UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C.  20549

FORM 10-Q

(Mark One)

For the quarterly period ended March 31, 2005

or

For the transition period from               to               

Commission File Number  1-10581

BENTLEY PHARMACEUTICALS, INC.

(Exact name of registrant as specified in its charter)

Bentley Park, 2 Holland Way, Exeter, New Hampshire  03833

(Current Address of Principal Executive Offices)

Registrant’s telephone number, including area code:  (603) 658-6100

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  ý    NO  o

Indicate by check mark whether the registrant is an accelerated filer (as defined in rule 12b-2 of the Exchange Act).
YES  ý     NO  o

The number of shares of the registrant’s common stock outstanding as of May 9, 2005 was 21,321,731.

Bentley Pharmaceuticals, Inc. and Subsidiaries

Form 10-Q for the Quarter Ended March 31, 2005

Index

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Bentley Pharmaceuticals, Inc. and Subsidiaries

Consolidated Balance Sheets

The accompanying Notes to Condensed Consolidated Financial Statements are an integral part of these financial statements.

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Bentley Pharmaceuticals, Inc. and Subsidiaries

Consolidated Income Statements

The accompanying Notes to Condensed Consolidated Financial Statements are an integral part of these financial statements.

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Bentley Pharmaceuticals, Inc. and Subsidiaries

Consolidated Statement of Changes in Stockholders’ Equity

The accompanying Notes to Condensed Consolidated Financial Statements are an integral part of these financial statements.

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Bentley Pharmaceuticals, Inc. and Subsidiaries

Consolidated Statements of Cash Flows

The accompanying Notes to Condensed Consolidated Financial Statements are an integral part of these financial statements.

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The accompanying Notes to Condensed Consolidated Financial Statements are an integral part of these financial statements.

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Bentley Pharmaceuticals, Inc. and Subsidiaries

Notes to Condensed Consolidated Financial Statements

History and Operations

Bentley Pharmaceuticals, Inc. and Subsidiaries (which may be referred to as Bentley Pharmaceuticals, Bentley, or the Company), headquartered in the U.S., is an international specialty pharmaceutical company, incorporated in the State of Delaware, focused on:

•                  development, licensing and sales of generic and branded pharmaceutical products and active pharmaceutical ingredients (API) and the manufacturing of pharmaceuticals for others; and

•                  research, development and licensing/commercialization of advanced drug delivery technologies and pharmaceutical products.

Bentley’s pharmaceutical product sales and licensing activities are based primarily in Spain, where it has a significant commercial presence and manufactures and markets approximately 120 pharmaceutical products through three wholly-owned Spanish subsidiaries; Laboratorios Belmac, Laboratorios Davur and Laboratorios Rimafar. Bentley’s products include various dosage strengths and product formulations of more than 30 chemical entities in four primary therapeutic areas: cardiovascular, gastrointestinal, neurological and infectious diseases. The Company continually adds to its product portfolio in response to increasing market demand for generic and branded therapeutic agents and, when appropriate, divests portfolio products considered to be redundant or that have become non-strategic.  Although most of the Company’s sales of these products are currently in the Spanish market, it has recently focused on increasing sales in other European countries and other geographic regions through strategic alliances with companies in these territories.  In April 2004, the Company purchased a manufacturing facility located in Zaragoza, Spain that specializes in the manufacture of active pharmaceutical ingredients. The facility has been approved by the U.S. Food and Drug Administration for the manufacture of one ingredient for marketing and sale in the U.S. The Company manufactures and markets these products through its subsidiary, Bentley API.

The Company has U.S. and international patents and other proprietary rights to technologies that facilitate the absorption of drugs. Bentley is developing products that incorporate its drug delivery technologies and has licensed applications of its proprietary CPE-215® drug delivery technology to Auxilium Pharmaceuticals, Inc., which launched Testim® in the U.S. market, in February 2003.  Testim, which incorporates Bentley’s CPE-215 drug delivery technology, is a gel indicated for testosterone replacement therapy. Bentley continues to seek other pharmaceutical and biotechnology companies to form additional strategic alliances to facilitate the development and commercialization of other products using its drug delivery technologies, including product formulations that deliver insulin to diabetic patients intranasally and that treat nail fungus infections topically.

Basis of Condensed Consolidated Financial Statements

The condensed consolidated financial statements of Bentley Pharmaceuticals as of March 31, 2005 and for the three months ended March 31, 2005 and 2004, included herein, have been prepared by the Company, without audit, pursuant to the rules and regulations of the Securities and Exchange Commission.  Certain information and footnote disclosures normally included in financial statements prepared in accordance with accounting principles generally accepted in the United States of America have been condensed or omitted insofar as such information was disclosed in the Company’s consolidated financial statements for the year ended December 31, 2004.  These condensed consolidated financial statements should be read in conjunction with the summary of significant accounting policies and the audited consolidated financial statements and notes thereto included in Bentley’s Annual Report on Form 10-K for the year ended December 31, 2004.

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In the opinion of management, the accompanying unaudited condensed consolidated financial statements as of March 31, 2005 and for the three months ended March 31, 2005 and 2004 are presented on a basis consistent with the audited consolidated financial statements for the year ended December 31, 2004 and contain all adjustments, consisting only of normal recurring adjustments, necessary to present fairly Bentley’s financial position as of March 31, 2005 and the results of its operations and cash flows for the three months ended March 31, 2005 and 2004.  The results of operations for the three months ended March 31, 2005 should not necessarily be considered indicative of the results to be expected for the full year ending December 31, 2005.

Cash and cash equivalents

The Company considers all highly liquid investments with remaining maturities of three months or less when purchased to be cash equivalents for purposes of classification in the Consolidated Balance Sheets and the Consolidated Statements of Cash Flows. Investments in securities that do not meet the definition of cash equivalents are classified as marketable securities in the Consolidated Balance Sheets.

Included in cash and cash equivalents at March 31, 2005 and December 31, 2004 are approximately $5,023,000 and $3,684,000 respectively, of short-term investments considered to be cash equivalents, as the original maturity dates of such investments were three months or less when purchased.

Marketable securities

The Company has investments in securities, with maturities of greater than three months when purchased, which are classified as available-for-sale, totaling $500,000 as of March 31, 2005, compared to $528,000 as of December 31, 2004. The Company’s investments are carried at amortized cost which approximates fair value due to the short-term nature of these investments.  Accordingly, no unrealized gains or losses have been recognized on these investments. Should the fair values differ significantly from the amortized costs, unrealized gains or losses would be included as a component of other comprehensive income (loss).

Receivables

Receivables consist of the following (in thousands):

Inventories

Inventories are stated at the lower of cost or market, cost being determined on the first in, first out (“FIFO”) method. Reserves for slow moving and obsolete inventories are provided based on historical experience and current product demand.

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Balances are comprised of the following (in thousands):

Fixed assets

Fixed assets consist of the following (in thousands):

In order to support the Company’s growth in Europe, management is adding additional capacity to its pharmaceutical products manufacturing facility through a series of improvements. The Company invested approximately $1,702,000 in capital additions during the three months ended March 31, 2005.

Depreciation expense of approximately $84,000 and $70,000 has been charged to operations as a component of depreciation and amortization expense in the Consolidated Income Statements for the three months ended March 31, 2005 and 2004, respectively. Depreciation totaling approximately $810,000 and $482,000 has been included in cost of net product sales during the three months ended March 31, 2005 and 2004, respectively.

Stockholders’ equity

A substantial amount of the Company’s business is conducted in Europe and is therefore influenced by fluctuations in the U.S. Dollar’s value in relation to other currencies, specifically the Euro. The exchange rates at March 31, 2005 and December 31, 2004 were .77 Euros and .73 Euros per U.S. Dollar, respectively. The weighted average exchange rates for the three months ended March 31, 2005 and 2004 were .76 Euros and .81 Euros per U.S. Dollar, respectively. The net effect of foreign currency translation on the Company’s Condensed Consolidated Financial Statements for the three months ended March 31, 2005 was a net decrease of $3,185,000 and the cumulative historical effect as of March 31, 2005 left a balance of $6,537,000, as reflected in the Consolidated Balance Sheets as accumulated other comprehensive income. The carrying value of assets and liabilities can be materially affected by foreign currency translation, as can the translated amounts of revenues and expenses. Nonetheless, management does not plan to modify its business practices.

During the three months ended March 31, 2005, the Company issued approximately 8,000 shares of Common Stock as equity-based compensation in lieu of cash contributions to the Company-sponsored 401(k) retirement savings plan.  Employees were granted stock options to purchase 370,000 shares of Common Stock in the same period.

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Revenue recognition

Revenue on product sales is recognized when persuasive evidence of an arrangement exists, the price is fixed and final, delivery has occurred and there is a reasonable assurance of collection of the sales proceeds.  The Company generally obtains purchase authorizations from its customers for a specified amount of product at a specified price and considers delivery to have occurred when the customer takes possession of the product.  The Company provides its customers with a limited right to return.  Revenue is recognized upon delivery and a reserve for sales returns is recorded when considered appropriate.  The Company has demonstrated the ability to make reasonable and reliable estimates of product returns in accordance with Statement of Financial Accounting Standards (SFAS) No. 48, Revenue Recognition When Right of Return Exists, and of allowances for doubtful accounts based on significant historical experience.

Revenue from service, research and development, and licensing and supply agreements is recognized when the service procedures have been completed or as revenue recognition criteria have been met for each separate unit of accounting as defined in Emerging Issues Task Force (EITF) Issue No. 00-21, Accounting for Revenue Arrangements with Multiple Deliverables.  The Company has deferred the recognition of approximately $2,628,000 and $2,147,000 of licensing revenues as of March 31, 2005 and December 31, 2004, respectively, for which the revenue recognition requirements had not yet been met.

Royalty revenues on Testim product sales are currently recognized based on an estimate of Auxilium’s sell-through of the Testim product based on prescriptions filled. For the three months ended March 31, 2005 and 2004, the Company recognized royalty revenues of $870,000 and $554,000, respectively. Under SFAS No. 48, the Company cannot recognize its royalty revenues earned on product shipments of Testim until product returns related to those shipments can be reasonably estimated. At such time the Company expects to record a one-time increase in licensing and collaboration revenues related to the recognition of previously deferred royalty revenues. As of March 31, 2005 and December 31, 2004, deferred income from Testim royalties totaled $1,333,000 and $1,233,000, respectively.

Provision for income taxes

As a result of reporting taxable income in Spain, the Company recorded a provision for foreign income taxes totaling $1,590,000 and $921,000 for the three months ended March 31, 2005 and 2004, respectively. These amounts represent 34% and 37% of the pre-tax income reported in Spain of $4,678,000 and $2,482,000 for the three months ended March 31, 2005 and 2004, respectively.

As future domestic operating profits cannot be reasonably assured, no tax benefit has been recorded for U.S. losses, which totaled $918,000 and $752,000 for the three months ended March 31, 2005 and 2004, respectively. Accordingly, the Company has established a valuation allowance equal to the full amount of the U.S. deferred tax assets. The provisions for income taxes differ from the amounts computed by applying the U.S. federal income tax rate of 34% to pre-tax income, primarily as a result of the increase in the valuation allowance to offset U.S. deferred tax assets, certain nondeductible expenses in Spain and the higher statutory income tax rate of 35% in Spain.

Should the Company determine that it is more likely than not that it will realize certain of its deferred tax assets for which it had previously provided a valuation allowance, an adjustment would be required to reduce the existing valuation allowance.

Basic and diluted net income per common share

Basic and diluted net income per common share is based on the weighted average number of shares of common stock outstanding during each period. The dilutive effect of outstanding stock options and stock purchase warrants, as calculated using the treasury stock method, were considered in the net income per share calculations for the three months ended March 31, 2005 and 2004.

The following is a reconciliation between basic and diluted net income per common share for the three months ended March 31, 2005 and 2004.  Dilutive securities issuable for the three months ended March 31, 2005 include approximately 1,215,000 dilutive incremental shares issuable as a result of various stock options that are outstanding. Dilutive securities issuable for the three months ended March 31, 2004 included approximately 2,187,000 dilutive incremental shares issuable as a result of various stock options and warrants that were outstanding.

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For the Three Months Ended March 31, 2005 (in thousands, except per share data):

For the Three Months Ended March 31, 2004 (in thousands, except per share data):

Excluded from the diluted EPS presentation, because their exercise prices were greater than the average fair value of the Common Stock in the respective periods, were options to purchase an aggregate of approximately 1,558,000 and 642,000 shares of Common Stock, for the three months ended March 31, 2005 and 2004, respectively.

Equity-based compensation

The Company has equity-based employee compensation plans that are described more fully in Note 11 of the Notes to Consolidated Financial Statements included in the Annual Report on Form 10-K for the year ended December 31, 2004.  The Company currently accounts for these plans under the recognition and measurement principles of Accounting Principles Board (APB) Opinion No. 25, Accounting for Stock Issued to Employees, and related Interpretations.  However, the Company is required to adopt SFAS No. 123 (Revised), Share-Based Payment as of January 1, 2006, which will change the method the Company uses to account for its equity-based compensation. Stock options granted under these plans have exercise prices equal to or greater than the market value of the underlying common stock on the dates of grant, which is generally the date on which compensation is measured. In addition to these plans, the Company also sponsors a 401(k) Plan for eligible employees and matches eligible contributions with shares of the Company’s Common Stock.

General and administrative expenses for the three months ended March 31, 2005 and 2004 include approximately $13,000 and $32,000, respectively, of non-cash equity-based compensation. Research and development expenses for the three months ended March 31, 2005 and 2004 include approximately $46,000 and $28,000, respectively, of non-cash equity-based compensation.

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The following table illustrates the effect on net income per share if the Company had applied the fair value recognition provisions of SFAS No. 123, Accounting for Stock-Based Compensation, to equity-based employee compensation (in thousands, except per share data):

The preceding pro forma results were calculated using the Black-Scholes option pricing model with the following weighted average assumptions (results may vary depending on the assumptions applied within the model):

Reclassifications

Certain prior period depreciation amounts have been reclassified from operating expenses to cost of net product sales to conform with the current period’s presentation.  Such reclassifications are not material to the Condensed Consolidated Financial Statements.

New Accounting Pronouncements

In December 2004, the Financial Accounting Standards Board (FASB) issued SFAS No. 123 (Revised), Share-Based Payment. This Statement is a revision of SFAS No. 123, Accounting for Stock-Based Compensation, and supersedes APB Opinion No. 25, Accounting for Stock Issued to Employees, and its related implementation guidance.  SFAS No. 123 (Revised) focuses primarily on accounting for transactions in which an entity obtains employee services in share-based payment transactions. The Statement requires entities to recognize stock compensation expense for awards of equity instruments to employees based on the grant-date fair value of those awards (with limited exceptions). On April 14, 2005, the Securities and Exchange Commission delayed the effective date of SFAS No. 123 (Revised) to the beginning of the first fiscal year after June 15, 2005. As a result, the Company anticipates adopting SFAS No. 123 (Revised) on January 1, 2006. Management is evaluating the two methods of adoption allowed by SFAS No. 123 (Revised), the modified-prospective transition method and the modified-retrospective transition method, and the related impact on its Consolidated Financial Statements.

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

You should read the following discussion and analysis together with all financial and non-financial information appearing elsewhere in this report and with our consolidated financial statements and related notes included in our Annual Report on Form 10-K for the year ended December 31, 2004, which has been previously filed with the SEC. In addition to historical information, the following discussion and other parts of this report contain forward-looking information that involves risks and uncertainties.  Our actual results could differ materially from those anticipated by such forward-looking information due to competitive factors and other risks discussed below under the caption “Important Factors That May Affect Future Results”.

Overview

We are a specialty pharmaceutical company focused on:

•                  development, licensing and sales of generic and branded pharmaceutical products and active pharmaceutical ingredients and the manufacturing of pharmaceuticals for ourselves and others in Spain, other parts of Europe and international markets, including the U.S. market; and

•                  research, development and licensing/commercialization of advanced proprietary drug delivery technologies for new and existing pharmaceutical products.

Branded and Generic Pharmaceuticals

Our pharmaceutical product sales activities are based in Spain, where we have a significant commercial presence and we manufacture and market approximately 120 pharmaceutical products.  Our products include various dosage strengths and product formulations of more than 30 chemical entities in four primary therapeutic areas: cardiovascular, gastrointestinal, neurological and infectious diseases. In 2004 approximately 30% of our product revenues were derived from two of our product lines. We market our branded and generic products to physicians and pharmacists through our three separate sales and marketing organizations based in Spain: Laboratorios Belmac, Laboratorios Davur and Laboratorios Rimafar.  As prices for prescription pharmaceuticals have been lowered in Spain by action of the Ministry of Health, which has authority to approve pharmaceutical prices, we are working to improve the efficiency of our manufacturing operations to reduce our costs, while also increasing sales.  We have recently focused on increasing our sales in other European countries and other geographic regions through strategic alliances with other generic companies and distributors in these territories.  We also target markets that offer compatible regulatory approval regimes and attractive product margins.

We also expect to grow our business by acquiring or licensing additional products to sell through our organization and our strategic alliances. We continually acquire rights to new products in response to increasing market demand for generic and branded therapeutic products and, when appropriate, we divest products that we consider to be redundant or that have become non-strategic.  For example, in November 2004, we entered into a multi-product collaboration agreement with Perrigo Company, the largest U.S. manufacturer of over-the-counter pharmaceutical and nutritional products for the store brand market, to co-develop and market in the U.S. and potentially other markets selected generic pharmaceutical products that we produce in Spain.

We also manufacture pharmaceuticals for other drug companies.  In April 2004, we purchased a manufacturing facility located in Spain that specializes in the manufacture of active pharmaceutical ingredients. The facility has been approved by the FDA for the manufacture of one ingredient for marketing and sale in the U.S. We are manufacturing and marketing these ingredients through our subsidiary, Bentley API.  In addition, our Spanish pharmaceutical product manufacturing facility produces pharmaceutical products that are marketed by other pharmaceutical companies both in Spain and in other international markets.

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Proprietary Drug Delivery Technologies and Products

We develop products that incorporate our drug delivery technologies that we have developed in the United States.  We have licensed applications of our proprietary CPE-215 drug delivery technology to Auxilium Pharmaceuticals, Inc., which launched Testim, the first product incorporating our CPE-215 drug delivery technology, in the United States in February 2003.  Testim is a gel indicated for low testosterone levels. Testim was launched in Germany in January 2005 and in the United Kingdom in April 2005. On April 25, 2005, we announced that we had entered into a license agreement with Dong Sung Pharm. Co. Ltd. for the development of an intranasal spray formulation of insulin for the South Korean market and possibly additional territories. On May 2, 2005 we announced the discovery and synthesis of a thermodynamically stable, biodegradable Nanocaplet^TM technology for the delivery of macromolecule therapeutics as a result of a four-year research collaboration with the University of New Hampshire.  We are also in discussions with other pharmaceutical and biotechnology companies to form additional strategic alliances to facilitate the development and commercialization of other products using our drug delivery technologies, including product formulations to treat nail fungus infections topically.

RESULTS OF OPERATIONS:

Three Months Ended March 31, 2005 versus Three Months Ended March 31, 2004

Revenues

Total revenues for the three months ended March 31, 2005 increased 40% from the same period in the prior year, or 34% when expressed in constant currency. An increase in the weighted average value of the Euro over the past year, in relation to the U.S. Dollar, had the effect of increasing first quarter 2005 revenues by approximately $1,081,000 compared to the first quarter of 2004. In addition to the favorable impact of currency, our current period growth was driven by increased sales to licensees and others, strong sales of omeprazole and simvastatin and sales of active pharmaceutical ingredients (API) from our API manufacturing facility that we purchased in April 2004. Our growing royalty stream from sales of Testim, the first marketed product incorporating our CPE-215 drug delivery technology, contributed approximately $870,000 to our revenues in the three months ended March 31, 2005, compared to $554,000 in the first quarter of the prior year.

Our revenues are generated through our primary sales channels of branded pharmaceuticals, generic pharmaceuticals, sales to licensees and others and licensing and collaboration revenues. The following is a summary of our revenues by sales channel and top-selling product lines:

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For the three months ended March 31, 2005:

For the three months ended March 31, 2004:

Spanish Operations.    The core of our Spanish operations has been the efficient manufacturing and in-country marketing of branded and generic pharmaceutical products.  Historically, our pharmaceutical products were sold only within Spain.  However, the execution of our long-term strategic plan over the past several years has created an opportunity for our Spanish operations to expand beyond the borders of Spain into other European countries and other countries outside of Europe. The increase in first quarter 2005 product sales is due primarily to: (1) an increase in sales of our two top selling product lines (omeprazole and simvastatin) totaling $1,691,000; (2) an increase in sales to licensees and others totaling $1,309,000; (3) an increase in the weighted average value of the Euro, in relation to the U.S. Dollar totaling $1,073,000; and (4) sales of active pharmaceutical ingredients (included in “All other products” above) totaling $688,000.

Branded Pharmaceutical Products