Unassociated Document

SECURITIES AND EXCHANGE COMMISSION

Washington, DC 20549

FORM 10-Q

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

For the quarterly period ended March 31, 2006

OR

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

For the transition period from _____ to _____

Commission File Number: 0-26372

CELLEGY PHARMACEUTICALS, INC.

(Exact name of registrant as specified in its charter)

Delaware		82-0429727
(State or other jurisdiction of incorporation or organization)		(I.R.S. Employer Identification Number)

1800 Byberry Rd., Building 13, Huntingdon Valley, PA 19006

(Address of principal executive offices, including zip code)

215-914-0900

(Registrant’s telephone number, including area code)

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Sections 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 a large accelerated filer, an accelerated filer, or a non-accelerated filer. See definition of “accelerated filer and large accelerated filer” in Rule 12b-2 of the Exchange Act. (Check one):

Large accelerated filer ¨ Accelerated filer ¨ Non-accelerated filer x

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

The number of shares outstanding of the registrant’s common stock at March 31, 2006 was 29,831,625.

CELLEGY PHARMACEUTICALS, INC.

CONTENTS OF QUARTRLY REPORT ON FORM 10-Q

			Page
PART I	FINANCIAL INFORMATION

Item 1.	Financial Statements:

		Condensed Consolidated Balance Sheets	3

		Condensed Consolidated Statements of Operations	4

		Condensed Consolidated Statements of Cash Flows	5

		Notes to Condensed Consolidated Financial Statements	7

Item 2.	Management’s Discussion and Analysis of Financial Condition and Results of Operations		17

Item 3.	Quantitative and Qualitative Disclosure of Market Risk		21

Item 4.	Controls and Procedures		21

PART II	OTHER INFORMATION

Item 1.	Legal Proceedings		22

Item 1A.	Risk Factors		22

Item 2.	Unregistered Sales of Equity Securities and Use of Proceeds		31

Item 3.	Defaults Upon Senior Securities		31

Item 4.	Submission of Matters to a Vote of Security Holders		31

Item 5.	Other Information		32

Item 6.	Exhibits		32

	Signatures		33

PART I - FINANCIAL INFORMATION

ITEM 1: Financial Statements

Cellegy Pharmaceuticals, Inc.

(a development stage company)

Condensed Consolidated Balance Sheets

(Amounts in thousands)

(Unaudited)

	March 31, 2006			December 31, 2005
Assets
Current assets:
Cash and cash equivalents	$	1,143		$	2,251
Short-term investments		—			11
Accounts receivable		439			1,085
Inventory		69			352
Prepaid expenses and other current assets		493			1,077
Total current assets		2,145			4,776
Restricted cash		—			—
Property and equipment, net		419			496
Goodwill		955			982
Intangible assets, net		109			196
Total assets	$	3,628		$	6,450
Liabilities and Stockholders' Deficit
Current liabilities:
Accounts payable	$	1,629		$	1,756
Accrued expenses and other current liabilities		1,930			2,402
Current portion of notes payable		5,081			4,976
Current portion of deferred revenue		258			303
Total current liabilities		8,898			9,437
Notes payable		237			213
Derivative instruments		247			193
Deferred revenue		3,065			3,084
Total liabilities		12,447			12,927
Commitments and contingencies (Note 12)
Stockholders' deficit:
Common stock		3			3
Additional Paid-in Capital		125,591			125,548
Accumulated other comprehensive income		250			284
Deficit accumulated during the development stage		(134,663	)		(132,312	)
Total stockholders' deficit		(8,819	)		(6,477	)
Total liabilities and stockholders' deficit	$	3,628		$	6,450

The accompanying notes are an integral part of these condensed consolidated financial statements.

Cellegy Pharmaceuticals, Inc

(a development stage company)

Condensed Consolidated Statements of Operations

(Amounts in thousands, except per share data)

(Unaudited)

	Three Months Ended March 31,							Period from June 26, 1989 (inception) toMarch 31,
		2006			2005			2006
Revenues:
Licensing and contract revenue from affiliates	$	—		$	—		$	1,145
Licensing, milestone and development funding		65			240			10,562
Grants		914			1,213			6,899
Product sales		423			153			8,195
Total revenues		1,402			1,606			26,801
Costs and expenses:
Cost of product sales		284			21			2,323
Research and development		1,106			2,777			91,362
Selling, general and administrative		2,104			4,018			49,713
Acquired in-process technology		—			—			22,332
Total costs and expenses		3,494			6,816			165,730
Operating loss		(2,092	)		(5,210	)		(138,929	)
Interest and other income		9			87			7,062
Interest and other expense		(214	)		(20	)		(2,372	)
Derivative revaluation		(54	)		57			1,025
Net income (loss)		(2,351	)		(5,086	)		(133,214	)
Non-cash Preferred Dividends		—			—			(1,449	)
Net income (loss) applicable to common stockholders
	$	(2,351	)	$	(5,086	)	$	(134,663	)
Net income (loss) per common share:
Basic	$	(0.08	)	$	(0.19	)
Diluted	$	(0.08	)	$	(0.19	)
Weighted average number of common shares used
in per share calculations:
Basic		29,832			26,136
Diluted		29,832			26,136

The accompanying notes are an integral part of these condensed consolidated financial statements.

Cellegy Pharmaceuticals, Inc.

(a development stage company)

Condensed Consolidated Statements of Cash Flows

(Amounts in thousands)

(Unaudited)


	Three Months Ended March							Period from June 26, 1989 (inception) to March 31,
		2006			2005			2006
Operating activities
Net loss	$	(2,351	)	$	(5,086	)	$	(133,214	)
Adjustments to reconcile net loss to net cash provided by (used in) operating activites:
Acquired in-process technology		—			—			22,332
Bad debt expense & other non-cash items		35			—			235
Depreciation expense		42			156			3,419
Intangible assets amortization		88			64			2,012
Loss (gain) on sale of fixed assets		36			999			1,648
Equity compensation expense		43			-			2,343
Derivative re-evaluation		54			131			(1,025	)
Interest accretion on notes payable		188			—			720
PDI settlement		—			—			2,000
Amortization of discount on notes payable and
deferred financing costs		—			—			24
Issuance of common shares for services		—			(35	)		1,041
Issuance of common stock for services rendered, interest and Neptune milestones		—			—			1,318
Changes in operating assets and liabilitites:
Prepaid expenses and other current assets		858			(590	)		(51	)
Accounts receivable		647			(78	)		(210	)
Other assets		—			(203	)		300
Accounts payable		(127	)		(287	)		349
Accrued expenses and other current liabilities		(519	)		2,556			(1,358	)
Other long term liabilities		24			(469	)		(10	)
Deferred revenue		(19	)		(1,995	)		906
Net cash used in operating activities		(1,001	)		(4,837	)		(97,221	)
Investing activities:
Purchases of property and equipment		—			(182	)		(5,507	)
Purchases of investments		—			—			(98,921	)
Sale of investments		11			—			43,521
Maturity of investments		—			—			55,305
Proceeds from restricted cash		—			—			614
Proceeds from sale of property		—			—			238
Acquisition of Vaxis and Quay and Biosyn		—			—			(816	)
Net cash provided by (used in) investing activities		11			(182	)		(5,566	)
Financing activities:
Proceeds from notes payable		—			—			8,047
Issuance of notes payable		—			—			4,444
Repayment of notes payable		(84	)		—			(6,694	)
Net proceeds from issuance of common stock		—			—			86,842
Other assets		—			—			(614	)
Issuance of convertible preferred stock, net of issuance cost
Deferred financing costs		—			—			(80	)
Net cash provided by (used in) financing activities		(84	)		—			103,703
Effect of exchange rate changes on cash		(34	)		1			227
Net increase (decrease) in cash and cash equivalents		(1,108	)		(5,021	)		1,143
Cash and cash equivalents, beginning of period		2,251			8,705			—
Cash and cash equivalents, end of period	$	1,143		$	3,684		$	1,143

The accompanying notes are an integral part of these condensed consolidated financial statements.

Cellegy Pharmaceuticals, Inc.

(a development stage company)

Condensed Consolidated Statements of Cash Flows

(Amounts in thousands)

(Unaudited)

						Period from June 26, 1989 (inception) to
	Three Months Ended March					March 31,
		2006		2005		2006
Supplemental cash flow information:
Interest paid	$	—	$	—	$	726
Supplemental disclosure of non-cash transactions:
Issuance of common stock in connection with acquired-in-process technology		—		—		7,350
Conversion of preferred stock to common stock		—		—		14,715
Issuance of common stock for notes payable		—		—		5,998
Issuance of warrants in connection with Kingsbridge financings		—		—		801
Issuance of warrants in connection with notes payable financing		—		—		959
Issuance of convertible preferred stock for notes payable		—		—		1,268
Issuance of common stock for milestone payments		—		—		1,500
Fair value of assets acquired net of liabilities assumed for
Biosyn acquisition		—		—		11,856
Interest expense amortization for long-term obligations		188		14		984

The accompanying notes are an integral part of these condensed consolidated financial statements.

Cellegy Pharmaceuticals, Inc.

(a development stage company)

Notes to Condensed Consolidated Financial Statements

(Unaudited)

Note 1: Basis of Presentation

The accompanying unaudited interim condensed consolidated financial statements have been prepared in accordance with generally accepted accounting principles for interim financial information and with the instructions to Form 10-Q and Article 10 of Regulation S-X promulgated by the Securities and Exchange Commission. Accordingly, certain information and footnote disclosures normally included in annual financial statements have been condensed or omitted. In the opinion of management, the accompanying un-audited interim condensed consolidated financial statements reflect all adjustments (including normal recurring adjustments and the elimination of inter-company accounts) considered necessary for a fair statement of all periods presented. The results of Cellegy’s operations for any interim periods are not necessarily indicative of the results of operations for any other interim period or for a full fiscal year. These un-audited interim condensed consolidated financial statements should be read in conjunction with the consolidated financial statements and footnotes thereto included in Cellegy’s Annual Report on Form 10-K for the year ended December 31, 2005.

Liquidity and Capital Resources

The accompanying interim financial statements have been prepared assuming the Company will continue as a going concern, which contemplates the realization of assets and satisfaction of liabilities and commitments in the normal course of business. However, we believe we do not have sufficient financial resources to continue operations beyond June 2006. At March 31, 2006, the Company had a deficit accumulated during the development stage of $134.7 million and recurring, negative cash flows from operations. We expect negative cash flow from operations to continue for the foreseeable future, with the need to continue or expand development programs and to commercialize products once regulatory approvals have been obtained. These factors raise substantial doubt about our ability to continue as a going concern. Our plans, with regard to these matters, include raising additional required funds through one or more of the following options, among others: sales of assets, seeking partnerships with other pharmaceutical companies or private foundations to co-develop and fund our research and development efforts, pursuing additional out-licensing arrangements with third parties, re-licensing and monetizing in the near term our future milestone and royalty payments expected from existing licensees and seeking equity or debt financing. In addition, we will continue to implement further cost reduction programs and reduce discretionary spending, if necessary.

There is no assurance that any of the above options will be implemented on a timely basis or that we will be able to obtain additional financing on acceptable terms, if at all. Alternatively, we may be required to accept less than favorable commercial terms in any such future arrangements. If adequate funds are not available on acceptable terms, we could be required to delay development or commercialization of certain products, to license to third parties the rights to commercialize certain products that we would otherwise seek to commercialize internally or to reduce resources devoted to product development. In addition, if we do not receive all, or a portion, of the planned Biosyn grant funding, or if such funding is delayed, this could impact our ability to complete our Biosyn development programs on a timely basis, if at all. The financial statements do not include any adjustments that might result from the outcome of this uncertainty. Any failure to dispel any continuing doubts about our ability to continue as a going concern could adversely affect out ability to enter into collaborative relationships with business partners, make it more difficult to obtain required financing on favorable terms or at all, negatively affect the market price of our common stock and could otherwise have a material adverse effect on our business, financial condition and results of operations.

There is a risk that one or more of our creditors could bring lawsuits to collect amounts to which they believe they are entitled. In the event of lawsuits of this type, if we are unable to negotiate settlements or satisfy our obligations, we could voluntarily file bankruptcy proceedings, or we could become the subject of an involuntary bankruptcy proceeding filed by one or more creditors against us.

Note 2: Comprehensive Loss

Comprehensive loss generally represents all changes in stockholders’ deficit except those resulting from investments or contributions by stockholders. The Company’s unrealized foreign currency translation (“FCT”) adjustments represent the only components of comprehensive loss that are excluded from the Company’s net loss.

Cellegy Pharmaceuticals, Inc.

(a development stage company)

Notes to Condensed Consolidated Financial Statements

(Unaudited)

Total comprehensive loss during the three months ended March 31, 2006 and 2005 consisted of (in thousands):

Calculation of Comprehensive Loss

	Three Months Ended March 31,
		2006			2005
Net loss	$	(2,351	)	$	(5,086	)
Change in FCT adjustments		(34	)		-
Comprehensive loss	$	(2,385	)	$	(5,086	)

Note 3: Basic and Diluted Net Income (Loss) per Common Share

Basic net loss per common share is computed using the weighted average number of common shares outstanding during the period. Diluted net loss per common share incorporates the incremental shares issued upon the assumed exercise of stock options and warrants, when dilutive. There is no difference between basic and diluted net loss per common share, as presented in the statement of operations, because all options and warrants are anti-dilutive. The total number of shares that had their impact excluded was (in thousands):

	Three Months Ended March 31,
	2006		2005
Options	$	3,659	$	4,297
Warrants		2,374		946
Total number of shares excluded	$	6,033	$	5,243

Excluded also are 2,121,212 shares that would be issuable upon conversion of the PDI Notes in 2006 (see also Note 11).

Note 4: Stock-Based Compensation

The Company’s stock holders approved the 2005 Equity Incentive Plan (the “2005 Plan”) at the Annual Meeting of Stockholders held September 28, 2005. The 2005 Plan replaces the 1995 Equity Incentive Plan (“Prior Plan”) which had expired. The 2005 Plan will be administered by the Board of Directors and the Board has delegated administration of the Plan to the Compensation Committee. The Board may at any time amend, alter, suspend, or discontinue the 2005 Plan without stockholder approval, except as required by applicable law. The 2005 Plan is not subject to ERISA and is not qualified under Section 401(a) of the Code.

The Company’s 2005 Plan allows for the granting of options to employees, directors and consultants. Options granted under the 2005 Plan may either be incentive stock options or non-qualified stock options. Incentive stock options may be granted only to employees. The Compensation Committee determines who will receive options or other awards under the 2005 Plan and their terms, including the exercise price, number of shares subject to the option or award, and the vesting and exercisability thereof. Options granted under the 2005 Plan generally have a term of ten years from the grant date, and the exercise price typically is equal to the closing price of the common stock on the grant date. Options typically vest over a three-year or four-year period. Options granted under the 2005 Plan typically expire if not exercised within 90 days from the date on which the optionee is no longer an employee, director, or consultant. The vesting and exercisability of options may also be accelerated upon certain change of control events. As of March 31, 2006 there were outstanding options to purchase 48,000 shares under the 2005 Plan and 952,000 shares were available for options for other awards under the 2005 Plan.

The total number of shares reserved and available for issuance pursuant to the exercise of Awards under the Prior Plan is 4,850,000 shares. The Prior Plan will continue to govern the stock options previously granted under the Prior Plan. The terms and conditions of the Prior Plan are substantially the same as the ones governing the 2005 Plan.

In 1995, Cellegy adopted the 1995 Directors’ Stock Option Plan (the “Directors’ Plan”) to provide for the issuance of non-qualified stock options to eligible outside Directors. When the plan was established, Cellegy reserved 150,000 shares for issuance. From 1996 to 2005, a total of 350,000 shares were reserved for issuance under the Directors’ Plan. The 2005 Plan replaces the Directors’ Plan.

The Directors’ Plan provides for the granting of initial and annual non-qualified stock options to non-employee directors. Initial options vest over a four-year period and subsequent annual options vest over three years. The exercise of options granted under the “Directors’ Plan” is the fair market value of the common stock on the grant date. Options generally expire ten years from the grant date, and generally expire within 90 days of the date the optionee is no longer a director. The vesting and exercisability of options under this plan may also be accelerated upon certain change of control events.

The compensation expense and related income tax benefit recognized in the Consolidated Statement of Operations in the first quarter of 2006 and the first quarter of 2005 for stock options was $43,000 and $0, respectively. The impact on earnings per share was $0.001 per share for the first quarter of 2006. Of the $43,000 of stock option compensation expense recognized in the first quarter of fiscal 2006, $38,000 was a component of selling, general and administrative expenses and $5,000 was a component of research and development expenses. None of the compensation costs were capitalized. No options were granted or exercised under all share-based payment arrangements for the quarter ended March 31, 2006. All of the compensation expense was derived by calculating the fair value of the unvested portion of all stock options issued after the first fiscal year beginning after December 15, 1994.

The Company continues to estimate the fair value of each option award on the date of granting using the Black-Scholes option valuation model. The company now estimates option forfeitures based on historical data and adjusts the rate to expected forfeitures periodically. The adjustment of the forfeiture rate will result in a cumulative catch-up adjustment in the period the forfeiture estimate is changed.

The fair value of each option calculated during the first quarter of fiscal 2006 and 2005 was estimated on the date of grant using the Black-Scholes option valuation model and weighted-average assumptions in the following table.

	Three Months Ended March 31, 2006			Three Months Ended March 31, 2005
Expected life in years		5.0			4.3
Expected volatility		80	%		81	%
Risk-free interest rate		3.96	%		4.24	%
Dividend yield		0	%		0	%

The status of the Company’s stock option plans at March 31, 2006, is summarized below:

2005 Equity Incentive Plan

	Shares Under Option			Weighted Average Exercise Price
Balance at December 31, 2005	49,500		$	1.34
Granted	—			—
Canceled	(1,500	)		(1.39	)
Exercised	—			—
Balance at March 31, 2006	48,000		$	1.34

The following table summarizes those stock options outstanding related to the 2005 Plan at March 31, 2006:

	Options Outstanding
Range of Exercise Prices		Weighted Average Number of Options	Weighted Average Remaining Contract Life		Exercise Price
$1.34		48,000	9.5 years	$	1.34
		48,000	9.5 years	$	1.34

There were no options exercisable under the 2005 plan as of March 31, 2006. None of the options vested in the quarter ended March 31,2006.

Prior Plan

	Shares Under Option			Weighted Average Exercise Price
Balance at December 31, 2005	2,238,737		$	4.67
Granted	—			—
Canceled	(138,790	)		(5.54	)
Exercised	—			—
Balance at March 31, 2006	2,099,947		$	4.61

The following table summarizes those stock-options outstanding and exercisable related to the Prior Plan at March 31, 2006:

	Options Outstanding					Options Exercisable
Range of Exercise Prices		Weighted Average Number of Options	Weighted Average Remaining Contract Life		Weighted Average Exercise Price		Number of Options		Weighted Average Exercise Price
$1.35 - $2.03		600,679	5.4 years	$	1.85		426,862	$	2.01
$2.89 - $3.88		520,768	2.6 years		3.52		481,602		3.57
$4.38 - $6.50		481,500	1.7 years		5.07		464,625		5.09
$7.00 - $8.81		444,000	1.9 years		7.91		444,000		7.91
$15.00		53,000	2.2 years		15.00		53,000		15.00
Total		2,099,947					1,870,089

No future options may be offered under the Prior Plan. The total fair value of the options vesting in the quarter ended March 31,2006 was $29,547.

Directors’ Stock Option Plan

	Shares Under Option		Weighted Average Exercise Price
Balance at December 31, 2005	307,500	$	4.74
Granted	—		—
Exercised	—		—
Balance at March 31, 2006	307,500	$	4.74

The following table summarizes those stock options outstanding and exercisable related to the Directors’ Plan at March 31, 2006:

	Options Outstanding				Options Exercisable
Range of Exercise Prices	Weighted Average Number of Options	Weighted Average Remaining Contractual Life		Weighted Average Exercise Price	Number of Options		Weighted Average Exercise Price
$1.34 - $3.25	35,000	5.6 years	$	2.62	35,000	$	2.62
$4.30 - $5.50	254,500	3.5 years		4.90	218,500		4.98
$6.50 - $8.50	18,000	2.3 years		6.72	18,000		6.72
Total	307,500	3.4 years	$	4.74	271,500	$	4.79

As of March 31, 2006, there were no options available for future grants under the Directors’ Plan. No additional vesting occurred in the quarter ended March 31, 2006.

Non-Plan Options

In November 2003, the Company granted an initial stock option to Mr. Richard C. Williams, on his appointment to become Chairman of the Board, to purchase 1,000,000 shares of common stock. 400,000 of the options have an exercise price equal to $2.89 per share, the closing price of the stock on the grant date and 600,000 of the options have an exercise price of $5.00 per share. The option was vested and exercisable in full on the grant date, although a portion of the option covering up to 600,000 initially and declining over time, is subject to cancellation if they have not been exercised in the event that Mr. Williams voluntarily resigns as Chairman and a director within certain future time periods. As of March 31, 2006, none of these options have been exercised.

In October 2004, in conjunction with its acquisition of Biosyn, Cellegy issued stock options to certain Biosyn option holders to purchase 236,635 shares of Cellegy common stock. All options issued were immediately vested and exercisable. During 2005, 74,446 options were exercised and 99,162 were cancelled. There was no activity in the quarter ended March 31, 2006.

The following table summarizes information about stock options outstanding and exercisable related to Biosyn option grants at March 31, 2006:

	Options Outstanding and Exercisable
Range ofExercise Prices	Number of Options	Weighted Average Remaining Contractual Life		Weighted Average Exercise Price
$0.06	11,872	2.4 years	$	0.06
$0.29	24,516	8.4 years		0.29
$1.46 - $6.83	8,564	9.3 years		1.46
$8.76	3,855	6.9 years		8.76
$14.60 - $21.02	18,503	3.9 years		18.68
Total	67,310	5.2 years	$	5.94

Shares Reserved

As of March 31, 2006, the Company has reserved shares of common stock for issuance as follows:

	Biosyn options	67,310
	Director's Plan	307,500
	Warrants	2,348,902
	Non-plan options	1,000,000
	Neptune agreement	1,080,082
	Kingsbridge SSO	3,493,601
	1995 Equity Incentive Plan	2,099,947
	2005 Equity Incentive Plan	952,000
	Total	11,349,342

Warrants

The Company has the following warrants outstanding to purchase common stock as of March 31, 2006:

Warrant

Shares

Exercise Price

Per Share

Date Issued

Expiration

Date

June 2004 PIPE Financing

604,000

4.62

July 27, 2004

July 27, 2009

Biosyn warrants

56,178

5.84-17.52

Oct. 22, 2004

2008 - 2014

Kingsbridge SSO

260,000

5.27

Jan. 16, 2004

Jan. 16, 2009

May 2005 PIPE Financing

Series A

714,362

2.25

May 13, 2005

May 13, 2010

Series B

714,362

2.50

May 13, 2005

May 13, 2010

Total

2,348,902

Options outstanding under the Company’s current plans have been granted at prices which are either equal to or above the market value of the stock on the date of grant. Options granted under the 2005 Plan generally vest over three to four years based on service conditions and expire no later than ten years after the grant date. Effective January 1, 2006, the Company generally recognizes compensation expense ratably over the vesting period (service period). As of March 31, 2006, there was $215,000 of total unrecognized compensation cost related to non-vested options, which is expected to be recognized over a remaining weighted-average vesting period of 1.8 years.

Note 5: Segment Reporting

The Company had two business segments: pharmaceuticals and skin care. The skin care segment was sold in December 2005. Pharmaceuticals include primarily research and clinical development expenses for potential prescription products to be marketed directly by Cellegy or through corporate partners.

All revenues during the three months ended March 31, 2006 and March 31, 2005 of $1,402,000 and $1,606,000, respectively, were derived from the Company’s pharmaceutical segment. Current pharmaceutical revenues consist primarily of Rectogesic® product sales in Australia, New Zealand, Singapore, United Kingdom and South Korea, grant revenue from research and clinical development trials as well the ProStrakan license revenues for Rectogesic and Tostrex® products.

Revenues from external sources by major geographic area are as follows (in thousands):

Revenues	Quarters ended March 31,
		2006		2005
North America
Pharmaceuticals	$	914	$	1,213
Skin care		—		—
Europe
Pharmaceuticals		322	$	240
Skin care		—		—
Australia & Pacific Rim
Pharmaceuticals		166		153
Skin care		—		—
	$	1,402	$	1,606

Cellegy allocates its revenues and operating expenses to each business segment. Management regularly assesses segment operating performance and makes decisions on how resources are allocated based upon segment performance, with the segment measurement of profitability being net income. The accounting policies of the reportable segments are the same as those described in the summary of significant accounting policies.

Operating Income (loss) by geographic region is as follows (in thousands):

Operating Income (Loss)	Quarters ended March 31,
		2006			2005
North America
Pharmaceuticals	$	(1,795	)	$	(4,258	)
Skin care		—			—
Europe
Pharmaceuticals		(632	)		(840	)
Skin care		—			—
Australia & Pacific Rim
Pharmaceuticals		76			12
Skin care		—			—
	$	(2,351	)	$	(5,086	)

All of the Company’s assets are related to the pharmaceutical segment and most of these assets are located in the United States. Assets by major geographic region are as follows (in thousands):

Assets	Quarters ended March 31,
		2006		2005
North America	$	2,364	$	7,413
Australia & Pacific Rim		1,263		1,336
	$	3,628	$	8,749

Note 6: Recent Accounting Pronouncements

Effective January 1, 2006, the Company began recording compensation expense associated with stock options and other forms of equity compensation in accordance with Statement of Financial Accounting Standards No. 123 (revised 2004), Share-Based Payment (SFAS 123R), as interpreted by SEC Staff Accounting Bulletin No. 107. Prior to January 1, 2006, the Company accounted for stock options according to the provisions of Accounting Principles Board Opinion No. 25, Accounting for Stock Issued to Employees (APB 25), and related interpretations, and therefore no related compensation expense was recorded for awards granted with no intrinsic value. The Company adopted the modified prospective transition method provided for under SFAS 123R and, consequently, has not retroactively adjusted results from prior periods. Under this transition method, compensation cost associated with stock options recognized in the first quarter of 2006 includes: 1) quarterly amortization related to the remaining unvested portion of all stock option awards granted prior to January 1, 2006, based on the grant date fair value estimated in accordance with the original provisions of SFAS 123, Accounting for Stock-Based Compensation; and 2) quarterly amortization related to all stock option awards granted on or subsequent to January 1, 2006, based on the grant-date fair value estimated in accordance with the provisions of SFAS 123R.

As a result of the adoption of SFAS 123R, the Company’s net loss for the quarter ended March 31, 2006, was $43,000 higher than under the Company’s previous accounting method for share-based compensation.

Prior to the adoption of SFAS 123R, the Company presented all tax benefits resulting from the exercise of stock options as operating cash flows in the Condensed Consolidated Statement of Cash Flows. SFAS 123R requires that cash flows resulting from tax deductions in excess of the cumulative compensation cost recognized for options exercised (excess tax benefits) be classified as financing cash flows. The Company has sufficient net operating loss carryforwards to generally eliminate cash payments for income taxes. Therefore, no cash has been retained as a result of excess tax benefits relating to share based payments made to directors and employees.

For stock options granted prior to the adoption of SFAS 123R, if compensation expense for the Company’s various stock option plans had been determined based upon estimated fair values at the grant dates in accordance with SFAS No. 123, the Company’s pro forma net loss and basic and diluted income per common share would have been as follows (in thousands):

		Three Months Ended
		March 31, 2005
Net loss, as reported	$	(5,086	)
Deduct: Total stock-based employee compensation costs determined under
the fair value based method for all awards		(167	)

Pro forma net loss	$	(5,253	)

Basic loss per share:
Basic and diluted net loss per common share, as reported	$	(0.19	)
Basic and diluted net loss per common share, pro forma	$	(0.20	)

The Company, on January 1, 2006, adopted FASB Statement 154, Accounting Changes and Error Corrections, a replacement of APB Opinion No. 20 and FASB Statement No. 3, which changes the requirements for the accounting for and reporting of a change in accounting principle. There was no effect upon the Company’s financial statements as a result of the adoption of this pronouncement.

Note 7: Accounts Receivable

Accounts receivable consists of the following (in thousands):

	Period Ended
	March 31, 2006		December 31, 2005
			,
Unbilled grants receivable	$	152	$	760
Trade receivables net of allowances of $26 in 2006 and $35 in 2005	286		265
Other receivables	1		60
Total	$	439	$	1,085

Note 8: Prepaid Expenses and Other Current Assets

At March 31, 2006 and December 31, 2005 this account includes the following (in thousands):

	Period Ended
	March 31, 2006		December 31, 2005
			,
Prepaid insurance	$	195	$	196
Prepaid rent	-		35
Prepaid compensation	299		803
Inventory	69		351
Other	-		44
Total	$	563	$	1,429

Prepaid compensation of $299,000 and $803,000 represents the unamortized balance of $902,000 in retention bonuses offered and accepted by employees in March and December 2005. The retention bonuses would be paid if the employee maintains his or her employment with the Company through the retention period indicated in the individual’s offer letter. The retention bonus is in lieu of all other severance or similar payments that the Company may be obligated to make under any other existing agreement. arrangement or understanding, but will be in addition to any accrued salary and vacation earned through the date of termination. The retention periods terminate on dates between January 15, 2006 and June 30, 2006.

Inventories are valued at the lower of cost or market.

Note 9: Accrued Expenses and Other Current Liabilities

The Company accrues for goods and services received but for which billings have not been received. Accruals for the following expenses and other current liabilities were made for the following expenses (in thousands):

	March 31, 2006		December 31, 2005

Clinical expenses	$	206	$	642
Legal fees	172		61
Retention bonuses and severance pay	859		1,039
Consulting fees	193		46
Kingsbridge Contract Penalty	266		-
Other	234		614
Total	$	1,930	$	2,402

Note 10: Deferred Revenue

The Company records upfront payments received from licensees as deferred revenue and amortize them to income over the life of the licensing agreement or the life of the product being licensed, whichever is longer. At March 31, 2006 total current and long-term deferred revenue of $3,323,000 substantially includes the remaining unearned portion of the upfront licensing fees received from ProStrakan Group, Limited for the right to store, promote, sell and/or distribute the Company’s Tostrex and Rectogesic products.

Note 11: Notes Payable

Notes payable at March 31, 2006 include two non-interest bearing notes issued in April 2005 by Cellegy to PDI pursuant to a lawsuit settlement signed by both parties in April 2005, and the note issued by Biosyn to Ben Franklin Technology Center of Southeastern Pennsylvania (Ben Franklin) in October 1992 for funds provided by Ben Franklin for the development of a compound to prevent transmission of AIDS. The notes have been recorded at their total net present value of $5.3 million.

The terms of the notes issued to PDI are as follows:

a.) The $3.0 million secured promissory note has an outstanding balance of $2.7 million and a net present value of $2.5 million at March 31, 2006 and is payable in October 2006. There is no stated interest rate and no periodic payments are required. Payment terms include payments to the extent of 50% of future funds to be received by Cellegy as licensing fees, royalties or milestone payments or similar payments from licensees of Cellegy’s Tostrex® (testosterone gel) and Rectogesic® (nitroglycerin ointment) products in territories outside of North America, 50% of licensing fees, royalties or milestone payments or similar payments from Fortigel licensees in North American markets, and 10% of proceeds received by Cellegy in excess of $5 million from financings. These various payments will be made until the note is paid in full. However, no regular periodic payments are required. The note is subject to a default interest rate of 12%.

b.) The $3.5 million non-negotiable senior convertible debenture stated at its net present value of $2.6 million has a maturity date of April 11, 2008, three years from the PDI settlement date of April 11, 2005. There is no stated interest rate and no periodic payments are required. Cellegy may redeem the note at anytime before the maturity date upon prior notice to PDI, at a redemption price equal to the principal amount. If Cellegy delivers such a redemption notice, PDI may convert the note into shares of Cellegy common stocks at a price of $1.65 per share. In addition, after the 18^th month anniversary of the debenture, PDI may convert the note into Cellegy common stock at a price of $1.65 per share. If Cellegy does redeem the note within the first 18 months, then Cellegy has agreed to file a registration statement relating to the possible resale of any shares issued to PDI after 18 months; approximately 2.1 million shares would be issuable upon such conversion. As long as amounts are owed under the note, Cellegy has agreed not to incur or become responsible for any indebted ness that ranks contractually senior or pari passu in right of payment to amounts outstanding under the note. Events of default under the senior note are generally similar to events of default under the secured note.

The net present value of the secured $3.0 million note will be recalculated based on its remaining principal whenever a payment is made by Cellegy.

The Ben Franklin note has a face value of $778,000 and net present value of $229,000 at March 31, 2006. The note has no scheduled repayment term. Payment is based on 3% of Biosyn’s revenues excluding other research and development grants.

At March 31, 2006, future minimum payments on the notes were payable as follows (in thousands):

2006	$	2,717
2007		—
2008		3,500
2009 and thereafter		778
Total payments		6,995
Less: Amount representing discount		(1,677	)
Net present value of notes at March 31, 2006	$	5,318

Note 12: Derivative Instruments.

The warrants from the May 2005 PIPE financing and Kingsbridge SSO are revalued at the end of each reporting period as long as they remain outstanding. The estimated fair value of all warrants, using the Black-Scholes valuation model, recorded as derivative liability at March 31, 2006 and December 31, 2005 was $247,000 and $193,000. The changes in the estimated fair value of the warrants have been recorded as other income and expense in the income statement. For the three months ended March 31, 2006 and 2005, the Company recognized a $54,000 expense and a $57,000 income respectively from derivative revaluation.

Note 13: Commitments and Contingencies

Legal Proceedings

The litigation with PDI is in the initial stages of discovery. There have been no substantial changes in the status of the PDI lawsuit since December 31, 2005.

Note 14: Subsequent Events

On April 11, 2006, Epsilon Pharmaceuticals, a company located in Australia, acquired all of the shares of Cellegy Australia PTY LTD, formerly a wholly owned subsidiary of Cellegy, in exchange for cash of approximately $1.25 million paid at closing. Cellegy is entitled to receive certain additional payments pursuant to the collection of its accounts receivable balance at closing.

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 to those statements included elsewhere in this Quarterly Report on Form 10-Q and our audited financial statements for the year ended December 31, 2005 included in our Annual Report on Form 10-K previously filed with the SEC. This discussion may contain forward-looking statements that involve substantial risks and uncertainties. These forward-looking statements are not historical facts, but are based on current expectations, estimates and projections about our industry, our beliefs and our assumptions. Words such as “believes,” “anticipates,” “expects,” “intends” and similar expressions are intended to identify forward-looking statements, but are not the exclusive means of identifying such statements. These forward-looking statements are not guarantees of future performance and concern matters that could subsequently differ materially from those described in the forward-looking statements. Actual events or results may also differ materially from those discussed in this Quarterly Report on Form 10-Q. These risks and uncertainties include those described in “Management’s Discussion and Analysis of Financial Condition and Results of Operations - Factors That May Affect Future Operating Results” and elsewhere in this Quarterly Report on Form 10-Q. Except as required by law, we undertake no obligation to revise any forward-looking statements in order to reflect events or circumstances that may arise after the date of this Quarterly Report on Form 10-Q.

General

Cellegy Pharmaceuticals is a development stage specialty biopharmaceutical company engaged in the development and commercialization primarily of prescription drugs targeting women’s health care conditions, including HIV prevention and sexual dysfunction, as well as gastrointestinal conditions using proprietary topical formulations and nitric oxide donor technologies.

Recent Events

On January 16, 2006, Cellegy entered into an amendment of its Exclusive License and Distribution Agreement dated July 9, 2004, with ProStrakan Group PLC, whereby ProStrakan will assume responsibility for all of the manufacturing and other product support functions for Tostrex in Europe. In December 2004, the product was approved by the MPA for sale in Sweden.

On February 1, 2006, Cellegy announced that it had entered into a non-exclusive, developing world licensing agreement with CONRAD for the collaboration on the development of Cellegy’s entire microbicide pipeline. The agreement encompasses the licensing of Savvy currently in Phase 3 clinical trials in the United States and Africa; UC-781, currently in expanded Phase 1 trials in the United States and Thailand; and Cyanovirin-N, currently in pre-clinical development.

On March 24, 2006, the Company announced that its European marketing partner, ProStrakan had successfully completed the European Union Mutual Recognition Procedure for Rectogesic. Following the successful conclusion of the MRP process, national licenses will be sought and are expected to be issued in due course in the 19 additional countries (in addition to the United Kingdom where approvals have been previously obtained) included in the MRP submission application. Cellegy is entitled to receive $250,000 for each marketing regulatory approval obtained in the first of any three countries out of France, Italy, Germany or Spain up to a maximum total amount payable of $750,000. Under its previous agreement with PDI, Inc., PDI is entitled to receive one-half of these payments.

On April 11, 2006, Epsilon Pharmaceuticals, a company located in Australia, acquired all of the shares of Cellegy Australia PTY LTD, formerly a wholly owned subsidiary of Cellegy, in exchanges for cash of approximately $1.25 million paid at closing. Cellegy is entitled to receive certain additional payments pursuant to the collection of its accounts receivable balance at closing.

On April 25, 2006, the FDA’s Cardiovascular Renal Drugs Advisory Committee (the “Committee”) met to review the Company’s New Drug Application relating to its Cellegesic™ (0.4% nitroglycerin ointment) product for reduction of pain associated with anal fissures. The Committee voted on three questions in connection with its review:

1.	A majority of the Committee agreed that the quadratic model was the proper analysis for the purpose of decision-making.

2.	A majority of the Committee found that, taking all three studies into consideration, the data is compelling that there is an effect of nitroglycerin ointment on the pain associated with anal fissures.

3.	In its final vote, six members of the Committee voted for “Approval” of Cellegesic and six voted “Approvable pending another study of effectiveness.” There were no votes for “Not Approvable.”

Results of Operations

Revenues. The Company had revenues of $1,402,000 and $1,606,000 for the three months ended March 31, 2006 and 2005, respectively. Revenues in both of the three month periods presented consist of licensing, milestone, product sales and grant revenues.

Licensing revenues. Licensing revenue consists primarily of amortization of upfront payments received from licensees in connection with the Company’s existing licensing agreements. The Company recorded revenues of $65,000 and $240,000 for the three months ended March 31, 2006 and 2005, respectively. In 2005, these amounts include $208,000 reflecting the amortization of $15.0 million upfront payment received from PDI in 2002. The agreement with PDI was terminated in April 2005 in connection with the settlement of the companies’ respective lawsuits.

Product Sales. Product sales for the period presented were $423,000 and $153,000 for the three months ended March 31, 2006 and 2005, respectively and were comprised primarily of Tostrex sales to ProStrakan and sales of Rectogesic generated by the Company’s Australian business unit. Products sales are expected to decline for the balance of 2006 due to the divestiture of Cellegy Australia in April 2006.

Grant Revenues. Grant revenues were $914,000 and $1,213,000 for the three months ended March 31, 2006 and 2005, respectively. Grant revenue is generated through the Company’s wholly owned subsidiary, Biosyn, Inc. (“Biosyn”), which was acquired in late 2004.

The level of grant funding under the various grant arrangements is generally dependent upon the amount of direct labor (primarily laboratory personnel) and direct expenses such as supplies, testing services and other direct costs expected to be incurred in connection with the given program over its duration. The grant agreements generally provide for an overhead percentage that is applied to the direct labor costs. These amounts, along with the amounts billed to the grantor for direct costs comprise the total amount billed and recorded as grant revenue. Grant agreements undergo periodic renegotiation and it is the prerogative of granting agency or foundation to determine the level and duration of future funding of Cellegy’s programs. There can be no assurance that Cellegy will be able to maintain grant funding at current levels or at levels necessary to properly fund its research programs.

In addition to the grants funding above, Biosyn benefits indirectly from agency funding paid to third party contractors in support of its ongoing Phase 3 clinical trials. These payments from the funding agencies are made directly to the service providers, not to Biosyn. Under the terms of certain of its funding agreements, Biosyn has been granted the right to commercialize products supported by the funding in developed and developing countries, and is obligated to make its commercialized products, if any, available in developing countries, as well as to public sector agencies in developed countries at prices reasonably above cost or at a reasonable royalty rate.

Research and Development Expenses. During the first quarters of 2006 and 2005, research and development expenses were $1,106,000 and $2,777,000, respectively. The decrease is due primarily to a decrease of $995,000 in professional fees, including clinical and consulting fees. Biosyn research expenses declined $262,000 due primarily to decreased clinical manufacturing costs. Prior year amounts include $313,000 in write-offs of fixed assets.

Selling, General and Administrative Expenses. Selling, general and administrative expenses during the first quarter of 2006 and 2005 were $2,104,000 and $4,018,000, respectively, a decrease of $1,914,000. The decrease includes: $1,256,000 in legal fees relating to the April, 2005 settlement of litigation with PDI; $291,000 decrease in accounting fees; $289,000 in write-offs of fixed assets and net a decrease in compensation expenses of $134,000. The overall decrease in expenses was partially offset by the accrual of $266,000 in financing fees owing to Kingsbridge in connection with the Structured Secondary Offering (“SSO”) agreement.

Other Income (Expense). Net other expense in 2006 was $259,000 as compared to net other income in 2005 of $124,000. The increase in interest expense of $189,000 in 2006 resulting from the accretion of interest expense relating to the PDI notes issued pursuant to the April, 2005 settlement of litigation with PDI. $111,000 of the variance represents a change in derivative expense recorded in connection with the Kingsbridge SSO.

Liquidity and Capital Resources

Cash, cash equivalents and restricted cash were $1.1 million at March 31, 2006, as compared with $2.3 million at December 31, 2005. Cash used in operations during the first quarter of 2006 was $1.1 million as compared to $5.0 million during the same period in the prior year. The first quarter of 2005 included non-cash expenses of $999,000 arising from the disposal of fixed assets in connection with the Company’s move. In connection with the PDI settlement of April 2005, the Company reclassified $2.0 million from deferred revenue to accrued expenses and other current liabilities. Prepaid expenses decreased by $1.4 million at March 31, 2006 compared to March 31, 2005 primarily as a result of retention and severance payouts, reduction of the rent equalization and liquidation of inventory. Accounts receivable decreased by $758,000 due to the timing of receipts at March 31, 2006 compared to March 31, 2005. The overall use of cash declined in 2006 due to a lower level of clinical and commercialization activity expenses.

In April 2006 the Company divested its Australian business unit which generated approximately $1.3 million in net cash proceeds.

We prepared the financial statements assuming that we will continue as a going concern, which contemplates the realization of assets and satisfaction of liabilities and commitments in the normal course of business. At March 31, 2006 we had a deficit accumulated during the development stage of $133.2 million, negative cash flows from operations of $97.3 million, and cash and cash equivalents of $1.1 million. We expect negative cash flow from operations to continue for the foreseeable future, with the need to continue or expand development programs and to commercialize products once regulatory approvals have been obtained. We believe we do not have sufficient financial resources to continue operations beyond June 2006. These factors raise substantial doubt about our ability to continue as a going concern. Our plans, with regard to these matters, include raising additional required funds through one or more of the following options, among others: sales of assets or technologies, seeking partnerships with other pharmaceutical companies or private foundations to co-develop and fund our research and development efforts, pursuing additional out-licensing arrangements with third parties, re-licensing and monetizing in the near term our future milestone and royalty payments expected from existing licensees and seeking equity or debt financing. In addition, we will continue to implement further cost reduction programs and reduce discretionary spending, if necessary.

Future expenditures and capital requirements depend on numerous factors including, without limitation, the progress and focus of our research and development programs, the progress of pre-clinical and clinical testing, the time and costs involved in obtaining regulatory approvals, the progress and outcome of the PDI litigation, the costs of filing, prosecuting, defending and enforcing patent claims, oppositions and appeals, the timing and level of grant funding to support Biosyn’s clinical programs and operations and our ability to establish new collaborative arrangements.

Cellegy believes that available cash resources will be adequate to satisfy our capital needs through at least June 30, 2006 assuming no material adverse financial impact associated with the PDI litigation. At present, our revenues from existing licensing arrangements, funding agreements and other sources are not sufficient to offset our ongoing operating expenses or to pay in full our current obligations reflected in our financial statements. Funds provided from sales of subsidiaries, assets, equity or debt financing, or other arrangements, if obtained, would permit satisfaction of capital needs for a longer period of time. The existence and extent of our obligations could adversely affect our business, operations and financial condition. Failure to obtain additional funds as described above may affect the timing of development, clinical trials or commercialization activities relating to certain products and could require us to curtail our operations, reduce personnel, sell part or all of our assets or seek protection under bankruptcy laws. There is a risk that one or more of our creditors could bring lawsuits to collect amounts to which they believe they are entitled. In the event of lawsuits of this type, if we are unable to negotiate settlements or satisfy our obligations, we could voluntarily file bankruptcy proceedings, or we could become the subject of an involuntary bankruptcy proceeding filed by one or more creditors against us.

Stock-Based Compensation

Effective January 1, 2006, the Company began recording compensation expense associated with stock options and other forms of equity compensation in accordance with SFAS 123R, Share-Based Payment. Prior to January 1, 2006, the Company accounted for stock options according to the provisions of Accounting Principles Board Opinion No. 25, Accounting for Stock Issued to Employees, and related interpretations, and, therefore, no related compensation expense was recorded for awards granted with no intrinsic value. The Company adopted the modified prospective transition method provided for under SFAS 123R and, consequently, has not retroactively adjusted results from prior periods. Under this transition method, compensation cost associated with stock options recognized in the first quarter of fiscal 2006 includes: 1) quarterly amortization related to the remaining unvested portion of all stock option awards granted prior to January 1, 2006, based on the grant date fair value estimated in accordance with the original provisions of SFAS No. 123; and 2) quarterly amortization related to all stock option awards granted on or subsequent to January 1, 2006, based on the grant-date fair value estimated in accordance with the provisions of SFAS 123R.

The compensation expense and related income tax benefit recognized in the Consolidated Statement of Income in the first quarter of fiscal 2006 for stock options and restricted stock awards was $43,000 and $0, respectively. The impact on earnings per share (EPS) was $0.001 per share. Of the $43,000 of stock option compensation expense recognized in the first quarter of fiscal 2006, $38,000 was a component of selling, general and administrative expenses and $5,000 was a component of research and development expenses. Nothing was capitalized in inventory at March 31, 2006. Cash received from options exercised under all share-based payment arrangements for the quarter ended March 31, 2006, was $0. The Company issues shares from stock previously reserved for the exercise of the 2005 Equity Incentive Plan’s stock options.

The Company continues to estimate the fair value of each option award on the date of grant using the Black-Scholes option valuation model. The Company now estimates option forfeitures based on historical data and adjusts the rate to expected forfeitures periodically. The adjustment of the forfeiture rate will result in a cumulative catch-up adjustment in the period the forfeiture estimate is changed.

Recent Accounting Pronouncements

Critical Accounting Policies and Estimates

Our critical accounting policies and estimates were discussed in our Annual Report on Form 10-K for the fiscal year ended December 31, 2005. No changes in those policies and estimates have occurred during the three months ended March 31, 2006.

ITEM 3. Quantitative and Qualitative Disclosure of Market Risk

Cellegy invests its excess cash in short-term, investment grade, fixed income securities under an investment policy. All of our investments are classified as available-for-sale. All of our securities owned as of March 31, 2006 were in money market funds and are classified as cash equivalents. We believe that potential near-term losses in future earnings, fair values or cash flows related to our investment portfolio are not significant.

As of March 31, 2006 our investment portfolio consisted of approximately $700,000 in money market funds. We currently do not hedge interest rate exposure. If market interest rates were to increase or decrease, the fair value of our portfolio would not be affected.

We are incurring market risk associated with the issuance of warrants to Kingsbridge to purchase 260,000 shares of our common stock and to the May 2005 investors to purchase approximately 1.4 million shares of our common stock. We will continue to calculate the fair value at the end of each quarter and record the difference to other income or expense until the warrants are exercised. We are incurring risk associated with increases or decreases in the market price of our common stock, which will directly impact the fair value calculation and the non-cash charge or credit recorded to the income statement in future quarters. For example, if our stock price increases by 20% during the second quarter of 2006 from the March 31, 2006 value, and all other inputs into the Black-Scholes model remained constant, we would record approximately $65,000 of other expense for the quarter ended June 30, 2006. If our stock price decreased by 20% from its value for the same periods, we would record approximately the same amount as other income.

ITEM 4. Controls and Procedures

As of the end of the period covered by this report, we carried out an evaluation, under the supervision and with the participation of our management, including our Chief Executive Officer and Chief Financial Officer, of the effectiveness of the design and operation of our disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)).

Based upon this evaluation, our Chief Executive Officer and our Chief Financial Officer concluded that, as of March 31, 2006, our disclosure controls and procedures were effective to ensure that information required to be disclosed in the reports filed or submitted under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in the United States Securities and Exchange Commission rules and forms.

During the period covered by this report, there have been no changes in our internal control over financial reporting that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting. A controls system, no matter how well designed and operated, cannot provide absolute assurance that the objectives of the controls are met, and no evaluation of controls can provide absolute assurance that all controls and instances of fraud, if any, within a company have been detected.

PART II - OTHER INFORMATION

ITEM 1. Legal Proceedings

The Litigation with PDI continues to be in the initial stages of discovery. There have been no material developments in the status of the PDI lawsuit since December 31, 2005.

ITEM 1A. Risk Factors

We have a history of losses, and we expect losses to continue.

We have incurred losses since our inception and negative cash flows from operations that raise substantial doubt about our ability to continue as a going concern. We believe we do not have sufficient financial resources to continue operations beyond June 2006. Our deficit accumulated during the development stage as of March 31, 2006, was approximately $134.7 million. We have never operated profitably and, given our planned level of operating expenses, we expect to continue to incur losses through at least 2006. Accordingly, without substantial revenues from new corporate collaborations, royalties on product sales or other revenue sources, we expect to incur substantial operating losses in the foreseeable future as our potential products move through development and as we continue to invest in research and clinical trials. As a result of our continuing losses, we may exhaust our resources and may be unable to complete the development of our products, and our accumulated deficit will continue to increase as we continue to incur losses. Our losses may increase in the future, and even if we achieve our revenue targets, we may not be able to sustain or increase profitability on a quarterly or annual basis. The amount of future net losses, and the time required to reach profitability, are both highly uncertain. To achieve sustained profitable operations, we must, among other things, successfully discover, develop, and obtain regulatory approvals for and market pharmaceutical products. We cannot assure you that we will ever be able to achieve or sustain profitability.

We have received a “going concern” opinion from our independent registered public accounting firm, which may negatively impact our business.

Our audit opinion from our independent registered public accounting firm regarding the consolidated financial statements for the years ended December 31, 2004 and 2005, included an explanatory paragraph indicating that there is substantial doubt about the Company’s ability to continue as a going concern. We have incurred losses and negative cash flows from operations since inception. The financial statements do not include any adjustments that might result from the outcome of this uncertainty. Any failure to dispel any continuing doubts about our ability to continue as a going concern could adversely affect our ability to enter into collaborative relationships with business partners, make it more difficult to obtain required financing on favorable terms or at all, negatively affect the market price of our common stock and could otherwise have a material adverse effect on our business, financial condition and results of operations.

Our prospects for obtaining additional financing are uncertain and failure to obtain needed financing could affect our ability to develop or market products or to continue operations.

Throughout our history, we have consumed substantial amounts of cash. Our cash needs may increase during 2006 to fund administrative and litigation expenses, and Biosyn’s operations to the extent these are not covered by various government and non-government organizations. In addition, one or more such organizations could withdraw, reduce the extent of, delay or terminate their funding commitments.

As of March 31, 2006, Cellegy had approximately $1.1 million in cash and cash equivalents. Cellegy has no current source of significant ongoing revenues or capital beyond existing cash, product sales and grant funding.

The amount of cash required to fund future expenditures and capital requirements will depend on numerous factors including, without limitation:

·	requirements in support of our development programs;

·	progress and results of pre-clinical and clinical testing;

·	time and costs involved in obtaining regulatory approvals, including the cost of complying with additional FDA information and/or clinical trial requirements to obtain marketing approval of our product candidates;

·	the commercial success of our products that are approved for marketing;

·	the costs of filing, prosecuting, defending and enforcing patent claims, oppositions and appeals, and our other intellectual property rights;

·	the cost and outcome of the current litigation with PDI, Inc., as well as expenses associated with any other unforeseen litigation;

·	our ability to establish new collaborative arrangements;

·	the validation of a second contract manufacturing site; and

·	the extent of expenses required to support Biosyn’s operations.

In order to complete the development, manufacturing and other pre-launch marketing activities necessary to commercialize our products, additional financing will be required. Cellegy may seek other alternatives such as private or public equity investments, partnerships with other pharmaceutical companies to co-develop and fund our research and development efforts, sales of technology or assets, additional out-licensing agreements with third parties, or agreements to monetize in the near term our future milestone and royalty payments expected from licenses. There is no assurance that such funding will be available for us to finance our operations on acceptable terms, if at all, and any future equity funding may involve significant dilution to our stockholders.

Insufficient funding may require us to delay, reduce or eliminate some or all of our research and development activities, planned clinical trials, administrative programs, personnel, outside services and facility costs; reduce the size and scope of our sales and marketing efforts; delay or reduce the scope of, or eliminate, one or more of our planned commercialization or expansion activities; seek collaborators for our product candidates at an earlier stage than otherwise would be desirable and on terms that are less favorable than might otherwise be available; or relinquish, license or otherwise dispose of rights to technologies, product candidates or products that we would otherwise seek to develop or commercialize ourselves on terms that are less favorable than might otherwise be available. In addition, even if we do receive additional financing, we may not be able to complete planned clinical trials, development, manufacturing or marketing of any or all of our product candidates.

Cellegy believes that available cash resources will be adequate to satisfy our capital needs through at least June 30, 2006 assuming no material adverse financial impact associated with the PDI litigation and any subsequent legal proceedings, although failure to obtain additional funds as described above may affect the timing of development, clinical trials or commercialization activities relating to certain products. Funds provided from sales of subsidiaries, assets, equity or debt financing, or other arrangements, if obtained, would permit satisfaction of capital needs for a longer period of time.

We could be forced into bankruptcy.

The outcome of the lawsuit with PDI is uncertain. An unfavorable outcome will have a material adverse affect on our financial position and stock price.

As more fully described under Item 3, “Legal Proceedings”, the Company is presently engaged in a lawsuit with PDI alleging that Cellegy is in material breach of the April 2005 settlement agreement between Cellegy and PDI and related documents, including two promissory notes given by Cellegy to PDI, as a result of Cellegy’s failure to notify PDI of the receipt of certain payments and of Cellegy’s failure to pay amounts to which PDI believes it is entitled. The lawsuit seeks immediate payment of the notes along with payments for default interest and damages. An unfavorable outcome to this lawsuit would have a material adverse affect on our business and stock price.

We are subject to regulation by regulatory authorities including the FDA, which could delay or prevent marketing of our products. Unexpected regulatory outcomes could adversely affect our business and stock price.

Cellegy’s product candidates, Savvy, Cellegesic, Fortigel and Tostrelle and our ongoing research and clinical activities relating to those product candidates are subject to extensive regulation by governmental regulatory authorities in the United States and in other countries. Before we obtain regulatory approval for the commercial sale of our potential drug products, we must demonstrate through pre-clinical studies and clinical trials that the product is safe and efficacious for use in the clinical indication for which approval is sought. The timing of NDA submissions, the outcome of reviews by the FDA and the initiation and completion of other clinical trials are subject to uncertainty, change and unforeseen delays. Under the Prescription Drug User Fee Act (“PDUFA”), the FDA establishes a target date to complete its review of an NDA. Although the FDA attempts to respond by the relevant PDUFA date to companies that file NDAs, there is no obligation on the FDA’s part to do so. In addition, extensive current pre-clinical and clinical testing requirements and the current regulatory approval process of the FDA in the United States and of certain foreign regulatory authorities, or new government regulations, could prevent or delay regulatory approval of Cellegy’s products.

The process of developing and obtaining approval for a new pharmaceutical product within this regulatory framework requires a number of years and substantial expenditures. There can be no assurance that necessary approvals will be obtained on a timely basis, if at all. Delays in obtaining regulatory approvals could delay receipt of revenues from product sales, increase our expenditures relating to obtaining approvals, jeopardize corporate partnership arrangements that we might enter into with third parties regarding particular products, or cause a decline in our stock price. If we fail to comply with applicable regulatory requirements, we could be subject to a wide variety of serious administrative or judicially imposed sanctions and penalties, any of which could result in significant financial penalties that could reduce our available cash, delay introduction of products resulting in deferral or elimination of revenues from product sales, and could result in a decline in our stock price.

The Company submitted an amended NDA relating to its Cellegesic product candidate containing new analyses of data from its trials to the FDA in April 2005 and has been under review at the FDA since then. On April 25, 2006, the FDA’s Cardiovascular Renal Drugs Advisory Committee (the “Committee”) met to review the Company’s New Drug Application relating to its Cellegesic™ (0.4% nitroglycerin ointment) product for reduction of pain associated with anal fissures. The Committee voted on three questions in connection with its review:

1.	A majority of the Committee agreed that the quadratic model was the proper analysis for the purpose of decision-making.

2.	A majority of the Committee found that, taking all three studies into consideration, the data is compelling that there is an effect of nitroglycerin ointment on the pain associated with anal fissures.

3.	In its final vote, six members of the Committee voted for “Approval” of Cellegesic and six voted “Approvable pending another study of effectiveness.” There were no votes for “Not Approvable.”

The FDA may take this recommendation of the Advisory Committee under advisement as it deliberates on the review of the NDA. The FDA does not have a time period within which it must complete its review of the NDA and has given the Company no indication as to when it will make its final determination. While the FDA will consider the findings of the Committee, the final regulatory decision rests with the Agency. Cellegesic cannot be marketed in the United States unless and until the FDA grants marketing approval for the product.

Similarly, since there is still no definitive agreement with the FDA regarding requirements for approval of Fortigel, the FDA will require an additional Phase 3 clinical trial. The FDA may also decide to have an Advisory Panel review the submission of our product candidates with an uncertain outcome of such panel’s recommendation, or take other actions having the effect of delaying or preventing commercial introduction of our products. The FDA or other regulatory agencies could impose requirements on future trials that could delay the regulatory approval process for our products. Similarly, there are risks and uncertainties associated with our female clinical trial programs for Tostrelle and Savvy in that sufficient resources for clinical development of these product candidates may not be available or one or both drugs may not prove to be safe and effective by standards established by worldwide regulatory authorities. There can be no assurance that the FDA, or other regulatory agencies, will find any of our trial data or other sections of our regulatory submissions sufficient to approve any of our product candidates for marketing in the United States or in other overseas markets.

Sales of Cellegy’s products outside the United States are subject to different regulatory requirements governing clinical trials and marketing approval. These requirements vary widely from country to country and could delay introduction of Cellegy’s products in those countries. Cellegy may not be able to obtain marketing approval for one or more of its products in any countries in addition to those countries where approvals have already been obtained.

Our clinical trial results are very difficult to predict in advance, and the clinical trial process is subject to delays. Failure of one or more clinical trials or delays in trial completion could adversely affect our business and our stock price.

Results of pre-clinical studies and early clinical trials may not be good predictors of results that will be obtained in later-stage clinical trials. We cannot provide any assurances that Cellegy’s present or future clinical trials will demonstrate the results required to continue advanced trial development and allow us to seek marketing approval for these or our other product candidates. Because of the independent and blind nature of certain human clinical testing, there will be extended periods during the testing process when we will have only limited, or no, access to information about the status or results of the tests. Cellegy and other pharmaceutical companies have believed that their products performed satisfactorily in early tests, only to find their performance in later tests, including Phase 3 clinical trials, to be inadequate or unsatisfactory, or that FDA Advisory Committees have declined to recommend approval of the drugs, or that the FDA itself refused approval, with the result that stock prices have fallen precipitously.

Clinical trials can be extremely costly. Certain costs relating to the Phase 3 trials for the Savvy product for contraception and reduction in the transmission of HIV, and other clinical and preclinical development costs for the Biosyn pipeline products acquired by Cellegy, are funded directly by certain grant and contract commitments from several governmental and non-governmental organizations (“NGOs”). Nevertheless, these Phase 3 trials and Cellegy’s other planned clinical trials could require Cellegy to provide substantial funding in 2006. There can be no assurance that funding from governmental agencies and NGOs will continue to be available at previous levels or at all, and any other Phase 3 trials that Cellegy may commence in the future relating to its products could involve the expenditure of several million dollars through the completion of the clinical trials. In addition, delays in the clinical trial process can be extremely costly in terms of lost sales opportunities and increased clinical trial costs. The speed with which we complete our clinical trials and our regulatory submissions, including NDAs, will depend on several factors, including the following:

·	the rate of patient enrollment, which is affected by the size of the patient population, the proximity of patients to clinical sites, the difficulty of the entry criteria for the study and the nature of the protocol;

·	the timely completion of clinical site protocol approval and obtaining informed consent from subjects;

·	analysis of data obtained from preclinical and clinical activities;

·	changes in policies or staff personnel at regulatory agencies during the lengthy drug application review; and

·	the availability of experienced staff to conduct and monitor clinical studies, internally or through contract research organizations.

Adverse events in our clinical trials may force us to stop development of our product candidates or prevent regulatory approval of our product candidates, which could materially harm our business.

Patients participating in the clinical trials of our product candidates may experience serious adverse health events. A serious adverse health event includes death, a life-threatening condition, hospitalization, disability, congenital anomaly, or a condition requiring intervention to prevent permanent impairment or damage. The occurrence of any of these events could interrupt, delay or halt clinical trials of our product candidates and could result in the FDA, or other regulatory authorities, denying approval of our product candidates for any or all targeted indications. An institutional review board or independent data safety monitoring board, the FDA, other regulatory authorities or we may suspend or terminate clinical trials at any time. Our product candidates may prove not to be safe for human use. Any delay in the regulatory approval of our product candidates could increase our product development costs and allow our competitors additional time to develop or market competing products.

Due to our reliance on contract research organizations or other third-parties to assist us in conducting clinical trials, we are unable to directly control all aspects of our clinical trials.

Currently, we rely on contract research organizations, or CROs, and other third parties to conduct our clinical trials. As a result, we have had and will continue to have less control over the conduct of the clinical trials, the timing and completion of the trials and the management of data developed through the trial than would be the case if we were relying entirely upon our own staff. Communicating with CROs can also be challenging, potentially leading to difficulties in coordinating activities. CROs may:

·	have staffing difficulties;

·	experience regulatory compliance issues;

·	undergo changes in priorities or may become financially distressed; or

·	not be able to properly control payments to government agencies or clinical sites, particularly in less developed countries.

These factors may adversely affect their ability to conduct our trials. We may experience unexpected cost increases or experience problems with the timeliness or quality of the work of the CRO. If we must replace these CROs or any other third party contractor, our trials may have to be suspended until we find another contract research organization that offers comparable services. The time that it takes us to find alternative organizations may cause a delay in the commercialization of our product candidates or may cause us to incur significant expenses. Although we do not now intend to replace our CROs, such a change would make it difficult to find a replacement organization to conduct our trials in an acceptable manner and at an acceptable cost. Any delay in or inability to complete our clinical trials could significantly compromise our ability to secure regulatory approval of our product candidates, thereby limiting our ability to generate product revenue resulting in a decrease in our stock price.

The type and scope of patent coverage we have may limit the commercial success of our products.

Cellegy’s success depends, in part, on our ability to obtain patent protection for our products and methods, both in the United States and in other countries. Several of Cellegy’s products and product candidates, such as Cellegesic, Savvy and Tostrelle, are based on existing molecules with a history of use in humans but which are being developed by us for new therapeutic uses or in novel delivery systems which enhance therapeutic utility. We cannot obtain composition patent claims on the compounds themselves, and instead rely on patent claims, if any, directed to use of the compound to treat certain conditions or to specific formulations. This is the case, for example, with our United States patents relating to Cellegesic and Fortigel products. Such method-of-use patents may provide less protection than a composition-of-matter patent, because of the possibility of “off-label” use of the composition. Cellegy may not be able to prevent a competitor from using a different formulation or compound for a different purpose.

No assurance can be given that any additional patents will be issued to us, that the protection of any patents that may be issued in the future will be significant, or that current or future patents will be held valid if subsequently challenged. For example, oppositions have been filed with the European Patent Office regarding our European patent protecting the manufacture and use of nitroglycerin ointment and related compounds for the treatment of anal disorders, including fissures and various hemorrhoidal conditions. In December 2003, we reported that the Board of Opposition of the European Patent Office had rendered a verbal decision revoking Cellegy’s European patent relating to its Cellegesic product and related compounds for the treatment of anal disorders, including fissures and various hemorrhoidal conditions. Although Cellegy has appealed this decision, an additional adverse outcome in the appeal process could have a negative effect on Cellegy, impacting the commercial success of our partner’s marketing and corporate licensing efforts in Europe and adversely affecting our royalty revenues and stock price.

The patent position of companies engaged in businesses such as Cellegy’s business generally is uncertain and involves complex legal and factual questions. There is a substantial backlog of patent applications at the United States Patent and Trademark Office, or USPTO. Patents in the United States are issued to the party that is first to invent the claimed invention. There can be no assurance that any patent applications relating to Cellegy’s products or methods will issue as patents, or, if issued, that the patents will not be challenged, invalidated or circumvented or that the rights granted there under will provide us a competitive advantage.

In addition, many other organizations are engaged in research and product development efforts in drug delivery and topical formulations that may overlap with Cellegy’s products. Such organizations may currently have, or may obtain in the future, legally blocking proprietary rights, including patent rights, in one or more products or methods under development or consideration by Cellegy. These rights may prevent us from commercializing technology, or may require Cellegy to obtain a license from the organizations to use the technology. Cellegy may not be able to obtain any such licenses that may be required on reasonable financial terms, if at all, and cannot be sure that the patents underlying any such licenses will be valid or enforceable. Moreover, the laws of certain foreign countries do not protect intellectual property rights relating to United States patents as extensively as those rights are protected in the United States. The issuance of a patent in one country does not assure the issuance of a patent with similar claims in another country, and claim interpretation and infringement laws vary among countries, so the extent of any patent protection is uncertain and may vary in different countries. As with other companies in the pharmaceutical industry, we are subject to the risk that persons located in other countries will engage in development, marketing or sales activities of products that would infringe our patent rights if such activities were in the United States.

Our product sales strategy involving corporate partners is highly uncertain.

Cellegy is seeking to enter into agreements with corporate partners regarding commercialization of our lead product candidates. Cellegy currently has a limited number of agreements with third parties to commercialize our product candidates. Cellegy may not be able to establish other future collaborative arrangements and we may not have the resources or the experience to successfully commercialize any such products on our own. Failure to enter into other arrangements could prevent, delay or otherwise jeopardize our ability to develop and market products in the United States and in markets outside of North America, reducing our revenues and profitability.

With the current and future planned corporate partner arrangements, we may rely on our partners to conduct clinical trials, obtain regulatory approvals and, if approved, manufacture, distribute, market or co-promote these products. Reliance on third party partners can create risks to our product commercialization efforts. Once agreements are completed, particularly if they are completed at a relatively early stage of product development, Cellegy may have little or no control over the development or marketing of these potential products and little or no opportunity to review clinical data before or after public announcement of results. Further, any arrangements that may be established may not be successful or may be subject to dispute or litigation between the parties.

We do not have any history of manufacturing products on a large scale, and we have a limited number of critical suppliers.

Cellegy has no direct experience in manufacturing commercial quantities of products and currently does not have any capacity to manufacture products on a large commercial scale. We currently rely on a limited number of contract manufacturers, primarily PendoPharm, Inc. and certain of Biosyn’s suppliers, to manufacture our formulations. In the future, we may not be able to obtain contract manufacturing on commercially acceptable terms for compounds or product formulations in the quantities we need. Manufacturing or quality control problems, lack of financial resources or qualified personnel could occur with our contract manufacturers causing product shipment delays, inadequate supply, or causing the contractor not to be able to maintain compliance with the FDA’s current Good Manufacturing Practice (“GMP”) requirements necessary to continue manufacturing. Such problems could limit our ability to produce clinical or commercial product, cause us to be in breach of contract obligations with our distributors to supply product to them, reduce our revenues from product sales, and otherwise adversely affect our business and stock price.

PendoPharm, Inc. is Cellegy’s contract manufacturer for our North American and European clinical and commercial supply of prescription products in those territories, while the Australian and South Korean product sales are sourced by a pharmaceutical manufacturer in Australia. In July 2003, PanGeo Pharma, our former contract manufacturer, filed for bankruptcy protection under Canadian law. Under a reorganization plan, PanGeo sold its facilities to an affiliate of Pharmascience, another Canadian manufacturer, and was renamed PendoPharm, Inc. Cellegy has not experienced any material adverse impact to date from the previous bankruptcy filing. The manufacturing facility was inspected and re-certified by Canadian regulatory authorities after its acquisition by PendoPharm, and PendoPharm has continued to supply product from the manufacturing facility without interruption.

Nevertheless, uncertainty exists concerning the future operations of PendoPharm’s manufacturing plant and whether PendoPharm will be able to meet Cellegy’s clinical and product requirements on a timely basis, if at all, in the future. In addition, there can be no assurances relating to PendoPharm’s ability to produce product under GMP as required by the FDA or by other regulatory agencies. There could be difficulty or delays in importing raw materials or exporting product into or out of Canada resulting in delays in our clinical trials or commercial product sales.

We have limited sales and marketing experience.

We may market some of our products, if successfully developed and approved and if we obtain sufficient funding, through a direct sales force in the United States. Cellegy has very limited experience in sales, marketing or distribution. To market these products directly, we may seek to establish a direct sales force in the United States or obtain the assistance of a marketing partner. However, Cellegy may not have the financial capability or the experience to successfully establish a direct sales force, marketing or distribution operations, which could delay or prevent the successful commercialization of our products and could reduce the ultimate profitability to Cellegy of such products if we needed to rely on a third party marketing partner to commercialize the products.

If medical doctors do not prescribe our products or the medical profession does not accept our products, our product sales and business would be adversely affected.

Our business is dependent on market acceptance of our products by physicians, healthcare payers, patients and the medical community. Medical doctors’ willingness to prescribe our products depends on many factors, including:

·	perceived efficacy of our products;

·	convenience and ease of administration;

·	prevalence and severity of adverse side effects in both clinical trials and commercial use;

·	availability of alternative treatments;

·	cost effectiveness;

·	effectiveness of our marketing strategy and the pricing of our products;

·	publicity concerning our products or competing products; and

·	our ability to obtain third-party coverage or reimbursement.

Even if we receive regulatory approval and satisfy the above criteria, physicians may not prescribe our products if we do not promote our products effectively. Factors that could affect our success in marketing our products include:

·	the experience, skill and effectiveness of the sales force and our sales managers;

·	the effectiveness of our production, distribution and marketing capabilities;

·	the success of competing products; and

·	the availability and extent of reimbursement from third-party payers.

Failure of our products or product candidates to achieve market acceptance would limit our ability to generate revenue and could harm our business.

If testosterone replacement therapies are perceived to create health risks, our testosterone gel product candidates may be jeopardized.

Past studies of female hormone replacement therapy products have reported an increase in certain health risks with long-term use. As a result of such studies, some companies that sell or develop female hormone replacement products have experienced decreased sales of these products, and in some cases, a decline in the value of their stock. Publications have, from time to time, suggested potential health risks associated with testosterone replacement therapy (“TRT”). It is possible that further studies on the effects of TRT could demonstrate other health risks. This, as well as negative publicity about the risks of hormone replacement therapy, including TRT, could adversely affect patient or prescriber attitudes and impact the development and successful commercialization of our Fortigel, Tostrex and Tostrelle product candidates. In addition, in a meeting with the FDA, the FDA informed Cellegy that specific guidelines regarding the long-term safety of testosterone for the treatment of female sexual dysfunction are under internal discussion by the Division of Reproductive and Urologic Drug Products. Cellegy is awaiting these guidelines before embarking on a Phase 3 program. If the new FDA guidelines prove to be too onerous or too costly to implement, the Phase 3 program may be significantly delayed or we may decide not to pursue further development of Tostrelle product. The above factors could adversely affect investor attitudes and the price of our common stock.

We have very limited staffing and will continue to be dependent upon key personnel.

Our success is dependent upon the efforts of a small management team and staff. We have compensation or employment arrangements and a severance/retention plan in place with all of our executive officers, but none of our executive officers is legally bound to remain employed for any specific term. These arrangements may be terminated by either Cellegy or the officer at any time upon notice. We do not have key man life insurance policies covering any of our executive officers or key employees. If key individuals leave Cellegy, we could be adversely affected if suitable replacement personnel are not quickly recruited. There is competition for qualified personnel in all functional areas, which makes it difficult to attract and retain the qualified personnel necessary for the development and growth of our business. Our future success depends upon our ability to continue to attract and retain qualified scientific, clinical and administrative personnel.

Our corporate compliance programs cannot guarantee that we are in compliance with all potentially applicable regulations.

The development, manufacturing, pricing, sales, and reimbursement of our products, together with our general operations, are subject to extensive regulation by federal, state and other authorities within the United States and numerous entities outside of the United States. We are a relatively small company and we rely heavily on third parties to conduct many important functions. We also have significantly fewer employees than many other companies that have the same or fewer product candidates in late stage clinical development. In addition, as a publicly traded company we are subject to significant regulations, including the Sarbanes-Oxley Act of 2002, some of which have either only recently been adopted or are currently proposals subject to change. While we have developed and instituted a corporate compliance program and continue to update the program in response to newly implemented or changing regulatory requirements, we cannot assure you that we are now or will be in compliance with all such applicable laws and regulations. If we fail to comply with any of these regulations, we could be subject to a range of regulatory actions, including suspension or termination of clinical trials, restrictions on our products or manufacturing processes, withdrawal of products from the market, significant fines, or other sanctions or litigation. Failure to comply with potentially applicable laws and regulations could also lead to the imposition of fines, cause the value of our common stock to decline, and impede our ability to raise capital or lead to the de-listing of our stock.

We are evaluating our internal controls over financial reporting to allow management to report on, and our independent registered public accounting firm to attest to, our internal controls, as required by the Sarbanes-Oxley Act. We will be performing the system and process evaluation and testing (and any necessary remediation) required to comply with the management certification and auditor attestation requirements of Section 404 of the Sarbanes-Oxley Act (“Section 404”). As a result, we expect to incur significant additional expenses and diversion of management’s time. Cellegy is considered a non-accelerated filer, and as such is required to comply with the Section 404 requirements for its fiscal year ending December 31, 2007. While we anticipate being able to fully implement the requirements relating to internal controls and all other aspects of Section 404 by our compliance deadline, we cannot be certain as to the timing of completion of our evaluation, testing and remediation actions or the impact of the same on our operations. If we are not able to implement the requirements of Section 404 in a timely manner or with adequate compliance, we might be subject to sanctions or investigation by regulatory authorities, including the SEC. In addition, we may be required to incur a substantial financial investment to improve our internal systems and the hiring of additional personnel or consultants.

Risks Relating to Our Industry

We face intense competition from larger companies, and in the future Cellegy may not have the resources required to develop innovative products. Cellegy’s products are subject to competition from existing products.

The pharmaceutical industry is subject to rapid and significant technological change. In the development and marketing of prescription drugs, Cellegy faces intense competition. Cellegy is much smaller in terms of size and resources than many of its competitors in the United States and abroad, which include, among others, major pharmaceutical, chemical, consumer product, specialty pharmaceutical and biotechnology companies, universities and other research institutions. Cellegy’s competitors may succeed in developing technologies and products that are safer and more effective than any that we are developing and could render Cellegy’s technology and potential products obsolete and noncompetitive. Many of these competitors have substantially greater financial and technical resources, clinical production and marketing capabilities and regulatory experience. In addition, Cellegy’s products are subject to competition from existing products. Cellegesic, if ever commercialized, is expected to compete with over-the-counter products, such as Preparation H marketed by Wyeth, and various prescription products. As a result, we cannot assure you that Cellegy’s products under development may not be able to compete successfully with existing products or with innovative products under development by other organizations.

Savvy is subject to competition from other microbicides that are currently undergoing clinical trials and which may be sold by prescription or over the counter, as well as non-microbicide products such as condoms. Additionally, if a vaccine for HIV/AIDS is successfully developed and made available, this could limit the potential market for Savvy and Biosyn’s other products. As a result, Biosyn’s products under development may not be able to compete successfully with existing products or other innovative products under development.

We are subject to the risk of clinical trial and product liability lawsuits.

The testing of human health care product candidates entails an inherent risk of allegations of clinical trial liability, while the marketing and sale of approved products entails an inherent risk of allegations of product liability. We are subject to the risk that substantial liability claims from the testing or marketing of pharmaceutical products could be asserted against us in the future. Cellegy has obtained clinical trials insurance coverage relating to our clinical trials in an aggregate amount of $3 million. If any of our product candidates are approved for marketing, we may seek additional coverage.

There can be no assurance that Cellegy will be able to obtain or maintain insurance on acceptable terms, particularly in overseas locations, for clinical and commercial activities or that any insurance obtained will provide adequate protection against potential liabilities. Moreover, our current and future coverage may not be adequate to protect us from all of the liabilities that we may incur. If losses from liability claims exceed our insurance coverage, we may incur substantial liabilities that exceed our financial resources. In addition, a product or clinical trial liability action against us would be expensive and time-consuming to defend, even if we ultimately prevailed. If we are required to pay a claim, we may not have sufficient financial resources and our business and results of operations may be harmed.

Our stock price could be volatile.

Our stock price has from time to time experienced significant price and volume fluctuations. Since becoming a public company, our stock price has fluctuated due to overall market conditions and due to matters or events more specific to Cellegy. Events or announcements that could significantly impact our stock price include:

·	Clinical trial results, particularly the outcome of our more advanced studies; or negative responses from both domestic and foreign regulatory authorities with regard to the approvability of our products;

·	Publicity or announcements regarding regulatory developments relating to our products;

·	Period-to-period fluctuations in our financial results, including our cash and investment balance, operating expenses, cash burn rate or revenue levels;

·	Negative public announcements, additional legal proceeding or financial problems of our key suppliers, particularly relating to our Canadian manufacturer and our service providers;

·	Common stock sales in the public market by one or more of our larger stockholders, officers or directors;

·	A negative outcome in existing litigation or other potential legal proceedings; or

·	Other potentially negative financial announcements, including delisting from the OTCBB, a review of any of our filings by the SEC, changes in accounting treatment or restatement of previously reported financial results or delays in our filings with the SEC.

The Kingsbridge Structured Secondary Offering (“Kingsbridge SSO”) financing arrangement may have a dilutive impact on our stockholders. The SSO arrangement imposes certain limitations on our ability to issue equity or equity-linked securities.

There are 4,000,000 shares of our common stock that are reserved for issuance under the structured secondary offering facility arrangement, or Kingsbridge SSO, that we entered into in January 2004 with Kingsbridge Capital Limited, or Kingsbridge, 260,000 shares of which are related to a warrant that we issued to Kingsbridge. In certain circumstances where the registration statement covering those shares is not effective or available to Kingsbridge, additional shares may be issuable to Kingsbridge under the agreement. Such circumstances could include, for example, suspending Kingsbridge’s ability to sell shares pursuant to the registration statement because of the existence of material undisclosed developments relating to Cellegy. If within 15 trading days following any settlement date on which Cellegy issues shares under the Kingsbridge SSO, Cellegy suspends Kingsbridge’s ability to sell shares by delivering a notice to Kingsbridge, referred to as a blackout notice, then if the volume weighted average market price (“VWAP”) of our common stock, is higher on the trading day immediately before the blackout notice is delivered than it is on the first trading date after the blackout trading period is lifted, Cellegy is obligated to pay to Kingsbridge an amount based on a percentage, ranging from 75% to 25% depending on when the blackout notice is delivered, of the difference between the two VWAP prices multiplied by the number of shares purchased by Kingsbridge under the most recent drawn down and held by Kingsbridge immediately before the suspension was imposed. Cellegy may, in its discretion, pay this amount either in cash or in shares, the value of which is based on the market price of the common stock on the first trading date after the registration statement became available again.

The issuance of shares under the Kingsbridge SSO at a discount to the market price of the common stock, and upon exercise of the warrant, will have a dilutive impact on other stockholders, and the issuance or even potential issuance of such shares, if any, could have a negative effect on the market price of our common stock. If we sell stock to Kingsbridge when our share price is decreasing, such issuance will have a more dilutive effect and may further decrease our stock price. A decrease in our stock price or other consequences of issuing shares under the Kingsbridge SSO could potentially cause us not to satisfy one or more requirements for the continued listing of our common stock on the OTCBB, or could impair or prevent our ability to obtain additional required financing, resulting in a damaged capital structure.

To the extent that Kingsbridge sells shares of our common stock issued under the Kingsbridge SSO to third parties, our stock price may decrease due to the additional selling pressure in the market. The perceived risk of dilution from sales of stock to or by Kingsbridge may cause holders of our common stock to sell their shares or encourage short sales. This could contribute to decline in our stock price.

During the two-year term of the Kingsbridge SSO, we are subject to certain restrictions on our ability to engage in certain equity or equity-linked financings without the consent of Kingsbridge. These restrictions primarily relate to non-fixed future-priced securities. We may not issue securities that are, or may become, convertible or exchangeable into shares of common stock where the purchase, conversion or exchange price for such common stock is determined using a floating or otherwise adjustable discount to the market price of the common stock during the two year term of our agreement with Kingsbridge. However, the agreement does not prohibit us from conducting most kinds of additional debt or equity financings, including Private Investments in Public Equity (“PIPE”), shelf offerings, and secondary offerings.

Under the terms of the Kingsbridge SSO, if we fail to issue and sell common stock to Kingsbridge pursuant to draw downs at least equal to $2.66 million, then we have agreed to pay $266,000 to Kingsbridge. We have made draw-downs of less than this amount. As a result, unless these provisions are amended or waived, we owe Kingsbridge $266,000. The Company has accrued this amount in the quarter ended March 31, 2006.

Future sales of shares of our common stock may negatively affect our stock price.

A substantial portion of our shares is held by a relatively small number of stockholders. Sales of a significant number of shares into the public markets, particularly in light of our relatively small trading volume, may negatively affect our stock price. We also have outstanding warrants and vested stock options that can be exercised by the holders to acquire shares of our common stock. The exercise of these options or warrants could result in significant dilution to our stockholders at the time of exercise.

In the future, we will likely issue additional shares of common stock or other equity securities, including but not limited to options, warrants or other derivative securities convertible into our common stock, which could result in significant dilution to our stockholders and adversely affect our stock price

Changes in the expensing of stock options could result in unfavorable accounting charges or require us to change our compensation practices.

For Cellegy, stock options are a significant component of compensation for existing employees and to attract new employees. We currently are not required to record stock-based compensation charges if the employee’s stock option exercise price equals or exceeds the fair value of our common stock at the date of grant. The Financial Accounting Standards Board has issued a new accounting standard requiring recording of expense for the fair value of stock options granted. During 2006, when we change our accounting policy to record expense for the fair value of stock options granted our net loss may increase. We intend to continue to include various forms of equity in our compensation plans, such as stock options and other forms of equity compensation allowed under our plans. If we continue our reliance on stock options, our reported losses could increase.

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

None

ITEM 3. Defaults Upon Senior Securities

None

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

None

ITEM 5. Other Information

None

ITEM 6. Exhibits

a)	Exhibits

	2.01	Share Purchase Agreement dated as of March 31, 2006 by and between the Registrant and Epsilon Pharmaceuticals Pty Ltd.

	31.1	Certification of Chief Executive Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002

	31.2	Certification of Chief Financial Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002

	32.1	Certification of Chief Executive Officer pursuant to Section 906 of the Sarbanes-Oxley Act of 2002

	32.2	Certification of Chief Financial Officer pursuant to Section 906 of the Sarbanes-Oxley Act of 2002

SIGNATURES

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


	CELLEGY PHARMACEUTICALS, INC.

Date: May 15, 2005	By:	/s/ Richard C. Williams
		Richard C. Williams
		Chairman and Interim Chief Executive Officer


Date: May 15, 2005	By:	/s/ Robert J. Caso
		Robert J. Caso
		Vice President, Finance and Chief Financial Officer