion of our field sales force as product growth, geographic reach or product acquisitions warrant.

        Our CARMOL^®40 product line accounted for approximately 24% of our sales for the nine months ended September 30, 2004 and has faced increasing competition. To lessen our dependence on this product line, we have sought to grow our other product lines both in terms of dollar volume and percentage of revenues. During 2004, we have launched ZODERM^® LOTION, GEL and CREAM, KERALAC^TM LOTION and GEL and ROSULA^®NS.

        ZODERM^® products are internally developed urea-based topical prescription products that treat acne. KERALAC^TM is a prescription urea-based topical therapy that removes the surface layer of dead cells and improves skin moisture. KERALAC^TM was launched as a second-generation product line to CARMOL^®40.

        On August 10, 2004, we purchased certain assets of Bioglan Pharmaceuticals Company, a wholly-owned subsidiary of Quintiles Transnational Corp. As part of the transaction, we acquired certain intellectual property, regulatory filings, and other assets relating to SOLARAZE^®(diclofenac sodium), a topical treatment indicated for the treatment of actinic keratosis, ADOXA^®(doxycycline monohydrate), an oral antibiotic indicated for the treatment of acne, ZONALON^® (doxepin hydrochloride), a topical treatment indicated for pruritus, TxSystems^®, a line of advanced topical treatments used during in-office procedures, and certain other dermatologic products. The total consideration was approximately $190 million, including acquisition costs.

        In connection with the acquisition, we hired certain sales representatives and other personnel of Bioglan and entered into a $50 million bridge loan, which replaced our existing credit facility. We funded the purchase price for the acquisition through the proceeds of the bridge loan and working capital. On September 28, 2004, we replaced the bridge loan with a $125 million credit facility, consisting of a $75 million term loan and $50 million revolver.

        ADOXA^® is a member of the tetracycline family of antibiotics and is available in 100mg, 75mg and 50mg tablets as doxycycline monohydrate. ADOXA^® tablets are small, easy-to-swallow, film-coated tablets, making them ideal for patients who have trouble swallowing capsules. The tetracycline family of antibiotics is useful adjunctive therapy for the treatment of severe acne. These medications work by suppressing the common bacteria known as P. acnes in the skin. They are often used in conjunction with topical therapies as part of an overall acne treatment regimen.

        ADOXA^® is one of several branded tetracycline products for acne treatment. The key advantages of ADOXA^® versus other treatments include its small, easy-to-swallow tablet form and doxycycline’s proven safety profile.

        SOLARAZE^® Gel is the first FDA-approved dermatological product containing the nonsteroidal anti- inflammatory diclofenac sodium in a 3% topical formulation. SOLARZAE^® Gel is in the class of therapy for actinic keratosis. Actinic keratoses are common dysplastic, pre-cancerous epidermal lesions affecting a large proportion of fair-skinned individuals. Actinic keratosis skin lesions are caused by over-exposure to the sun. Prior to the introduction of SOLARAZE^® Gel, dermatology treatment options typically included cryosurgery, 5-fluorouracil and aminolevulinic acid HCI.

        The key advantages of SOLARAZE^® Gel versus other treatment options include its efficacy, tolerability/side-effect profile and its convenient, easy-to-apply non-greasy gel form. SOLARAZE^® is also the only topical treatment for actinic keratosis that is approved for use on other parts of the body besides the face.

        ZONALON^® cream relieves itch for management of moderate pruritus associated with atopic dermatitis.

        TxSystems^® includes AFIRM, a retinol based topical cream, and B-LIFTx, a salicyclic acid based, in-office peel. AFIRM reduces the appearance of fine lines, and its microsponge technology helps reduce the potential for irritation.

Results of Operations

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

        NET SALES for the three months ended September 30, 2004 were $28,497,000, representing an increase of $8,514,000, or approximately 43%, from $19,983,000 for the three months ended September 30, 2003.

        For the three months ended September 30, 2004, Doak Dermatologics’ Net Sales were $17,461,000, representing an increase of $1,407,000, or approximately 9%, from $16,054,000 for the three months ended September 30, 2003. The increase in Net Sales was led by new product sales from LIDAMANTLE^® LOTION, launched in the Fourth Quarter 2003, of $252,000; LIDAMANTLE^®HC LOTION, launched in the Fourth Quarter 2003, of $343,000; ZODERM^® GEL 4.5%, launched in the First Quarter 2004, of $175,000; ZODERM^® GEL 8.5%, launched in the First Quarter 2004, of $20,000; ZODERM^® CREAM 4.5%, launched in the First Quarter 2004, of $387,000; ZODERM^® CREAM 8.5%, launched in the First Quarter 2004, of $45,000; ZODERM^® CLEANSER 4.5%, launched in the First Quarter 2004, of $476,000; ZODERM^® CLEANSER 8.5%, launched in the First Quarter 2004, of $344,000; KERALAC™ LOTION 7oz, launched in the Second Quarter 2004, of $965,000; KERALAC^™ LOTION 11oz, launched in the Second Quarter 2004, of $1,287,000; KERALAC™ GEL, launched in the Second Quarter 2004, of $2,007,000; ROSULA^®NS, launched in the Third Quarter 2004, of $1,952,000; ZODERM^® GEL 6.5%, launched in the Third Quarter 2004, of $799,000; ZODERM^® CREAM 6.5%, launched in the Third Quarter 2004, of $705,000; and ZODERM^® CLEANSER 6.5%, launched in the Third Quarter 2004, of $1,191,000. Doak’s new product sales were offset by declines in CARMOL^®40 CREAM of $3,126,000, CARMOL^®40 LOTION of $870,000, CARMOL^®40 GEL of $952,000, LIDAMANTLE^® CREAM of $508,000, LIDAMANTLE^®HC CREAM of $710,000, and in comparison to a newly launched products during the same period last year, ROSULA^® AQUEOUS GEL declined $479,000 and ROSULA^® AQUEOUS CLEANSER declined $1,983,000. The total Net Sales for CARMOL^®40 CREAM, LOTION and GEL for the three months ended September 30, 2004 were $4,220,000.

        For the three months ended September 30, 2004, Kenwood Therapeutics’ Net Sales were $7,326,000, representing an increase of $3,398,000, or approximately 87%, from $3,928,000 for the three months ended September 30, 2003. The increase in Net Sales were led by new product sales of FLORA-Q™, launched in First Quarter 2004, of

$61,000 and product sales growth from ANAMANTLE®HC of $2,708,000 and DECONAMINE® products of $1,264,000, which were partially offset by a decline in GLUTOFAC® ZX of $377,000, and in comparison to a newly launched product during the same period last year, PAMINE®FORTE 5mg declined $337,000.

        On August 10, 2004, we acquired certain assets of Bioglan Pharmaceuticals Company. The Bioglan Net Sales for the period from the purchase date through September 30, 2004 were $3,709,000, which were comprised of Net Sales of ADOXA^® of $2,469,000, SOLARAZE^®of $643,000, ZONALON^® of $292,000 and other products of $305,000. Bioglan Net Sales during the period were negatively impacted by lower wholesaler purchases as wholesalers reduced their inventory levels. We expect normalized wholesaler purchasing patterns to begin in the Fourth Quarter 2004.

        For the nine months ended September 30, 2004, Doak Dermatologics’ Net Sales were $52,316,000, representing an increase of $12,726,000, or approximately 32%, from $39,590,000 for the nine months ended September 30, 2003. The increase in Net Sales was led by new product sales from LIDAMANTLE^®LOTION, launched in the Fourth Quarter 2003, of $985,000; LIDAMANTLE^®HC LOTION, launched in the Fourth Quarter 2003, of $1,426,000; ZODERM^® GEL 4.5%, launched in the First Quarter 2004, of $778,000; ZODERM^® GEL 8.5%, launched in the First Quarter 2004, of $906,000; ZODERM^® CREAM 4.5%, launched in the First Quarter 2004, of $1,163,000; ZODERM^® CREAM 8.5%, launched in the First Quarter 2004, of $1,061,000; ZODERM^® CLEANSER 4.5%, launched in the First Quarter 2004, of $1,481,000; ZODERM^® CLEANSER 8.5%, launched in the First Quarter 2004, of $1,436,000; KERALAC™ LOTION 7oz, launched in the Second Quarter 2004, of $1,853,000; KERALAC™ LOTION 11oz, launched in the Second Quarter 2004, of $2,753,000; KERALAC™ GEL, launched in the Second Quarter 2004, of $3,957,000; ROSULA^®NS, launched in the Third Quarter 2004, of $1,952,000; ZODERM^® GEL 6.5%, launched in the Third Quarter 2004, of $799,000; ZODERM^® CREAM 6.5%, launched in the Third Quarter 2004, of $705,000; and ZODERM^® CLEANSER 6.5%, launched in the Third Quarter 2004, of $1,191,000. Doak’s new product sales were offset by declines in CARMOL^®40 CREAM of $5,489,000, CARMOL^®40 LOTION of $2,019,000, LIDAMANTLE^® CREAM of $601,000, LIDAMANTLE^®HC CREAM of $665,000, and ROSULA^® AQUEOUS GEL of $1,390,000. The total Net Sales for CARMOL^®40 CREAM, LOTION and GEL for the nine months ended September 30, 2004 were $18,332,000.

        For the nine months ended September 30, 2004, Kenwood Therapeutics’ Net Sales were $20,494,000, representing an increase of $8,836,000, or approximately 76%, from $11,658,000 for the nine months ended September 30, 2003. The increase in Net Sales were led by new product sales of FLORA-Q™, launched in First Quarter 2004, of $505,000 and product sales growth from ANAMANTLE^®HC of $6,803,000, PAMINE^® 2.5mg of $649,000, PAMINE^® FORTE 5mg of $486,000 and DECONAMINE^® products of $1,020,000, which were partially offset by a decline in GLUTOFAC^® ZX of $212,000.

        The overall increase in the sales of ANAMANTLE^® HC and new product sales, excluding sales as a result of initial stocking related to ZODERM^®products, KERALAC™ products and ROSULA^®NS, during the three and nine months ended September 30, 2004 were primarily due to promotional efforts, including an increase in the number of sales representatives detailing those products to high potential physicians. The increase in DECONAMINE^® products was primarily due to an increase in wholesaler buying patterns. In addition, initial stocking sales from ZODERM^® products in the First Quarter and Third Quarter 2004, KERALAC™LOTION and GEL in the Second Quarter 2004 and ROSULA^®NS in the Third Quarter 2004 significantly contributed to the increased sales in comparison to the same periods in the prior year. As a result of certain ZODERM^® products sales being initial stocking by our customers during the First Quarter 2004, ZODERM^® sales during Second Quarter and Third Quarter 2004 were significantly less than the First Quarter 2004. Further, as a result of certain other ZODERM^® products and ROSULA^®NS being initial stocking by our customers during the Third Quarter 2004, sales of those products during Fourth Quarter 2004 will most likely be significantly less than the Third Quarter 2004.

        During the Second Quarter 2003, a competitor launched a competing product with the same active ingredient as CARMOL^® 40 CREAM. During the Fourth Quarter 2003, generic competitors introduced less expensive comparable products to CARMOL^® 40 CREAM, LOTION and GEL, also with the same active ingredient. These introductions of competing products resulted in reduced demand for our CARMOL^® 40 CREAM and LOTION products during the three and nine months ended September 30, 2004, and CARMOL^® 40 GEL during the three months ended September 30, 2004, in comparison to the same periods in the prior year. In order to minimize a reduction in our overall Net Sales arising from increased competition related to the CARMOL^® 40 products, the Company has implemented life cycle management techniques, including launching new products KERALAC™ LOTION and GEL.

        During October 2004, generic competitors introduced less expensive comparable products to ANAMANTLE^®HC. As a result of the increased competition for ANAMANTLE^®HC based on price, we expect lower Net Sales for this existing ANAMANTLE^®HC product in the upcoming quarters. In order to minimize an aggregated reduction in Net Sales related to increased competition for ANAMANTLE^®HC, the Company will attempt to implement life cycle management techniques by launching line extensions. If sales of the CARMOL^®40 product line or any other material product line decreases, including ZODERM^®products, KERALAC™LOTION and GEL, ANAMANTLE^®HC, PAMINE^® or other Company products, as a result of increased competition, government regulations, wholesaler buying patterns, physicians prescribing habits or for any other reason and we fail to replace those sales, our revenues and profitability would decrease.

        COST OF SALES for the three months ended September 30, 2004 were $2,460,000, representing an increase of $852,000, or approximately 53%, from $1,608,000 for the three months ended September 30, 2003. Cost of sales for the nine months ended September 30, 2004 were $6,616,000, representing an increase of

$2,300,000, or approximately 53%, from $4,316,000 for the nine months ended September 30, 2003. The gross profit percentage for the three and nine months ended September 30, 2004 was 91% in comparison to 92% for the same periods the prior year. The gross profit percentage for Bioglan products was 80% for the period from August 10, 2004, to the date of acquisition, through September 30, 2004. As a result of the Bioglan purchase occurring in the middle of the Third Quarter 2004, Bioglan’s lower gross profit percentage was offset by a price increase on our legacy products. We expect a lower gross profit percentage during the Fourth Quarter 2004 due to inclusion of a three full months of Bioglan operations.

        SELLING, GENERAL AND ADMINISTRATIVE EXPENSES for the three months ended September 30, 2004 were $17,038,000, representing an increase of $7,355,000, or 76%, compared to $9,683,000 for the three months ended September 30, 2003. Selling, general and administrative expenses for the nine months ended September 30, 2004 were $42,977,000, representing an increase of $15,470,000, or 56%, compared to $27,507,000 for the nine months ended September 30, 2003. The increase in selling, general and administrative expenses reflects increased spending on sales and marketing to implement our strategy of aggressively marketing our dermatology, podiatry and gastrointestinal brands. The following table sets forth the increase in certain expenditures for the periods indicated:

* Increases in travel and entertainment primarily relate to increased number of sales representatives and travel associated with increased number of conventions attended by Company personnel.

** Total research and development expenses for the three and nine months ended September 30, 2004 were $114,000 and $629,000, respectively.

        Selling, general and administrative expenses as a percentage of Net Sales were 60% for the three months ended September 30, 2004, representing an increase of 12% compared to 48% for the three months ended September 30, 2003. Selling, general and administrative expenses as a percentage of Net Sales were 56% for the nine months ended September 30, 2004, representing an increase of 2% compared to 54% for the nine months ended September 30, 2003.

        DEPRECIATION AND AMORTIZATION EXPENSES for the three months ended September 30, 2004 were $1,618,000, representing an increase of $1,309,000 from $309,000 for the three months ended September 30, 2003. Depreciation and amortization expenses for the nine months ended September 30, 2004 were $2,260,000, representing

an increase of $1,364,000 from $896,000 in the nine months ended September 30, 2003. The increase in depreciation and amortization expenses was primarily due to the purchase of amortizable intangibles and property and equipment relating to the Bioglan acquisition.

        GAIN ON INVESTMENT for the three months ended September 30, 2004 was $4,000, representing a decrease of $60,000 from $64,000 in the three months ended September 30, 2003. Gain on investment for the nine months ended September 30, 2004 was $35,000, representing a decrease of $29,000 from $64,000 for the nine months ended September 30, 2003.

        INTEREST INCOME for the three months ended September 30, 2004 was $368,000, representing an increase of $85,000 from the three months ended September 30, 2003. Interest income for the nine months ended September 30, 2004 was $1,904,000, representing an increase of $1,409,000 from the nine months ended September 30, 2003. The increases were principally due to investment of the net proceeds of $96,205,000 from the issuance of 4.6 million shares of common stock in December 2003. As a result of the Bioglan acquisition, cash and cash equivalents and short-term investments at September 30, 2004 decreased in comparison to the same date last year, and we expect a decrease in interest income during the Fourth Quarter 2004.

        INTEREST EXPENSE for the three months ended September 30, 2004 was $1,691,000, representing an increase of $1,251,000 from the three months ended September 30, 2003. Interest expense for the nine months ended September 30, 2004 was $2,736,000, representing an increase of $2,188,000 from the nine months ended September 30, 2003. The increases were principally due to interest expense related to our convertible notes, bridge loan and the credit facility which replaced the bridge loan.

        INCOME TAX EXPENSE for the three months ended September 30, 2004 was $2,401,000, representing a decrease of $832,000 from $3,233,000 for the three months ended September 30, 2003. Income tax expense for the nine months ended September 30, 2004 was $9,452,000, representing an increase of $2,222,000 from $7,230,000 for the nine months ended September 30, 2003. The effective tax rate used to calculate the income tax expense for the three and nine months ended September 30, 2004 was approximately 40%. The effective tax rate used to calculate the income tax expense for the three and nine months ended September 30, 2003 was approximately 39%. The increase in the effective tax rate during the three and nine months ended September 30, 2004 was principally due to a projected increase in the federal statutory rate, as our estimated pretax income for 2004 will result in a higher tax bracket.

        NET INCOME for the three months ended September 30, 2004 was $3,661,000, representing a decrease of $1,396,000, or 28%, from $5,058,000 for the three months ended September 30, 2003. Net income as a percentage of Net Sales for the three months ended September 30, 2004 was 13%, representing a decrease of 12% compared to 25% for the three months ended September 30, 2003. Net income for the nine months ended September 30, 2004 was $14,417,000 representing an increase of $3,108,000, or 27%,

from $11,309,000 for the nine months ended September 30, 2003. Net income as a percentage of Net Sales for the nine months ended September 30, 2004 was 19%, representing a decrease of 3% compared to 22% for the nine months ended September 30, 2003. The decrease in net income for the three months ended September 30, 2004 was principally due to an increase in selling, general and administrative expenses, depreciation and amortization expenses and interest expense partially offset by an increase in Net Sales and interest income. The increase in net income in the aggregate for the nine months ended September 30, 2004 was principally due to an increase in Net Sales and interest income partially offset by an increase in selling, general and administrative expenses, depreciation and amortization expenses and interest expense.

Recent Accounting Pronouncements

        In December 2003, the FASB issued FASB Interpretation No. 46(R), “Consolidation of Variable Interest Entities” (“FIN 46(R)”). FIN 46(R) clarifies the application of Accounting Research Bulletin 51, “Consolidated Financial Statements,” for certain entities that do not have sufficient equity at risk for the entity to finance its activities without additional subordinated financial support from other parties or in which equity investors do not have the characteristics of a controlling financial interest (“variable interest entities”). Variable interest entities within the scope of FIN 46(R) will be required to be consolidated by their primary beneficiary. The primary beneficiary of a variable interest entity is determined to be the party that absorbs a majority of the entity’s expected losses, receives a majority of its expected returns, or both. FIN 46(R) applies immediately to variable interest entities created after January 31, 2003, and to variable interest entities in which an enterprise obtains an interest after that date. It applies to us in the first fiscal year or interim period ending after December 15, 2003, to variable interest entities in which an enterprise holds a variable interest that it acquired before February 1, 2003. We adopted FIN 46(R) in December 2003. Adoption of FIN 46(R) did not have a material effect on our financial position or results of operations.

        In March 2004, the EITF reached a consensus opinion on EITF 03-6, “Participating Securities and the Two-Class Method under FASB Statement No. 128, Earnings per Share.” The EITF reached several consensuses on the definition of a participating security and when and how to apply the two-class method when an entity has any type of participating security. EITF 03-6 is effective in periods beginning after March 31, 2004. Adoption of EITF 03-6 did not have an effect.

        In March 2004, the Emerging Issues Task Force (“EITF”) reached a consensus on Issue No. 03-1, “The Meaning of Other-Than-Temporary Impairment and Its Application to Certain Investments.” This consensus clarifies the meaning of other-than-temporary impairment and its application to investments classified as either available-for-sale or held-to-maturity under SFAS No. 115, “Accounting for Certain Investments in Debt and Equity Securities,” and investments accounted for under the cost method or the equity method. The application of this guidance should be used to determine when an investment is considered impaired, whether an impairment is other than temporary, and

the measurement of an impairment loss. The guidance also includes accounting considerations subsequent to the recognition of an other-than-temporary impairment and requires certain disclosures about unrealized losses that have not been recognized as other-than-temporary impairments. The guidance for evaluating whether an investment is other-than-temporarily impaired is effective for evaluations made in reporting periods beginning after June 15, 2004. We do not believe that the application of this consensus will have a material impact on our results of operations or financial position.

        In March 2004 the FASB issued a proposed standard entitled “Share-Based Payment—An Amendment of FAS Nos. 123 and 95.” The proposed rules will eliminate the disclosure-only election under FAS 123 and require the recognition of compensation expense for stock options and other forms of equity compensation based on the fair value of the instruments on the date of grant. The FASB currently expects the final standard to be effective during 2005 for the Company. See Note B for the quarterly disclosures of the pro forma dilutive impact on net income and earnings per share of expensing stock options based on the Black-Scholes model. The FASB’s proposal advocates using a binomial (lattice-based) option pricing model rather than the Black-Scholes model we currently use to determine grant date fair value. We have not yet determined what, if any, impact using the recommended binomial model will have on our estimated net income and earnings per share dilution compared to the Black-Scholes model.

        On July 1, 2004, the Emerging Issues Task Force (the “EITF”) of the FASB reached a tentative conclusion that would require all shares that are contingently issuable under outstanding convertible notes to be considered outstanding for its diluted earnings per share computations, if dilutive, using the “if converted” method of accounting from the date of issuance. Currently these shares are only included in the diluted earnings per share computation if the common stock price has reached certain conversion trigger prices. If approved, this EITF statement (“EITF 04-8”) would also require retroactively restate prior periods diluted earnings per share. If adopted, we believe EITF 04-8 will not have a material impact on our diluted earnings per share.

Liquidity and Capital Resources

        Our cash and cash equivalents and short-term investments were $70,284,000 at September 30, 2004 and $182,503,000 at December 31, 2003. Cash provided by operating activities for the nine months ended September 30, 2004 was $8,281,000. The sources of cash primarily resulted from net income of $14,417,000 plus non-cash charges for depreciation and amortization of $2,260,000; non-cash charges for amortization of deferred financing costs of $351,000; non-cash compensation for services of $125,000; tax benefit from exercise of non-qualified stock options and warrants of $362,000; a decrease in deferred income tax assets of $217,000; and an increase in accrued expenses of $1,474,000. The sources of cash were partially offset by a gain on investment of $35,000 from sales of short-term investments; an increase in accounts receivable of $5,315,000, primarily due to the initial sales of the newly launched products being recorded during the Third Quarter 2004; an increase in inventories of $1,118,000, primarily due to initial purchases of finished goods of our newly launched products; an

increase in prepaid expenses and other of $1,258,000; a decrease in accounts payable of $580,000 primarily due to increased payments during the period; and a decrease in income taxes payable of $2,619,000, primarily due to increased tax payments.

        Cash used in investing activities for the nine months ended September 30, 2004 was $182,316,000, resulting from purchase of intangible assets of $2,600,000 relating to an international distribution agreement with Dermik Laboratories; purchase of certain assets of Bioglan Pharmaceuticals Company on August 10, 2004 and related acquisition costs of $189,761,000, which was partially financed by a $50 million bridge loan; and purchases of property and equipment of $556,000. The uses of cash were partially offset by net sales of short-term investments of $10,601,000.

        Cash provided by financing activities for the nine months ended September 30, 2004 was $72,413,000, resulting from proceeds from term note included in the credit facility dated September 28, 2004 of $75,000,000; proceeds from exercise of stock options and warrants of $1,133,000; proceeds from the bridge loan of $50,000,000; and distribution of treasury shares valued at $145,000 to fund our 401(k) plan, partially offset by deferred financing costs associated with the term note of $3,347,000; payments of registration costs associated with the sale of our common stock during December 2003 of $77,000; payments of notes payable of $24,000; payment of bridge loan of $50,000,000 and the purchase of treasury shares for $418,000.

        Our previous loan agreement with respect to a $5 million revolving asset-based credit facility and a $10 million acquisition facility was replaced on August 10, 2004 with a $50 million bridge loan from Wachovia Bank, which was replaced on September 28, 2004 with a $125 million credit facility from a syndicate of lenders led by Wachovia.

        The $125 million credit facility is comprised of a $75 million term loan and a $50 million revolving line of credit. The credit facility expires and becomes due upon the earlier to occur of (i) September 28, 2009; and (ii) May 15, 2008 if, after giving effect to a redemption of our outstanding $37 million of convertible senior subordinated notes due 2013 that may be compelled by the noteholders on June 15, 2008, we would fail to meet certain financial ratios described in the credit agreement. The credit facility is secured by a lien upon substantially all of our assets, including those of our subsidiaries, and is guaranteed by our operating subsidiaries. We intend to use the credit facility for general corporate purposes, including potential acquisitions and the repayment we made of the former bridge loan.

        Amounts outstanding under the credit facility accrue interest at our choice from time to time of either (i) the base rate (which is equal to the greater of the applicable prime rate or the federal funds rate plus 1/2 of 1%) plus 1.00% to 1.75%, depending upon our leverage ratio; or (ii) a rate equal to the sum of the applicable LIBOR rate plus 2.00% to 2.75%, depending upon our leverage ratio. In addition, the lenders under the credit facility are entitled to customary facility fees based on unused commitments under the facility and outstanding letters of credit.

        The financial covenants under the credit facility require that we maintain (i) a senior funded debt to EBITDA ratio less than or equal to 2.50 to 1.00 prior to June 20, 2005, 2.25 to 1.00 from July 1, 2005 through June 30, 2006 and 2.00 to 1.00 from July 1, 2006 through maturity; (ii) a funded debt to EBITDA ratio less than or equal to 3.00 to 1.00 prior to June 30, 2005, 2.75 to 1.00 from July 1, 2005 through June 30, 2006 and 2.50 to 1.00 from July 1, 2006 through maturity; and (iii) a fixed charge coverage ratio (which is a ratio of (A) EBITDA minus consolidated capital expenditures to (B) the sum of consolidated interest expenses, funded debt payments, cash taxes paid and certain restricted payments) greater than or equal to 1.20 to 1.00. As of September 30, 2004, we are in compliance with those covenants, the entire $75 million term loan is outstanding and no amounts are outstanding under the revolving credit facility.

        As stated in our Form 8-K filed with the SEC on August 12, 2004, statements of income and cash flows for the Bioglan business for any period prior to March 22, 2002, the date on which the Bioglan business was acquired by Quintiles, were not available or able to be produced by Quintiles. Due to the significance of this acquisition to us, among other factors, we were unable to obtain a waiver from the SEC of the requirement to include the pre-March 22, 2002 statements of income and cash flows. Once we have filed audited financial statements that include the operations of the Bioglan business for an appropriate post-closing period, we intend to again seek a waiver from the SEC concerning its omission of those financial statements, which would allow us to have future registration statements for our securities declared effective by the SEC, though we cannot assure whether or when that waiver may be granted. Until we are able to have registration statements for public offerings of our securities declared effective by the SEC, we would need to pursue additional borrowings or private placements of securities if desired to conduct a financing, which could result in increased costs or other less favorable terms compared to public offerings.

        As of September 30, 2004, we had the following contractual obligations and commitments:

        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 during that period.

Critical Accounting Policies

        In preparing financial statements in conformity with accounting principles generally accepted in the U.S., 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:

        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 typically do not provide any form of price protection to our wholesale customers and we typically permit product returns only if the product is damaged or if it is returned within six to twelve months of expiration and twelve months after expiration.

        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 payers, 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, returns and rebates based upon various factors, including current contract prices, historical trends and our future expectations. The amount of actual chargebacks, returns 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 prior to 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 revenues. 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. If we over or under estimate the level of sales, which 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 prior to January 1, 2002, 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:

        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 amount is less than the asset’s value, we measure any impairment based on a 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.

        As of January 1, 2002, we adopted Statement of Financial Accounting Standards (“SFAS”) No. 142, “Goodwill and Other Intangible Assets,” which eliminated the amortization of purchased goodwill. Adoption of this standard did not have a material effect on our financial statements. Upon adoption of SFAS No. 142, we performed an impairment test of our goodwill, which amounted to $289,328 at January 1, 2002, and determined that no impairment of the recorded goodwill existed. The fair value of our Doak Dermatologics subsidiary that we acquired in January 1995 was calculated on the basis of discounted estimated future cash flows and compared to the related book value. Under SFAS No. 142, goodwill will be 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, 2003, and noted that no impairment existed.

        As of January 1, 2002, we also adopted SFAS No. 144, “Accounting for the Impairment or Disposal of Long-lived Assets,” which supersedes SFAS No. 121, “Accounting for the Impairment of Long-lived Assets and for Long-lived Assets to be Disposed of.” The adoption of SFAS No. 144 had no effect on our financial statements.

        Deferred income taxes are provided for the future tax consequences attributable to the differences between the carrying amounts of assets and liabilities and then respective tax base. Deferred tax assets are reduced by a valuation allowance when, in our opinion, it is more likely than not that some portion of the deferred tax assets will not be realized. As of September 30, 2004 and December 31, 2003, we determined that no deferred tax asset valuation allowance was necessary, and we eliminated our previously established valuation allowance. We believe that our projections of future taxable income makes it more likely than not that these deferred tax assets will be realized. If our projections of future taxable income changes in the future, we may be required to reduce deferred tax assets by a valuation allowance.

Certain Risk Factors Affecting Our Business and Prospects

        There are many factors that may affect our business and the results of our operations, some of which are beyond our control. These factors include:

        For a discussion of these and other factors affecting our business and prospects, see “Item 1. Business — Risk Factors That May Affect Future Results” in our Annual Report on Form 10-K for the year ended December 31, 2003.

Item 3. Quantitative and Qualitative Disclosures Concerning Market Risks

        Our operating results and cash flows are subject to fluctuations from changes in foreign currency exchange rates and interest rates.

        Our purchases of ENTSOL^® SPRAY are made in Euros. We expect to make purchases several times per year. During 2003, our cost of sales relating to ENTSOL^® SPRAY was $214,492.

        We purchase finished goods and samples from a Canadian company, Groupe Parima Inc. Our purchases from Groupe Parima are made in U.S. dollars, but are subject currency fluctuations if the quarterly average Canadian dollar per U.S. dollar is outside of a previously negotiated range. The range has a cap of $1.51 Canadian dollars per U.S. dollar and a floor of $1.29 Canadian dollars per U.S. dollar. If the average Canadian dollar per U.S. dollar at the end of each calendar quarter is less than $1.29, Groupe Parima will invoice us the difference multiplied by the sum of all invoices initiated during the calendar quarter. If the average Canadian dollar per U.S. dollar at the end of each calendar quarter is more than $1.51, we will invoice Groupe Parima the difference multiplied by the sum of all invoices initiated during the calendar quarter. During 2003, our expenses, in U.S. dollars, relating to Groupe Parima finished goods and samples were $5,125,150. If the average Canadian dollar per U.S. dollar, based upon 2003 expenses, were $0.01 less than $1.29, we would have incurred an additional $39,720 in additional expenses.

        While the effect of foreign currency translations has not been material to our results of operations to date, currency translations on import purchases could be affected adversely in the future by the relationship of the U.S. dollar to foreign currencies. In addition, foreign currency fluctuations can have an adverse effect upon exports, even though we recognize sales to international wholesalers in U.S. dollars. Foreign currency fluctuations can directly affect the marketability of our products in international markets.

        We are exposed to fluctuations in interest rates on borrowings under credit facility, which currently we have borrowed $75 million. The interest rates payable on these borrowings are based on LIBOR. If LIBOR rates were to increase by 1%, our annual interest expense on variable rate debt would increase by approximately $750,000.

        As of September 30, 2004, we had the following outstanding debt with fixed rate interest:

        Our interest income is also exposed to interest rate fluctuations on our short-term investments that are comprised of U.S. government treasury notes, which we hold on an available-for-sale basis. We have not entered into derivative financial instruments.

Item 4. Controls and Procedures

        We maintain a set of disclosure controls and procedures that are designed to ensure that information required to be disclosed in the reports that we file under the Securities Exchange Act of 1934, as amended (“Exchange Act”), is recorded, processed, summarized and reported within the time periods specified in the SEC’s rules and regulations. We carried out an evaluation under the supervision and with the participation of management, including our President and Chief Executive Officer and our Chief Financial Officer, of the effectiveness of the design and operation of Bradley’s disclosure controls and procedures pursuant to Rule 13a-15(b) of the Exchange Act as of the end of the period covered by this report. Our President and Chief Executive Officer and Chief Financial Officer concluded that our disclosure controls and procedures provide reasonable assurance as of the end of the period for which the report is being filed that (i) information required to be disclosed in our reports under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in the SEC’s rules and forms and (ii) such information is accumulated and communicated to our management, including our President and Chief Executive Officer and our Chief Financial Officer, as appropriate, to allow timely decisions regarding required disclosure.

        We are committed to a continuing process of identifying, evaluating and implementing improvements to the effectiveness of our disclosure and internal controls and procedures. Our management, including our President and Chief Executive Officer and Chief Financial Officer, does not expect that our controls and procedures will prevent all errors. Because of the inherent limitations in all control systems, no evaluation of controls can provide absolute assurance that all control issues within Bradley have been or will be detected.

        There has not been any change in our internal controls over financial reporting that occurred during the nine months ended September 30, 2004 that has materially

affected, or is reasonably likely to materially affect, our internal controls over financial reporting.

PART II – OTHER INFORMATION

Item 1. Legal Proceedings

Dermik/Aventis Litigation

        We entered into a settlement agreement with Dermik, dated as of June 30, 2004, in which the parties agreed to settle all legal proceedings between them involving patents owned by us relating to dermatologic compositions with approximately 21% to 40% urea and their therapeutic uses.

DPT Lakewood Litigation

        On February 25, 2003, we filed an action in the United States District Court for the District of New Jersey against DPT Lakewood, Inc., an affiliate of DPT Laboratories Ltd. In this lawsuit, we alleged, among other things, that DPT Lakewood breached a confidentiality agreement and misappropriated our trade secrets relating to CARMOL^®40 CREAM. During 1999, we provided, in accordance with a confidentiality agreement entered into for the possible manufacture of our CARMOL^®40 CREAM, substantial trade secret information to a company of which we believed DPT Lakewood is a successor, including processing methods and formulations essential to the manufacture of CARMOL^®40 CREAM. DPT Lakewood currently manufactures a 40% urea cream for Dermik and Aventis. Among other things, we sought damages from DPT Lakewood for misappropriation of our trade secrets. DPT Lakewood counterclaimed against us seeking a declaration of invalidity and non-infringement of the patents in question and making a claim for interference with contract and prospective economic advantage. The patent claims and counterclaims were recently dismissed with the consent of both parties. This dismissal led to the successful application to have remaining state law based claims and counterclaims dismissed without prejudice for lack of subject matter jurisdiction.

        On June 3, 2004, DPT Lakewood instituted a New Jersey state court action against us asserting the common law defamation and tortious interference claims that were recently dismissed by the federal court for lack of subject matter jurisdiction. Our response to the complaint (a motion to dismiss) was recently denied, however, the appellate court has returned this matter to the trial court for reconsideration.

        On March 6, 2003, DPT Laboratories, Ltd., filed a lawsuit against us alleging defamation arising from our press release announcing commencement of the litigation against DPT Lakewood. On July 11, 2003, the District Court for the Western District of Texas denied our motion to dismiss. DPT Laboratories recently designated an expert opining that it has suffered over $1 million in damages as a result of our allegedly defamatory comment in a press release regarding the New Jersey patent infringement litigation. We have subsequently identified an expert witness in the case calling into

serious question both the methodology and the facts upon which DPT Laboratories’ expert based that opinion.

        DPT Laboratories and we are actively engaged in negotiations to resolve our dispute, but there can be no assurance that an amicable resolution, on favorable terms, will be obtained.

General Litigation

        We and our operating subsidiaries are parties to other routine actions and proceedings incidental to our 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 business, financial condition or results of operations.

Item 2. Changes in Securities, Use of Proceeds and Issuer Purchases of Equity Securities

        During September 2004, our previously announced program to repurchase up to $4 million of outstanding common stock expired. During September 2004, prior to the plan’s expiration, we repurchased 20,000 shares at a cost of $418,077. We had repurchased, from the plan’s inception during September 2002, a total of 117,713 shares at a cost of $1,474,102.

        On October 27, 2004, our Board of Directors approved a program to repurchase up to $8 million of our outstanding common stock. Repurchases are currently subject, however, to a restriction under our recently established $125 million credit facility, which limits the aggregate repurchases of stock by us 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.

The following table summarizes our repurchases of our common stock since January 1, 2004: