UNITED STATES SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, DC 20549

FORM 10-Q

(Mark One)

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

For the quarterly period ended: September 30, 2006

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

For the transition period from                      to                     

DUSA PHARMACEUTICALS, INC.

(Exact Name of Registrant as Specified in Its Charter)

New Jersey		22-3103129
(State of Other Jurisdiction of Incorporation or Organization)		(I.R.S. Employer Identification No.)
25 Upton Drive, Wilmington, MA		01887
(Address of Principal Executive Offices)		(Zip Code)

(978) 657-7500

(Former Name, Former Address and Former Fiscal Year,
if Changed Since Last Report)

Indicate by check mark whether the registrant: (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.

Yes þ 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” in Rule 12b-2 of the Exchange Act. (Check one):

Large Accelerated Filer o Accelerated Filer þ Non-accelerated Filer o

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

As of November 3, 2006, the registrant had 19,480,067 shares of Common Stock, no par value per share, outstanding.

 

 

DUSA Pharmaceuticals, Inc.
TABLE OF CONTENTS TO FORM 10-Q

		PAGE
		NUMBER
PART I. FINANCIAL INFORMATION
Item 1. Financial Statements			3
Condensed Consolidated Balance Sheets at September 30, 2006 and December 31, 2005 (Unaudited)
Condensed Consolidated Statements of Operations for the three and nine-month periods ended September 30, 2006 and 2005 (Unaudited)
Condensed Consolidated Statements of Cash Flows for the nine-month periods ended September 30, 2006 and 2005 (Unaudited)
Notes to the Condensed Consolidated Financial Statements (Unaudited)
Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations			19
Item 3. Quantitative and Qualitative Disclosures About Market Risk			35
Item 4. Controls and Procedures			36
PART II. OTHER INFORMATION
Item 1. Legal Proceedings			37
Item 1A. Risk Factors			39
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds			51
Item 3. Defaults Upon Senior Securities			51
Item 4. Submission of Matters to a Vote of Security Holders			51
Item 5. Other Information			51
Item 6. Exhibits			52
SIGNATURES			53
Exhibit Index			54
EX-10(a) AMENDMENT NO. 1 TO EMPLOYMENT AGREEMENT FOR RICHARD C. CHRISTOPHER
EX-31(a) SECTION 302 CERTIFICATION OF THE C.E.O.
EX-31(b) SECTION 302 CERTIFICATION OF THE C.F.O.
EX-32(a) SECTION 906 CERTIFICATION OF THE C.E.O.
EX-32(b) SECTION 906 CERTIFICATION OF THE C.F.O.

PART I.

ITEM 1. FINANCIAL STATEMENTS

DUSA PHARMACEUTICALS, INC.

		SEPTEMBER 30,				DECEMBER 31,
		2006				2005
ASSETS
CURRENT ASSETS
Cash and cash equivalents		$	5,139,183			$	4,210,675
Marketable securities			13,414,499				30,579,486
Accrued interest receivable			111,952				353,449
Accounts receivable, net			1,826,197				373,130
Inventory			2,158,886				1,860,793
Deferred acquisition costs			—				831,875
Prepaids and other current assets			1,463,945				776,293
TOTAL CURRENT ASSETS			24,114,662				38,985,701
Restricted cash			160,836				144,541
Property, plant and equipment, net			2,691,425				2,971,869
Intangible assets			16,183,342				—
Goodwill			5,772,505				—
Deferred charges and other assets			956,654				228,520
TOTAL ASSETS		$	49,879,424			$	42,330,631
LIABILITIES AND SHAREHOLDERS’ EQUITY
CURRENT LIABILITIES
Accounts payable		$	227,224			$	934,694
Accrued compensation			1,277,799				1,071,677
Other accrued expenses			3,469,518				1,995,679
Deferred revenue			1,066,326				94,283
TOTAL CURRENT LIABILITIES			6,040,867				4,096,333
Other liabilities			205,893				205,570
TOTAL LIABILITIES			6,246,760				4,301,903
COMMITMENTS AND CONTINGENCIES (NOTE 13)
SHAREHOLDERS’ EQUITY
Capital Stock
Authorized: 100,000,000 shares; 40,000,000 shares designated as common stock, no par, and 60,000,000 shares issuable in series or classes; and 40,000 junior Series A preferred shares. Issued and outstanding: 19,449,442 and 17,041,197 shares of common stock, no par, at September 30, 2006 and December 31, 2005, respectively
			142,870,571				125,626,163
Additional paid-in capital			3,448,899				2,035,783
Accumulated deficit			(102,618,371	)			(89,537,470	)
Accumulated other comprehensive loss			(68,435	)			(95,748	)
TOTAL SHAREHOLDERS’ EQUITY			43,632,664				38,028,728
TOTAL LIABILITIES AND SHAREHOLDERS’ EQUITY		$	49,879,424			$	42,330,631

See the accompanying Notes to the Condensed Consolidated Financial Statements.

DUSA PHARMACEUTICALS, INC.

		THREE MONTHS ENDED								NINE MONTHS ENDED
		SEPTEMBER 30,								SEPTEMBER 30,
		2006				2005				2006				2005
Product Revenues		$	6,062,720			$	2,392,244			$	17,432,350			$	7,988,974
Cost of Product Revenues and Royalties			2,849,485				1,307,433				7,635,407				4,781,589
GROSS MARGIN			3,213,235				1,084,811				9,796,943				3,207,385
Operating Costs
Research and Development			1,343,880				1,414,428				4,382,134				4,809,294
In-process Research and Development			—				—				1,600,000				—
Marketing and Sales			3,246,886				1,804,439				9,114,093				6,885,755
General and Administrative			2,603,237				1,663,697				8,427,324				5,187,415
Restructuring							150,917								150,917
TOTAL OPERATING COSTS			7,194,003				5,033,481				23,523,551				17,033,381
LOSS FROM OPERATIONS			(3,980,768	)			(3,948,670	)			(13,726,608	)			(13,825,996	)
OTHER INCOME
Other income, net			194,129				340,389				645,707				1,059,982
NET LOSS		$	(3,786,639	)		$	(3,608,281	)		$	(13,080,901	)		$	(12,766,014	)
BASIC AND DILUTED NET LOSS PER COMMON SHARE		$	(0.19	)		$	(0.21	)		$	(0.77	)		$	(0.75	)
WEIGHTED-AVERAGE NUMBER OF COMMON SHARES OUTSTANDING, BASIC AND DILUTED			19,449,442				16,930,746				17,041,197				16,920,220

See the accompanying Notes to the Condensed Consolidated Financial Statements.

DUSA PHARMACEUTICALS, INC.

		NINE MONTHS ENDED SEPTEMBER 30,
		2006				2005
CASH FLOWS PROVIDED BY (USED IN) OPERATING ACTIVITIES
Net loss		$	(13,080,901	)		$	(12,766,014	)
Adjustments to reconcile net loss to net cash used in operating activities:
Amortization of premiums and accretion of discounts on marketable securities available-for-sale			38,766				401,221
Realized gain on sale of marketable securities, available-for-sale			(14,015	)			(72,195	)
Stock-based compensation			1,413,116				19,444
In-process research and development charge			1,600,000				—
Depreciation and amortization			3,302,624				755,593
Changes in other assets and liabilities impacting cash flows from operations (net of impact of acquisition):
Accrued interest receivable			241,497				220,170
Accounts receivable			259,100				7,153
Inventory			(79,271	)			(651,578	)
Prepaid and other current assets			(730,129	)			(611,338	)
Deferred charges and other assets			(793,082	)			—
Accounts payable			(1,310,300	)			(291,654	)
Accrued compensation and other accrued expenses			(143,590	)			(180,045	)
Deferred revenue			971,443				188,700
Other liabilities			323				12,267
NET CASH USED IN OPERATING ACTIVITIES			(8,324,419	)			(12,968,276	)
CASH FLOWS PROVIDED BY (USED IN) INVESTING ACTIVITIES
Cash paid for acquisition, net of cash received			(7,767,006	)			—
Purchases of marketable securities			(4,008,844	)			(40,683,061	)
Proceeds from maturities and sales of marketable securities			21,176,393				52,901,367
Restricted cash			(16,295	)			(2,589	)
Purchases of property, plant and equipment			(172,277	)			(406,217	)
NET CASH PROVIDED BY INVESTING ACTIVITIES			9,211,971				11,809,500
CASH FLOWS PROVIDED BY FINANCING ACTIVITIES
Proceeds from exercise of options			40,956				232,035
NET INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS			928,508				(926,741	)
CASH AND CASH EQUIVALENTS AT BEGINNING OF PERIOD			4,210,675				2,928,143
CASH AND CASH EQUIVALENTS AT END OF PERIOD		$	5,139,183			$	2,001,402

See the accompanying Notes to the Condensed Consolidated Financial Statements.

DUSA PHARMACEUTICALS, INC.

1) BASIS OF PRESENTATION

The Condensed Consolidated Balance Sheet as of September 30, 2006, and the Condensed Consolidated Statements of Operations for the three and nine months ended September 30, 2006 and 2005, and Condensed Consolidated Statements of Cash Flows for the nine months ended September 30, 2006 and 2005 of DUSA Pharmaceuticals, Inc. (the “Company” or “DUSA”) have been prepared in accordance with accounting principles generally accepted in the United States of America (“U.S. GAAP”). These condensed consolidated financial statements are unaudited but include all normal recurring adjustments, which management of the Company believes to be necessary for fair presentation of the periods presented. The results of the Company’s operations for any interim period are not necessarily indicative of the results of the Company’s operations for any other interim period or for a full year.

Certain information and footnote disclosures normally included in financial statements prepared in accordance with U.S. GAAP have been condensed or omitted. These condensed consolidated financial statements should be read in conjunction with the Consolidated Financial Statements and Notes to the Consolidated Financial Statements included in our Annual Report on Form 10-K for the year ended December 31, 2005 filed with the Securities and Exchange Commission (“SEC”). The balance sheet as of December 31, 2005 has been derived from the audited financial statements at that date but does not include all of the information and footnotes required by U.S. GAAP for complete financial statements.

2) SIGNIFICANT ACCOUNTING POLICIES

REVENUE RECOGNITION AND PROVISIONS FOR ESTIMATED REDUCTIONS TO GROSS REVENUES

Photodynamic Therapy (PDT) Drug and Device Products.

Revenues on the Kerastick^® and BLU-U^® product sales are recognized when persuasive evidence of an arrangement exists, the price is fixed and determinable, delivery has occurred, and collection is probable. Product sales made through distributors, historically, have been recorded as deferred revenue until the product was sold by the distributors to the end users because we did not have sufficient history with our distributors to be able to reliably estimate returns. Beginning in the first quarter of 2006, we began recognizing revenue as product is sold to distributors because we believe we have sufficient history to reliably estimate returns from distributors as of January 1, 2006. This change in estimate was not material to the Company’s revenues or results of operations. Certain device units are held by physicians for a trial period. No revenue is recognized on these units until the physician elects to purchase the equipment and all other revenue recognition criteria are met.

Non-PDT Drug Products.

We recognize revenue for these products in accordance with SEC’s Staff Accounting Bulletin (“SAB”) No. 101, “Revenue Recognition in Financial Statements”, as amended by SAB No. 104, “Revenue Recognition.” Our accounting policy for revenue recognition has a substantial impact on our reported results and relies on certain estimates that require difficult, subjective and complex judgments on the part of management. We recognize revenue for sales when substantially all the risks and rewards of ownership have transferred to the customer, which generally occurs on the date of shipment to wholesale customers, with the exceptions described below. Revenue is recognized net of revenue reserves, which consist of allowances for discounts, returns, rebates, chargebacks, and fees paid to wholesalers under distribution service agreements.

In the case of sales made to wholesalers as a result of incentives and that are in excess of the wholesaler’s ordinary course of business inventory level, substantially all the risks and rewards of ownership do not

6

STOCK-BASED COMPENSATION

Prior to January 1, 2006, we used the intrinsic value-based method to account for employee stock option awards under the provisions of Accounting Principles Board Opinion (“APB”) No. 25, and to provide disclosures based on the fair value method in the Notes to the Consolidated Financial Statements as permitted by Statement of Financial Accounting Standards (“SFAS”) No. 123, as amended. Stock or other equity-based compensation for non-employees is accounted for under the fair value-based method as required by SFAS No. 123 and Emerging Issues Task Force (“EITF”) No. 96-18, “Accounting for Equity Instruments That Are Issued to Other Than Employees for Acquiring, or in Conjunction with Selling, Goods or Services” and other related interpretations. Under this method, the equity-based instrument is valued at either the fair value of the consideration received or the equity instrument issued on the date of grant. The resulting compensation cost is recognized and charged to operations over the service period which, in the case of stock options, is generally the vesting period.

In December 2004, the Financial Accounting Standards Board (“FASB”) issued SFAS No. 123R, “Share-Based Payment,” a revision of SFAS No. 123. We adopted SFAS 123R effective January 1, 2006, using the modified prospective application method, and beginning in 2006, we measure all employee share-based compensation awards using a fair value based method and record share-based compensation expense in our financial statements if the requisite service to earn the award is provided.

3) BUSINESS ACQUISITION

On March 10, 2006, the Company acquired all of the outstanding common stock of Sirius Laboratories, Inc. (“Sirius”) in exchange for 2,396,245 shares of DUSA common stock and $8 million in cash. Pursuant to the terms of the Merger Agreement, the actual number of shares that were issued in the transaction was derived by dividing $17 million by the average closing price of the Company’s shares over the 20 trading day period prior to the close, or $7.094 per share. For accounting purposes, these shares are valued at $7.30 per share, the average market price of the Company’s common stock over the 5 day period beginning two days prior and ending two days subsequent to the public announcement of the signing of the First Amendment to the Merger Agreement. Sirius was a dermatology specialty pharmaceuticals company founded in 2000 with a primary focus on the treatment of acne vulgaris and acne rosacea. The purchase of Sirius was intended to enable DUSA to expand its product portfolio, capitalize on cross-selling and marketing opportunities, increase its sales force size; as well as, provide a pipeline of new products. The aggregate purchase price, net of cash received of $0.5 million, was approximately $26.8 million, which consisted of $17.2 million in shares of common stock, net of estimated registration costs of $0.3 million, $7.5 million in cash, $0.3 million outstanding balance on line of credit, and transaction costs of $1.8 million, which primarily consisted of fees for legal and financial advisory services. Of the 2,396,245 shares issued in the acquisition, 422,892 shares have been placed in an escrow account established to secure the indemnification obligations of the shareholders of Sirius as set forth in the Merger Agreement. The escrow account is established for a period of two years and will be used to satisfy liability claims, if any, made by the Company. No amounts may be distributed from the liability escrow account unless and until any individual claim exceeds $25,000 and cumulative claims exceed $100,000.

The Company has agreed to pay additional consideration in future periods, based upon the attainment of defined operating objectives, including new product approvals or launches and the achievement of pre-determined total cumulative sales milestones for the Sirius products over the period ending 42 months from the date of close. The pre-determined cumulative sales milestones for the Sirius products and the related milestone payments are, as follows:

Cumulative		Additional
Sales Milestone		Consideration
$25.0 million		$1.5 million
35.0 million		$1.0 million
45.0 million		$1.0 million
Total		$3.5 million

In addition, there are three milestones related to new product approvals and/or launches each in the amount of $500,000 per milestone, or $1.5 million in the aggregate, that will be paid if the milestones are achieved. As of September 30, 2006 none of the milestones had been achieved; however, we do anticipate that a milestone related to a new product launch could occur in early 2007.

The Company will not accrue contingent consideration obligations prior to the attainment of the objectives. At September 30, 2006, the maximum potential future consideration pursuant to such arrangements, to be resolved over the period ending 42 months from the date of close, is $5.0 million. If attained, a portion of the contingent consideration is payable in cash and a portion is payable in either common stock or cash, at the Company’s sole discretion. Any payments will result in increases in goodwill at time of payment.

The acquisition was accounted for using the purchase method of accounting and the results of operations of the acquired business since March 10, 2006, the date of acquisition, were included in the results of the Company. The purchase price allocation is preliminary and a final determination of required purchase accounting adjustments will be made when all necessary information is obtained and final allocations are made. Goodwill may change as a result of final allocations. The Company may incur costs in the future related to manufacturing concerns that were identified with the manufacturing of one of Sirius’ product lines. Some of these products are in short supply or back-order positions while such concerns are being addressed. The Company may seek indemnification for these potential costs and lost revenues through the liability escrow agreement, and may also seek indemnification from the manufacturer under the terms of the supply and development agreement. The total purchase consideration was allocated to the assets acquired and liabilities assumed at their estimated fair values as of the date of acquisition, as determined by management and, with respect to identified intangible assets, by management with the assistance of an appraisal provided by a third-party valuation firm. The excess of the purchase price over the amounts allocated to assets acquired and liabilities assumed has been recorded as goodwill. The goodwill is not deductible for tax purposes.

The following table summarizes the estimated fair value of the assets acquired and liabilities assumed at the date of acquisition:

		(IN THOUSANDS)
Total consideration:
Common stock issued, net of estimated registration costs of $295,000		$	17,203
Cash paid to stockholders			8,000
Balance on line-of-credit			251
Transaction costs accrued			346
Transaction costs paid			1,525
Total purchase consideration			27,325
Allocation of the purchase consideration
Current assets (including cash of $485), exclusive of inventory			2,198
Inventory			1,983
Fixed assets			109
Long-term assets			14
Identifiable intangible assets			17,160

		(IN THOUSANDS)
In-process research and development			1,600
Goodwill			5,773
Total assets acquired			28,837
Fair value of liabilities assumed			(1,512	)
Fair value of assets acquired and liabilities assumed		$	27,325

The following are identified intangible assets acquired and the respective estimated periods over which the assets will be amortized:

						WEIGHTED AVERAGE
		AMOUNT				AMORTIZATION PERIOD
		(IN THOUSANDS)				(IN YEARS)
Core/Developed Technology		$	17,160				3.78
In-process Research and Development		$	1,600				—

The core/developed technology, comprised of the combined value of Sirius’ product lines, which inherently includes the value of related patents, trademarks/trade names, as applicable, is being amortized over its useful life, based upon the pattern in which the expected benefits will be realized, or on a straight-line basis, whichever is greater. The core/developed technologies all belong to the same therapeutic category, “non-photodynamic therapy dermatological treatment of acne and rosacea” and are considered a single asset group for purposes of measuring impairment. The values of the intangible assets acquired were determined using projections of revenues and expenses specifically attributed to the intangible assets. The income streams were then discounted to present value using estimated risk adjusted discount rates. The intangible assets were valued using the income approach, specifically the excess earnings method. The key assumptions used in valuing the intangible assets are discount rates of 17% for core/developed technology and 18% for in-process research and development and an assumed tax rate of 40%. The in-process research and development represents the estimated fair value based on risk-adjusted cash flows related to product development projects. At the date of acquisition, the development of these projects had not yet reached technological feasibility and the research and development in progress had no alternative future uses. Accordingly, these costs were expensed as of the acquisition date.

The results of operations of Sirius have been included in the financial statements of the Company since March 10, 2006, the date of acquisition. The following table reflects unaudited pro forma results of operations of the Company for the three and nine months ended September 30, 2006 and 2005 assuming that the Sirius acquisition had occurred on January 1, 2005 (in thousands, except per share data):

		THREE MONTHS ENDED								NINE MONTHS ENDED
		SEPTEMBER 30,								SEPTEMBER 30,
		2006				2005				2006				2005
Revenues		$	6,062,720			$	4,603,800			$	20,350,009			$	14,731,772
Net loss			(3,100,781	)			(4,078,334	)			(9,185,622	)			(14,309,032	)
Net loss per share		$	(0.16	)		$	(0.21	)		$	(0.47	)		$	(0.74	)

The pro-forma net loss and net loss per share for the three and nine months ended September 30, 2006 and 2005 excludes the impact of increased cost of goods sold resulting from the purchase accounting fair value adjustment to inventory due to its non-recurring nature, and for the nine months ended September 30, 2006 and 2005 excludes a $1.6 million charge related to purchased in-process research and development.

4) GOODWILL AND INTANGIBLE ASSETS

Under Statement of Financial Accounting Standards No. 142, “Goodwill and Other Intangible Assets” (“SFAS No. 142”), goodwill and certain intangible assets are deemed to have indefinite lives and are not amortized, but are reviewed at least annually for impairment. Other identifiable intangible assets are amortized over their estimated useful lives. SFAS No. 142 requires that goodwill be tested for impairment annually, utilizing the “fair value” methodology. The Company has adopted December 1st as the date of the annual impairment test for goodwill.

The following is a summary of goodwill and intangible assets as of September 30, 2006 (in thousands):

		GROSS
		CARRYING				ACCUMULATED				NET BOOK
		VALUE				AMORTIZATION				VALUE
Goodwill		$	5,773				—			$	5,773
Amortizable intangible assets:
Core/Developed Technology			17,160				(977	)			16,183
Total		$	22,933			$	(977	)		$	21,956

All goodwill is associated with the Non-PDT Drug Products operating segment (see Note 11). Amortization expense, included in cost of product revenues and royalties in the accompanying Condensed Consolidated Statements of Operations, related to intangible assets was $437,000 and $977,000 for the three and nine month periods ended September 30, 2006. Amortization expense related to intangible assets is expected to be approximately $0.4 million for the remainder of 2006 and approximately $2.8 million, $3.3 million, $3.4 million, $3.2 million and $1.3 million for the years ending December 31, 2007, 2008, 2009, 2010 and 2011, respectively.

5) MARKETABLE SECURITIES

The Company’s investment securities consist of securities of the U.S. government and its agencies, and investment grade corporate bonds, all classified as available-for-sale. As of September 30, 2006, current yields range from 2.50% to 5.74% and maturity dates range from October 15, 2006 to September 15, 2010. The estimated fair value and cost of marketable securities at September 30, 2006 and December 31, 2005 are as follows:

		SEPTEMBER 30, 2006
						GROSS				GROSS
		AMORTIZED				UNREALIZED				UNREALIZED				FAIR
		COST				GAINS				LOSSES				VALUE
United States government securities		$	9,568,645			$	2,061			$	(56,799	)		$	9,513,907
Corporate securities			3,914,289				—				(13,697	)			3,900,592
Total marketable securities available-for-sale		$	13,482,934			$	2,061			$	(70,496	)		$	13,414,499

		DECEMBER 31, 2005
						GROSS				GROSS
		AMORTIZED				UNREALIZED				UNREALIZED				FAIR
		COST				GAINS				LOSSES				VALUE
United States government debt securities		$	19,857,171			$	3,732			$	(72,243	)		$	19,788,660
Investment grade corporate debt securities			10,818,063				15,136				(42,373	)			10,790,826
Total marketable securities available for sale		$	30,675,234			$	18,868			$	(114,616	)		$	30,579,486

Net unrealized gains and losses on such securities for the three and nine months ended September 30, 2006 were $(56,756) and $(27,313), respectively, as compared to $(166,714) and $(413,323) for the three and nine months ended September 30, 2005. These amounts have been recorded in accumulated other comprehensive loss, which is reported as part of shareholder’s equity in the Condensed Consolidated Balance Sheets.

Realized gains on sales of marketable securities for the three and nine months ended September 30, 2006 were $0 and $14,000, respectively, as compared to $66,000 and $72,000 for the three and nine months ended September 30, 2005. Because the Company has the ability and intent to hold its investments until a recovery of fair value, which may be maturity, the Company does not consider investments with unrealized losses to be other-than-temporarily impaired at September 30, 2006.

6) CONCENTRATION OF CREDIT RISK

The Company invests cash in accordance with a policy objective that seeks to preserve both liquidity and safety of principal. The Company manages the credit risk associated with its investments in marketable securities by investing in U.S. government securities and investment grade corporate bonds.

The Company is also exposed to concentration of credit risk related to accounts receivable that are generated from its customers consisting of wholesalers, distributors and direct customers. To manage credit risk, the Company performs regular credit evaluations of its customers and provides allowances for potential credit losses, when applicable. Concentrations of credit risk in the Company’s total revenues for the three and nine months ended September 30, 2006 and 2005, and accounts receivable as of September 30, 2006 and December 31, 2005 are as follows:

		% OF REVENUE								% OF REVENUE								% OF ACCOUNTS
		THREE MONTHS ENDED								NINE MONTHS ENDED								RECEIVABLE AS OF
		SEPTEMBER 30,				SEPTEMBER 30,				SEPTEMBER 30,				SEPTEMBER 30,				SEPTEMBER 30,				DECEMBER 31,
		2006				2005				2006				2005				2006				2005
Customer A							17	%			—				17	%			—				6	%
Customer B			4	%			13	%			6	%			14	%			6	%
Customer C			14	%			—				11	%			—				24	%			—
Customer D			27	%			—				19	%			—				32	%			—
Customer E			7	%			—				6	%			—				9	%
Other customers			48	%			70	%			58	%			69	%			29	%			94	%
Total			100	%			100	%			100	%			100	%			100	%			100	%

The Company is dependent upon sole-source suppliers for a number of its products. There can be no assurance that these suppliers will be able to meet the Company’s future requirements for such products or parts or that they will be available at favorable terms. Any extended interruption in the supply of any such products or parts or any significant price increase could have a material adverse effect on the Company’s operating results in any given period.

7) INVENTORY

Inventory consisted of the following:

		SEPTEMBER 30,				DECEMBER 31,
		2006				2005
Finished goods		$	987,119			$	1,004,772
BLU-U® evaluation units			183,183				292,129
Work in-process			269,112				60,805
Raw materials			719,472				503,087
		$	2,158,886			$	1,860,793

BLU-U^® commercial light sources placed in physicians’ offices for an initial evaluation period are included in inventory until all revenue recognition criteria are met. The Company amortizes the cost of the evaluation units during the evaluation period to cost of product revenues to approximate its net realizable value.

8) OTHER ACCRUED EXPENSES

Other accrued expenses consisted of the following:

		SEPTEMBER 30,				DECEMBER 31,
		2006				2005
Research and development costs		$	325,001			$	347,220
Marketing and sales costs			256,858				173,092
Product related costs			981,481				667,388
Legal and other professional fees			1,567,629				488,401
Employee benefits			297,994				225,628
Other expenses			40,555				93,950
		$	3,469,518			$	1,995,679

9) STOCK-BASED COMPENSATION

Under the Company’s 2006 Equity Compensation Plan (the “2006 Plan”), the Company may grant stock-based awards in amounts not to exceed the lesser of: (i) 20% of the total number of shares of the Company’s common stock issued and outstanding at any given time less the number of shares issued and outstanding under any other equity compensation plan of the Company at such time; or (ii) 3,888,488 shares less the number of shares issued and outstanding under any other equity compensation plan of the Company from time to time. The maximum number of shares of common stock that may be granted to any individual during any calendar year is 300,000.

The 2006 Plan is administered by the Compensation Committee of the Board of Directors (the “Committee”). The 2006 Plan provides for the grant of incentive stock options (“ISO”), nonqualified

stock options (“NSO”), stock awards, and stock appreciation rights to (i) employees, consultants, and advisors; (ii) the employees, consultants, and advisors of the Company’s parents, subsidiaries, and affiliates; and (iii) and the Company’s non-employee directors.

Non-Qualified Stock Options — All the NSOs granted under the 2006 Plan have an expiration period not exceeding seven years and are issued with an exercise price of not less than the market value of the common stock on the grant date. The Committee may establish such vesting and other conditions with respect to options as it deems appropriate. In addition, the Company initially grants each individual who agrees to become a director 15,000 NSO to purchase common stock of the Company. Thereafter, each director reelected at an Annual Meeting of Shareholders will automatically receive an additional 10,000 NSO on June 30 of each year. Grants to directors immediately vest on the date of the grant.

Incentive Stock Options — ISOs granted under the 2006 Plan have an expiration period not exceeding seven years (five years for ISOs granted to employees who are also ten percent shareholders) and are issued with an exercise price of not less than the market value of the common stock on the grant date. The Committee may establish such vesting and other conditions with respect to options as it deems appropriate.

The 2006 Plan replaced the Company’s 1996 Omnibus Plan (the “1996 Plan”), which expired on June 6, 2006. A summary of stock option transactions in both the 1996 Plan and the 2006 Plan follows:

		WEIGHTED				WEIGHTED
		NUMBER				AVERAGE
		OF SHARES				EXERCISE
		(IN THOUSANDS)				PRICE
OUTSTANDING AT DECEMBER 31, 2005			2,850,250			$	11.85
Options granted			415,500				6.65
Options cancelled/forfeited/expired			(443,437	)			8.50
Options exercised			(12,000	)			3.41
OUTSTANDING AT SEPTEMBER 30, 2006			2,810,313			$	11.65
EXERCISABLE AT SEPTEMBER 30, 2006			1,998,318			$	12.86

The weighted average remaining contractual term was approximately 3.4 years for stock options outstanding and approximately 5.8 years for stock options exercisable as of September 30, 2006.

The total intrinsic value (the excess of the market price over the exercise price) was approximately $592,000 and $487,000 for stock options outstanding and exercisable, respectively, as of September 30, 2006. The total intrinsic value for stock options exercised in 2006 was approximately $45,000. At September 30, 2006, total unrecognized estimated compensation cost related to non-vested stock options granted prior to that date was $3,590,000, which was expected to be recognized over a weighted average period of 2.1 years.

The amount of cash received from the exercise of stock options in 2006 was approximately $41,000 and the related tax deduction was approximately $14,000 in 2006.

The fair value of stock options granted was estimated on the date of grant using a Black-Scholes option valuation model that uses the assumptions in the following table. The Company’s employee stock options have various restrictions that reduce option value, including vesting provisions and restrictions on transfer and hedging, among others, and are often exercised prior to their contractual maturity.

The weighted-average estimated fair value of employee stock options granted during the nine months ended September 30, 2006 was $4.62 per share using the Black-Scholes option valuation model with the following weighted-average assumptions (annualized percentages):

		NINE MONTHS
		ENDED
		SEPTEMBER 30, 2006
Volatility			63.7	%
Risk-free interest rate			5.10	%
Expected dividend yield			0	%
Expected life-directors and officers		8.0		years
Expected life-non-officer employees		6.3		years

The Company used a combination of historical and implied volatility of market-traded options in the Company’s stock for the expected volatility assumption input to the Black-Scholes model, consistent with the guidance in FAS 123R and the SEC’s SAB No. 107. Prior to the first quarter of fiscal 2006, the Company had used its historical stock price for purposes of its pro forma information. The decision to use a combination of historical and implied volatility data to estimate expected volatility was based upon the availability of actively traded options on the Company’s stock and the Company’s assessment that the combination is more representative of future stock price trends than historical volatility alone.

The risk-free interest rate assumption is based upon observed interest rates appropriate for the term of the Company’s employee stock options. The expected life is based on the Company’s historical option cancellation and employee exercise information. The expected life of employee stock options represents the weighted-average period the stock options are expected to remain outstanding post-vesting. In calculating the expected life of the options for 2006, the Company classified its grantee population into two groups, directors and officers and non-officer employees. As share-based compensation expense recognized in the Consolidated Statements of Operations for fiscal 2006 is based on awards ultimately expected to vest, it is reduced for estimated forfeitures. FAS 123R requires forfeitures to be estimated at the time of grant and revised, if necessary, in subsequent periods if actual forfeitures differ from those estimates. In 2006, departure rates, defined as the annual percentage of options forfeited or exercised early due to departure, were estimated to be approximately 2.96% for officers and directors and 10.53% for non-officer employees based on historical experience. Prior to 2006, the Company had used a company-wide weighted average expected life of five years for grants in 2005, 2004 and 2003 and seven years for grants in 2002.

Total estimated share-based compensation expense, related to all of the Company’s share-based awards, recognized for the three and nine months ended September 30, 2006 was comprised as follows:

		THREE MONTHS ENDED				NINE MONTHS ENDED
		SEPTEMBER 30, 2006				SEPTEMBER 30, 2006
Cost of product revenues		$	24,000			$	61,000
Research and development			101,000				263,000
Selling and marketing			123,000				270,000
General & administrative			195,000				819,000
Share-based compensation expense		$	443,000			$	1,413,000

Prior to adopting the provisions of FAS 123R, the Company recorded estimated compensation expense for employee stock options based upon their intrinsic value on the date of grant pursuant to APB 25, “Accounting for Stock Issued to Employees” and provided the required pro forma disclosures of FAS 123. Because the Company established the exercise price based on the fair market value of the Company’s stock at the date of grant, the stock options had no intrinsic value upon grant, and therefore no estimated expense was recorded prior to adopting FAS 123R.

For purposes of pro forma disclosures under FAS 123 for the three and nine months ended September 30, 2005, the estimated fair value of the stock options was amortized to expense over the stock options’ vesting periods. The pro forma effects of recognizing estimated compensation expense under the fair value method on net loss and loss per common share for the three and nine months ended September 30, 2005 were as follows:

		THREE MONTHS ENDED				NINE MONTHS ENDED
		SEPTEMBER 30, 2005				SEPTEMBER 30, 2005
Net loss, as reported		$	(3,608,281	)		$	(12,766,014	)
Add: stock-based compensation expense included in reported net loss							19,444
Deduct: Share-based employee compensation expense determined under the fair value based method for all awards			(339,471	)			(1,439,514	)
Pro forma net loss		$	(3,947,752	)		$	(14,186,084	)
Loss per common share:		$	(0.21	)		$	(0.75	)
Basic and diluted loss per share— as reported		$	(0.02	)		$	(0.09	)
Basic and diluted loss per share — pro forma		$	(0.23	)		$	(0.84	)

The pro forma effects of estimated share-based compensation expense on net loss and loss per common share for the nine months ended September 30, 2005 were estimated at the date of grant using the Black-Scholes option-pricing model based on the following assumptions (annualized percentages):

Volatility			69.4	%
Risk-free interest rate			3.72	%
Dividend yield			0.0	%
Expected life (years)			5.0

The Black-Scholes weighted average estimated fair value of stock options granted during the nine months ended September 30, 2005 was $6.55 per share.

10) BASIC AND DILUTED NET LOSS PER SHARE

Basic net loss per common share is based on the weighted-average number of shares outstanding during each period. For the periods ended September 30, 2006, and 2005, stock options, warrants and rights totaling approximately 3,110,000 and 3,396,000 shares, respectively, have been excluded from the computation of diluted net loss per share as the effect would be antidilutive. The 2,396,245 shares issued in the Sirius acquisition, which includes 422,892 shares placed into the liability escrow account, are included in the weighted average number of shares outstanding from the date of issuance, March 10, 2006.

11) SEGMENT REPORTING

Beginning in the first quarter of 2006 with the acquisition of Sirius, the Company has two reportable operating segments, Photodynamic Therapy (PDT) Drug and Device Products and Non-Photodynamic Therapy (Non-PDT) Drug Products. Prior to the beginning of the first quarter of 2006, the Company was a single reportable segment entity. Operating segments are defined as components of the Company for which separate financial information is available to manage resources and evaluate performance regularly by the chief operating decision maker. The table below presents the revenues, costs of revenues and gross margins attributable to these reportable operating segments for the periods presented. The Company does not allocate research and development, selling and marketing and general and administrative expenses to its reportable operating segments, because these activities are managed at a corporate level.

		THREE MONTHS ENDED								NINE MONTHS ENDED
		SEPTEMBER 30,				SEPTEMBER 30,				SEPTEMBER 30,				SEPTEMBER 30,
		2006				2005				2006				2005
REVENUES
PDT Drug & Device Product Revenues		$	3,235,000			$	2,392,000			$	10,929,000			$	7,989,000
Non-PDT Drug Product Revenues			2,828,000				—				6,503,000				—
Total Revenues			6,063,000				2,392,000				17,432,000				7,989,000
COSTS OF REVENUES
PDT Drug & Device Cost of Product
Revenues and Royalties			1,243,000				1,307,000				3,971,000				4,782,000
Non-PDT Drug Cost of Product
Revenues and Royalties			1,606,000				—				3,664,000				—
Total Costs of Product Revenues and Royalties			2,849,000				1,307,000				7,635,000				4,782,000
GROSS MARGINS
PDT Drug and Device Product Gross Margin			1,992,000				1,085,000				6,958,000				3,207,000
Non-PDT Drug Product Gross Margin			1,222,000				—				2,839,000				—
Total Gross Margins		$	3,214,000			$	1,085,000			$	9,797,000			$	3,207,000

During the three and nine months ended September 30, 2006 and 2005, the Company derived revenues from the following geographies (as a percentage of product revenues):

		Three Months Ending September 30,								Nine Months Ending September 30,
		2006				2005				2006				2005
United States			96	%			87	%			94	%			86	%
Canada			4	%			13	%			6	%			14	%
Total			100	%			100	%			100	%			100	%

Asset information by reportable segment is not reported to or reviewed by the chief operating decision makers and, therefore, we have not disclosed asset information for each reportable segment.

12) COMPREHENSIVE LOSS

For the three and nine months ended September 30, 2006 and 2005, comprehensive loss consisted of the following:

		THREE MONTHS ENDED								NINE MONTHS ENDED
		SEPTEMBER 30,								SEPTEMBER 30,
		2006				2005				2006				2005
NET LOSS		$	(3,786,639	)		$	(3,608,281	)		$	(13,080,901	)		$	(12,766,014	)
Change in net unrealized gains and losses on marketable securities available-for-sale			(56,756	)			(166,714	)			(27,313	)			(413,323	)
COMPREHENSIVE LOSS		$	(3,843,395	)		$	(3,774,995	)		$	(13,108,214	)		$	(13,179,337	)

Accumulated other comprehensive loss consists of net unrealized gains and losses on marketable securities available-for-sale, which is reported as part of shareholders’ equity in the Condensed Consolidated Balance Sheets.

13) COMMITMENTS AND CONTINGENCIES

LEGAL MATTERS:

RIVER’S EDGE

On March 28, 2006, a lawsuit was filed by River’s Edge Pharmaceuticals, LLC against us alleging, among other things, that, prior to our merger with the former Sirius Laboratories, Inc. Sirius agreed to authorize River’s Edge to market a generic version of Nicomide^®, and that the United States patent covering Nicomide^® issued to Sirius in December, 2005 is invalid. Nicomide^® is one of the key products DUSA acquired from Sirius in our merger. The declaratory judgment suit was filed in the United States District Court for the Northern District of Georgia, Gainesville Division. On June 19, 2006, the Georgia court dismissed River’s Edge complaint.

River’s Edge has also filed an application with the U.S. Patent and Trademark Office requesting reexamination of the Nicomide patent. We have notified the Patent Office that we do not object to the reexamination process and we expect the Patent Office to notify the parties about its decision to accept or deny the patent reexamination process shortly.

On April 20, 2006, we filed a patent infringement suit in the United States District Court in Trenton, New Jersey alleging that a River’s Edge niacinamide product infringes our U.S. patent 6,979,468. On May 12, 2006, the New Jersey court granted our motion and entered an order for preliminary injunction, effective May 15, 2006, enjoining River’s Edge from selling its niacinamide formula drug as a generic substitute for Nicomide^®. We have posted $750,000 in lieu of a performance bond with the Court which bears interest. The parties are in the discovery stage of the New Jersey litigation. A motion to stay this litigation while the patent reexamination process takes its course was denied. An unfavorable ruling in the Patent Office or in the New Jersey litigation with respect to the validity of the Nicomide patent would allow generic manufacturers to compete directly with us and could have a material impact on the Company’s revenues, results of operations and liquidity.

The Company has not accrued any amounts for potential contingencies as of September 30, 2006, as these amounts are neither probable nor estimable.

14) RECENT ACCOUNTING PRONOUNCEMENTS

In June 2006, the FASB issued Interpretation No. 48 (FIN 48), “Accounting for Uncertainty in Income Taxes, an interpretation of FASB Statement No. 109, Accounting for Income Taxes.” The interpretation prescribes a recognition threshold and measurement attribute for the financial statement recognition and measurement of a tax position taken or expected to be taken, in a tax return. FIN 48 also provides guidance on derecognition, classification, interest and penalties accounting in interim periods, disclosure and transition. The interpretation is effective for fiscal years beginning after December 15, 2006. The Company is in the process of determining the effects that adoption of FIN 48 will have on the Company’s financial position, cash flows and results of operations.

In September 2006, the FASB issued SFAS No. 157, “Fair Market Measurements” (“SFAS 157”), which establishes a framework for measuring fair value and expands disclosures about the use of fair value measurements and liabilities in interim and annual reporting periods subsequent to initial recognition. Prior to SFAS 157, which emphasizes that fair value is a market-based measurement and not an entity-specific measurement, there were different definitions of fair value and limited definitions for applying those definitions in GAAP. SFAS 157 is effective for the Company on a prospective basis for the

reporting period beginning January 1, 2008. The effect of adoption on the Company’s financial position and results of operations have not been determined.

In September 2006, the SEC staff published SAB 108, Considering the Effects of Prior Year Misstatements when Quantifying Misstatements in Current Year Financial Statements (“SAB 108”). SAB 108 provides interpretive guidance on how the effects of the carryover or reversal of prior year misstatements should be considered in quantifying a current year misstatement. The SAB is effective for fiscal years ending after November 15, 2006. Application of this SAB will not alter previous conclusions and is not expected to impact the Company’s financial position, results of operations or cash flows.

15) SUBSEQUENT EVENT

On October 18, 2006 the Company’s Board of Directors extended the term of Two Hundred Fifty Thousand (250,000) Class B warrants, originally issued to the Company’s Chairman of the Board of Directors and Chief Executive Officer at the time of DUSA’s initial public offering, for an additional four years to January 29, 2011. An additional Fifty Thousand (50,000) of the Three Hundred Thousand (300,000) Class B warrants he currently owns will lapse if they are not exercised prior to January 29, 2007. The warrants have an exercise price of CDN $6.79 per share. No other terms of the warrants were amended. There are no other holders of the Class B warrants. The Company will record a non-cash charge to earnings of approximately $500,000 during the fourth quarter of 2006 related to the extension of the warrants.

ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

OVERVIEW

DUSA is a dermatology company that is developing and marketing Levulan photodynamic therapy and other products for common skin conditions. Our current marketed products include Levulan^® Kerastick^® 20% Topical Solution with PDT, the BLU-U^® brand light source, Nicomide^®, Nicomide-T^® and the AVAR^® line of products. We acquired Nicomide^®, Nicomide-T^®, the AVAR^® line of products, among others, and certain product candidates in early stages of development, which target the treatment of acne vulgaris and acne rosacea, as well as psoriasis, in connection with our recent merger with Sirius Laboratories, Inc., or Sirius, which was completed on March 10, 2006. We are also continuing to seek to acquire and/or license additional dermatology products that complement our current product portfolio that would provide our sales force with additional complementary products to sell in the near to medium term.

Our drug, Levulan^® brand of aminolevulinic acid HCl, or ALA, is being used with light, for use in a broad range of medical conditions. When we use Levulan^® and follow it with exposure to light to treat a medical condition, it is known as Levulan^® photodynamic therapy, or Levulan^® PDT. When we use Levulan^® and follow it with exposure to light to detect medical conditions it is known as Levulan^® photodetection, or Levulan^® PD.

Two of our products, Levulan^® Kerastick^® 20% Topical Solution with PDT and the BLU-U^® brand light source were launched in the United States, or U.S., in September 2000 for the treatment of actinic keratoses, or AKs, of the face or scalp. AKs are precancerous skin lesions caused by chronic sun exposure that can develop over time into a form of skin cancer called squamous cell carcinoma. In addition, in September 2003 we received clearance from the U.S. Food and Drug Administration, or FDA, to market the BLU-U^® without Levulan^® PDT for the treatment of moderate inflammatory acne vulgaris and general dermatological conditions.

Sirius, a dermatology specialty pharmaceuticals company, was founded in 2000 with a primary focus on the treatment of acne vulgaris and acne rosacea. We believe this acquisition has allowed us to expand our product portfolio, capitalize on cross-selling and marketing opportunities, increased our sales force size, as well as providing a pipeline of new products.

Nicomide^® is an oral prescription vitamin supplement, and Nicomide-T^® is a topical cosmetic product.

Both products target the acne and acne rosacea markets. Acne rosacea is a condition that primarily affects the skin of the face and typically first appears between the ages of 30 and 60 as a transient flushing or blushing on the nose, cheeks, chin or forehead, progressing in many patients to a papulopustular form clinically similar to acne vulgaris (inflammatory acne). Given its resemblance to inflammatory acne, and the general public’s limited knowledge of rosacea, the condition is frequently mistaken by patients as adult acne. If untreated, rosacea has the tendency to worsen over time, although it can also wax and wane. The AVAR line of products includes a number of leave-on and cleanser formulations of sodium sulfacetamide and sulphur, a drug combination long known to have anti-acne, anti-inflammatory properties.

We are a vertically integrated company, primarily responsible for regulatory, sales, marketing, customer service, manufacturing of our Kerastick^®, and other related product activities. Our current objectives include increasing the sales of our non-PDT products in the United States and our PDT products in the United States, Canada and Latin America, continuing our efforts of exploring partnership opportunities for Levulan^® PDT for non-dermatology indications, and for dermatology in Europe and elsewhere, and continuing our clinical development programs. To further these objectives, we entered into a marketing and distribution agreement with Stiefel Laboratories, Inc. in January 2006 granting Stiefel an exclusive right to distribute the Levulan^® Kerastick^® in Mexico, Central and South America. On October 17, 2006, we announced that regulatory approval had been obtained in Brazil. We anticipate the Brazilian launch will occur in early 2007. During 2004 we signed clinical trial agreements with the National Cancer Institute, or NCI, Division of Cancer Prevention, or DCP, for the clinical development of Levulan^® PDT for the treatment of high-grade dysplasia, or HGD, within Barrett’s Esophagus, or BE, and oral cavity dysplasia treatment, and are working with the NCI DCP to advance the development of these programs. In addition, we continue to support independent investigator trials to advance research in the use and applicability of Levulan^® PDT for other indications in dermatology, and selected internal indications.

We are developing Levulan^® PDT and PD under an exclusive worldwide license of patents and technology from PARTEQ Research and Development Innovations, the licensing arm of Queen’s University, Kingston, Ontario, Canada. We also own or license certain other patents relating to methods for using pharmaceutical formulations which contain Levulan^® and related processes and improvements.

In the United States, AVAR^®, AVAR Green^®, AVAR-e ^®, AVAR-e Green^®, AVAR Cleanser^®, BLU-U^®, DUSA^®, DUSA Pharmaceuticals, Inc.^®, Levulan^®, Kerastick^®, Sirius Laboratories, Inc.^®, METED ^® , Nicomide ^®, Nicomide-T ^®, Psoriacap ^® and Psoriatec^® are registered trademarks. Several of these trademarks are also registered in Europe, Australia, Canada, and in other parts of the world. Numerous other trademark applications are pending.

Historically, we devoted most of our resources to fund research and development efforts in order to advance the Levulan^® PDT/PD technology platform. In addition, we are continuing to evaluate and develop several potential products that we acquired in our merger with Sirius which target patients with acne and rosacea.

As of September 30, 2006, we had an accumulated deficit of approximately $102,618,000. We expect to continue to incur operating losses until sales of our products increase substantially. Achieving our goal of becoming a profitable operating company is dependent upon greater acceptance of our PDT therapy by the medical and consumer constituencies, and increasing sales of the products we acquired from Sirius.

We operate in a highly regulated and competitive environment. Our competitors include larger fully integrated pharmaceutical companies and biotechnology companies. Many of the organizations competing with us have substantially greater capital resources, larger research and development staffs and facilities, greater experience in drug development and in obtaining regulatory approvals, and greater manufacturing and sales and marketing capabilities than we do. Particularly in the field of acne and rosacea, we compete with well-established therapies, such as over-the-counter topical medications for

mild cases, and prescription topical medications or oral antibiotics for mild to moderate cases, as well as various laser and non-laser light sources. The entry of new products from time to time, including as recently as the quarter ended September 30, 2006, could cause fluctuations in our product revenues in this market.

Marketing and sales activities since the October 2003 launch of our sales force have resulted in significant additional revenues as well as expenses. Kerastick^® unit sales to end-users were 27,480 and 95,358 for the three and nine-month periods ended September 30, 2006, respectively, including 2,400 and 12,990, respectively, sold in Canada. This represents an increase from 20,286 and 69,162 Kerastick^® units sold in the three and nine-month periods ended September 30, 2005, respectively, including 2,520 and 9,990, respectively, sold in Canada.

The net number of BLU-U^® units placed in doctors’ offices during the three months ended September 30, 2006 and 2005 was 69 and 98, respectively, including 9 and 22 placed in Canada, respectively. As of September 30, 2006 and December 31, 2005 there were 1,548 and 1,337 units in doctor’s offices, consisting of 1,328 and 1,142 in the U.S. and 220 and 195 in Canada, respectively. During 2005 we began a BLU-U^® marketing effort to allow prospective customers to evaluate a BLU-U for a short period of time prior to making a purchase decision. BLU-U^® commercial light sources placed in physicians’ offices pursuant to the Company’s BLU-U^® evaluation program are classified as inventory in the accompanying Consolidated Balance Sheets. The Company amortizes the cost of the evaluation units during the evaluation period to cost of product revenues to approximate its net realizable value.

Net revenues generated by the products acquired as part of our acquisition of Sirius totaled $2,828,000 and $6,503,000 for the three-month period ended September 30, 2006 and the period March 10, 2006 (date of acquisition) through September 30, 2006, respectively. The substantial majority of these revenues were from sales of Nicomide^®. We have continued our efforts to penetrate the market for both PDT and non-PDT products by expanding our sales coverage in key geographic locations, including areas not previously served by Sirius. We are encouraged with the year-over-year increase in sales, as well as the positive feedback we continue to receive from physicians across the country that believe Levulan^® PDT should become a routine part of standard dermatological practice. We are currently exploring opportunities to develop, market, and distribute our Levulan^® PDT platform in Europe and/or other countries outside of the United States, Canada and Latin America following our recently completed agreement with Stiefel Laboratories, Inc. We cannot predict when product sales may offset the costs associated with our efforts to penetrate the PDT market; however, based on current revenue expectations we believe that we will approach positive cash flow from operations more quickly than we otherwise would have without the Sirius acquisition. We are aware that physicians have been using Levulan^® with the BLU-U^® using drug incubation times shorter than our approved label specifies, with light devices manufactured by other companies, and for uses other than our FDA-approved use. While we are not permitted to market our products for so-called ‘off-label’ uses, we believe that these activities are positively affecting the sales of our products.

We believe that the activities of compounding pharmacies are negatively impacting our sales growth. We believe that some compounding pharmacies are exceeding the legal limits for their activities, including manufacturing and/or selling quantities of ALA in circumstances which may be inducing purchasers to infringe our intellectual property. Since December 2004, we filed lawsuits against two compounding pharmacies and several physicians. All of these lawsuits have been settled favorably to us. Recently, we filed a suit against a chemical supplier as part of our ongoing strategy to protect our intellectual property. See section entitled “Part II. Other Information, Item 1. Legal Proceedings”.

In connection with our merger with Sirius, we have assumed a number of key agreements relating to the manufacture and supply of the Sirius current and potential products, and relating to the development of

certain product candidates. We intend to continue to use third-party manufacturers for such products. The Sirius products are distributed through several major wholesalers in the United States pursuant to customary industry arrangements. The foregoing agreements are discussed later in this report.

Certain of the products acquired in connection with the Sirius merger must meet certain minimum manufacturing and labeling standards established by the FDA and applicable to products marketed without approved marketing applications. FDA regulates such products under its marketed unapproved drugs compliance policy guide entitled, “Marketed New Drugs without Approved NDAs or ANDAs.” Under this policy, FDA recognizes that certain unapproved products, based on the introduction date of their active ingredients and the lack of safety concerns, have been marketed for many years and, at this time, will not be the subject of any enforcement action. FDA is encouraging manufacturers of such products to submit applications to obtain marketing approval and we have begun discussions with FDA to begin that process. FDA’s enforcement discretion policy does not apply to drugs or firms that may be in violation of regulatory requirements other than preapproval submission requirements and FDA may bring an action against a drug or a firm when FDA concludes that such other violations exist. The contract manufacturer of Nicomide has received a request from the FDA for labeling information and justification for the belief that the product is exempt from drug approval requirements and has been cited for GMP violations, however, we believe the GMP issues do not directly involve our products. There can be no assurance that the FDA will continue this policy or not take a contrary position with any individual products. If the FDA were to do so, we may be required to market these products as over-the-counter products or as dietary supplements under applicable legislation, or withdraw such products from the market, unless and until we submit a marketing application and obtain FDA marketing approval.

As a result of our due diligence efforts, including inspection of the third-party manufacturers, we are working with the supplier of the AVAR^® line of products to address certain manufacturing concerns that were identified during due diligence. Some of these products are on back-order while such concerns are being addressed. Revenues from these products are not material to the Company’s overall revenues.

On March 28, 2006, a lawsuit was filed by River’s Edge Pharmaceuticals, LLC against us alleging, among other things, that, prior to our merger with the former Sirius Laboratories, Inc. Sirius agreed to authorize River’s Edge to market a generic version of Nicomide^®, and that the United States patent covering Nicomide^® issued to Sirius in December, 2005 is invalid. Nicomide^® is the key product DUSA acquired from Sirius in our merger. The declaratory judgment suit was filed in the United States District Court for the Northern District of Georgia, Gainesville Division. On June 19, 2006, the Georgia court dismissed River’s Edge complaint.

River’s Edge has also filed an application with the U.S. Patent and Trademark Office requesting reexamination of the Nicomide patent. We have notified the Patent Office that we do not object to the reexamination process and we expect the Patent Office to notify the parties about its decision to accept or deny the patent reexamination process shortly.

On April 20, 2006, we filed a patent infringement suit in the United States District Court in Trenton, New Jersey alleging that a River’s Edge niacinamide product infringes our U.S. patent 6,979,468. On May 12, 2006, the New Jersey court entered an order for preliminary injunction, which was effective May 15, 2006, enjoining River’s Edge from selling its niacinamide formula drug as a generic substitute for Nicomide^®. We have posted $750,000 in lieu of a performance bond with the Court which bears interest. The parties are in the discovery stage of the New Jersey litigation. A motion to stay this litigation while the patent reexamination process takes its course was denied. An unfavorable ruling in the Patent Office or in the New Jersey litigation with respect to the validity of the Nicomide patent would allow generic manufacturers to compete directly with us and could have a material impact on the Company’s revenues, results of operations and liquidity.

On May 30, 2006, we entered into a patent license agreement under which we granted PhotoCure ASA a non-exclusive license under the patents we license from PARTEQ for ALA esters. In addition, we granted a non-exclusive license to PhotoCure for its existing formulations of Hexvix^® and Metvix^® (known in the U.S. as Metvixia^®) for any patent we own now or in the future. PhotoCure is obligated to pay royalties on sales of its ester products to the extent they are covered by our patents in the US and certain other territories. As part of the agreement, PhotoCure paid us a prepaid royalty in the amount of $1 million, which we received during the three-month period ended June 30, 2006.

We continue to believe that issues related to reimbursement have negatively impacted the economic competitiveness of our therapy with other AK therapies and have hindered its adoption. We are aware that some physicians believe that current reimbursement levels do not fully reflect the efforts required to routinely execute our therapy in their practices. We support efforts to improve reimbursement levels to physicians. Such efforts included working with the Centers for Medicare and Medicaid Services, or CMS, and the American Academy of Dermatology, or AAD, on matters related to the PDT procedure fee and the separate drug reimbursement fee. Physicians can also bill for any applicable visit fees. Effective January 1, 2006, the CMS average national reimbursement for the use of Levulan^® PDT for AK’s Ambulatory Patient Classifications code (“APC code”) was increased. The APC code is used by many hospitals. The CMS Current Procedural Terminology code (“CPT code”), which is used by private physician clinics using Levulan^® PDT for treating AKs was not increased for 2006 from 2005 levels as had originally been proposed by CMS. However, CMS recently published proposed fees for January 1, 2007, and beyond, that include increases to the CPT code used by private physician clinics using Levulan^® PDT for treating AKs. The proposed increases will be phased in over four years, beginning January 1, 2007, and completing January 1, 2010. We will continue to support ongoing efforts that might lead to further increases in reimbursement in the future; and intend to continue supporting efforts to seek reimbursement for our FDA-cleared use of the BLU-U^® alone in the treatment of mild to moderate inflammatory acne of the face.

Most major private insurers have approved coverage for our AK therapy. We believe that due to these efforts, plus future improvements, along with our education and marketing programs, a more widespread adoption of our therapy should occur over time. As of September 30, 2006, we had a staff of 78 full-time employees and 2 part-time employees, as compared to 64 full-time employees and 2 part-time employees at the end of 2005, including marketing and sales, production, maintenance, customer support, and financial operations personnel, as well as those who support research and development programs for dermatology and internal indications. During 2006 we expanded our sales capacity to 37 from 26 at the end of 2005. We may add and/or replace employees during 2006 as business circumstances deem necessary.

CRITICAL ACCOUNTING POLICIES

Our accounting policies are disclosed in Note 2 to the Notes to the Consolidated Financial Statements in our Annual Report on Form 10-K for the year ended December 31, 2005. Since all of these accounting policies do not require management to make difficult, subjective or complex judgments or estimates, they are not all considered critical accounting policies. We have discussed these policies and the underlying estimates used in applying these accounting policies with our audit committee. We consider the following policies and estimates to be critical to our financial statements.

REVENUE RECOGNITION AND PROVISIONS FOR ESTIMATED REDUCTIONS TO GROSS REVENUES

Photodynamic Therapy (PDT) Drug and Device Products.

Revenues on the Kerastick^® and BLU-U^® product sales are recognized when persuasive evidence of an arrangement exists, the price is fixed and determinable, delivery has occurred, and collection is probable. Product sales made through distributors, historically, have been recorded as deferred revenue until the product was sold by the distributors to the end users because we did not have sufficient history with our

distributor to be able to reliably estimate returns. Beginning in 2006, we began recognizing revenue as product is sold to distributors because we now believe have sufficient history to reliably estimate returns from distributors. Certain device units are held by physicians for a trial period. No revenue is recognized on these units until the physician elects to purchase the equipment and all other revenue recognition criteria are met.

Non-PDT Drug Products.

We recognize revenue for these products in accordance with SAB No. 101, Revenue Recognition in Financial Statements, as amended by SAB No. 104, Revenue Recognition. Our accounting policy for revenue recognition has a substantial impact on our reported results and relies on certain estimates that require difficult, subjective and complex judgments on the part of management. We recognize revenue for sales when substantially all the risks and rewards of ownership have transferred to the customer, which generally occurs on the date of shipment to wholesale customers, with the exceptions described below. Revenue is recognized net of revenue reserves, which consists of allowances for discounts, returns, rebates chargebacks and fees paid to wholesalers under distribution service agreements.

In the case of sales made to wholesalers as a result of incentives and that are in excess of the wholesaler’s ordinary course of business inventory level, substantially all the risks and rewards of ownership do not transfer upon shipment and, accordingly, such sales are recorded as deferred revenue and the related costs as deferred cost of revenue until the product is sold through to the wholesalers’ customers on a FIFO basis.

We evaluate inventory levels at our wholesale customers, which account for the vast majority of our sales in the Non-PDT Drug Products segment, through an analysis that considers, among other things, wholesaler purchases, wholesaler shipments to retailers, available end-user prescription data purchased from third parties and on-hand inventory data received directly from our two largest wholesale customers. We believe that our evaluation of wholesaler inventory levels, as described in the preceding sentence, allows us to make reasonable estimates for our applicable revenue related reserves. Additionally, our products are sold to wholesalers with a product shelf life that allows sufficient time for our wholesaler customers to sell our products in their inventory through to the retailers and, ultimately, to the end-user consumer prior to product expiration.

A summary of activity in the Company’s gross revenue reserves follows for each of the periods presented:

						FOR THE THREE-MONTH PERIOD
						ENDED SEPTEMBER 30, 2006:
						PROVISION				PROVISION				ACTUAL
						RELATED TO				FOR				RETURNS
						SALES MADE				SALES				OR CREDITS
		BALANCE				IN THE				MADE IN				IN THE				BALANCE
		AT JULY 1,				CURRENT				PRIOR				CURRENT				AT SEPTEMBER
		2006				PERIOD				PERIODS				PERIOD				30, 2006
Accrued Expenses:
Returns and allowances		$	252,000			$	304,000			$	—			$	(236,000	)		$	320,000
Accounts receivable:
Prompt payment discounts		$	26,000			$	67,000			$	—			$	(65,000	)		$	28,000

						FOR THE NINE-MONTH PERIOD ENDED SEPTEMBER 30, 2006:
										PROVISION								ACTUAL
						BALANCE				RELATED TO				PROVISION				RETURNS
						ACQUIRED AS				SALES MADE				FOR SALES				OR CREDITS
						PART OF				IN THE				MADE IN				IN THE				BALANCE AT
		BALANCE AT				SIRIUS				CURRENT				PRIOR				CURRENT				SEPTEMBER
		JANUARY 1, 2006				ACQUISITION				PERIOD				PERIODS				PERIOD				30, 2006
Accrued Expenses:
Returns and allowances		$	—			$	357,000			$	594,000			$	—			$	(631,000	)		$	320,000
Accounts receivable:
Prompt payment discounts		$	—			$	—			$	151,000			$	—			$	($123,000	)		$	28,000

Our provision for returns and allowances consists of our estimates of future sales returns, rebates and chargebacks.

Sales Returns- We account for sales returns in accordance with SFAS No. 48 by establishing an accrual in an amount equal to our estimate of sales recorded for which the related products are expected to be returned. We determine the estimate of the sales return accrual primarily based on historical experience regarding sales returns, but also by considering other factors that could impact sales returns. These factors include levels of inventory in the distribution channel, estimated shelf life, product recalls, product discontinuances, price changes of competitive products, introductions of generic products and introductions of competitive new products. It is our policy to accept returns of Non-PDT Drug products when product is within nine months of expiration. We consider all of these factors and adjust the accrual periodically to reflect actual experience.

Chargebacks and Rebates — Chargebacks typically occur when suppliers enter into contractual pricing arrangements with end-user customers, including certain federally mandated programs, who then purchase from wholesalers at prices below what the supplier charges the wholesaler. Since we only offer “preferred pricing” to end-user customers under federally mandated programs, chargebacks have not been significant to the Company. Our rebate programs can generally be categorized into the following two types: Medicaid rebates and consumer rebates. Medicaid rebates are amounts owed based on legal requirements with public sector benefit providers after the final dispensing of the product by a pharmacy to a benefit plan participant. Consumer rebates are amounts owed as a result of mail-in coupons that are distributed by health care providers to consumers at the time a prescription is written. Since only a small percentage of our prescriptions are reimbursed under Medicaid and the quantity of consumer coupon redemptions have not been substantial, rebates have not been significant to the Company. Chargebacks and rebates in the aggregate were $46,000 and $136,000, for the three and nine month periods ended September 30, 2006, respectively.

We offer many of our customers a 2% prompt pay discount. We evaluate the amounts accrued for prompt pay discounts by analyzing the unpaid invoices in our accounts receivable aging subject to a prompt pay discount. Prompt pay discounts are known within 15 to 30 days of sale, and therefore can be reliably estimated based on actual and expected activity at each reporting date. The Company records these discounts at the time of sale and they are accounted for as a reduction of revenues.

Historically, our adjustments to actual have not been material. The sensitivity of our estimates can vary by type of revenue reserve. Our estimate associated with returns and allowances is evaluated based primarily on historical returns experience relative to sales volumes, but also considers the length of time from the sale to the lapse of the return right. There have been no material adjustments to our accruals based on actual returns.

INVENTORY

Inventories are stated at the lower of cost or market value. Cost is determined using the first-in, first-out

method. Inventories are continually reviewed for slow moving, obsolete and excess items. Inventory items identified as slow-moving are evaluated to determine if an adjustment is required. Additionally, our industry is characterized by regular technological developments that could result in obsolete inventory. Although we make every effort to assure the reasonableness of our estimates, any significant unanticipated changes in demand, technological development, or significant changes to our business model could have a significant impact on the value of our inventory and our results of operations. We use sales projections to estimate the appropriate level of inventory reserves, if any, that are necessary at each balance sheet date.

VALUATION OF LONG-LIVED AND INTANGIBLE ASSETS

We review our long-lived and intangible assets for impairment whenever events or changes in circumstances indicate that the carrying amount of a long-lived or intangible asset may not be recoverable or that the useful lives of these assets are no longer appropriate. Recoverability of assets to be held and used is measured by a comparison of the carrying amount of an asset to future undiscounted net cash flows expected to be generated by the asset. When it is determined that the carrying value of a long-lived asset is not recoverable, the asset is written down to its estimated fair value on a discounted cash flow basis.

Goodwill is deemed to have an indefinite life and is no longer amortized, but is reviewed at least annually for impairment, utilizing the “fair value” methodology. The Company has adopted December 1st as the date of the annual impairment test for goodwill.

STOCK-BASED COMPENSATION

In December 2004, the Financial Accounting Standards Board (“FASB”) issued SFAS No. 123R, “Share-Based Payment,” a revision of SFAS Statement No. 123. We adopted SFAS 123R effective January 1, 2006, using the modified prospective application method, and beginning with the first quarter of 2006, we measure all employee share-based compensation awards using a fair value based method and record share-based compensation expense in our financial statements if the requisite service to earn the award is provided. The pro forma results and assumptions used in fiscal years 2005, 2004 and 2003 were based solely on historical volatility of our common stock over the most recent period commensurate with the estimated expected life of our stock options. The adoption of SFAS No. 123R did not affect our net cash flow, but it did have a material negative impact on our results of operations. In accordance with SFAS 123R, we recognize the expense attributable to stock awards that are granted or vest in periods ending subsequent to December 31, 2005 in the accompanying condensed consolidated statements of operations.

In connection with our adoption of SFAS 123R, we refined our valuation assumptions and the methodologies used to derive those assumptions; however, we elected to continue using the Black-Scholes option valuation model. Concurrent with our adoption of SFAS 123R, we determined that a combination of historical and implied volatility for traded options on DUSA’s stock would be a better measure of market conditions and expected volatility than historical volatility of our common stock alone. Previously, we used historical stock price volatility as it was the most reliable source of volatility data. We estimate the weighted-average expected life of our stock-option awards based on historical cancellation and exercise data related to our stock-based awards as well as the contractual term and vesting terms of the awards. In calculating the expected life of the options for 2006, we classified our grantee population into two groups, directors and officers and non-officer employees. Prior to the first quarter of 2006, we had used a company-wide weighted average expected life of five years for grants in 2005, 2004 and 2003 and seven years for grants in 2002. Stock-based compensation expense related to stock options is recognized net of estimated forfeitures. We estimated forfeitures based on our historical experience. In the first quarter of 2006, departure rates, defined as the annual percentage of options forfeited or exercised early due to departure, were estimated to be approximately 2.96% for officers and directors and 10.53% for non-officer employees.

RECENT ACCOUNTING PRONOUNCEMENTS

In June 2006, the FASB issued Interpretation No. 48 (FIN 48), “Accounting for Uncertainty in Income Taxes, an interpretation of FASB Statement No. 109, Accounting for Income Taxes.” The interpretation prescribes a recognition threshold and measurement attribute for the financial statement recognition and measurement of a tax position taken or expected to be taken, in a tax return. FIN 48 also provides guidance on derecognition, classification, interest and penalties accounting in interim periods, disclosure and transition. The interpretation is effective for fiscal years beginning after December 15, 2006. We are in the process of determining the effects that adoption of FIN 48 will have on our financial position, cash flows and results of operations.

In September 2006, the FASB issued SFAS No. 157, “Fair Market Measurements” (“SFAS 157”), which establishes a framework for measuring fair value and expands disclosures about the use of fair value measurements and liabilities in interim and annual reporting periods subsequent to initial recognition. Prior to SFAS 157, which emphasizes that fair value is a market-based measurement and not an entity-specific measurement, there were different definitions of fair value and limited definitions for applying those definitions in GAAP. SFAS 157 is effective for the Company on a prospective basis for the reporting period beginning January 1, 2008. The effect of adoption on our financial position and results of operations have not been determined.

In September 2006, SEC staff published SAB 108, “Considering the Effects of Prior Year Misstatements when Quantifying Misstatements in Current Year Financial Statements” (“SAB 108”). SAB 108 provides interpretive guidance on how the effects of the carryover or reversal of prior year misstatements should be considered in quantifying a current year misstatement. The SAB is effective for fiscal years ending after November 15, 2006. Application of this SAB will not alter previous conclusions and is not expected to impact our financial position, results of operations or cash flows.

RESULTS OF OPERATIONS — THREE MONTHS ENDED SEPTEMBER 30, 2006 VERSUS SEPTEMBER 30, 2005

REVENUES — Total revenues for the three and nine month periods ended September 30, 2006 were $6,063,000 and $17,432,000, respectively as compared to $2,392,000 and $7,989,000 in 2005, and were comprised of the following:

		THREE MONTHS ENDED SEPTEMBER 30,												NINE MONTHS ENDED SEPTEMBER 30,
		(UNAUDITED)								INCREASE/				(UNAUDITED)								INCREASE/
		2006				2005				(DECREASE)				2006				2005				(DECREASE)
PDT PRODUCT REVENUES
KERASTICK® PRODUCT REVENUES
United States		$	2,490,000			$	1,630,000			$	860,000			$	8,212,000			$	5,389,000			$	2,823,000
Canada			176,000				176,000				—				939,000				693,000				246,000
Subtotal Kerastick® product revenues			2,666,000				1,806,000				860,000				9,151,000				6,082,000				3,069,000
BLU-U® PRODUCT REVENUES
United States			516,000				462,000				54,000				1,633,000				1,489,000				144,000
Canada			53,000				124,000				(71,000	)			145,000				418,000				(273,000	)
Subtotal BLU-U® product revenues			569,000				586,000				(17,000	)			1,778,000				1,907,000				(129,000	)
TOTAL PDT PRODUCT REVENUES			3,235,000				2,392,000				843,000				10,929,000				7,989,000				2,940,000
TOTAL NON-PDT DRUG PRODUCT REVENUES			2,828,000				—				2,828,000				6,503,000				—				6,503,000
TOTAL PRODUCT REVENUES		$	6,063,000			$	2,392,000			$	3,671,000			$	17,432,000			$	7,989,000			$	9,443,000

For the three and nine month periods ended September 30, 2006 total PDT Drug and Device Products revenues were $3,235,000 and $10,929,000, respectively. This represents an increase of $843,000 or 35%, and $2,940,000 or 37%, over the comparable 2005 totals of $2,392,000 and $7,989,000, respectively. The incremental revenue on a year-to-date basis was driven by increased Kerastick^® revenues which were partially offset by decreased BLU-U^® revenues.

For the three and nine month periods ended September 30, 2006, Kerastick^® revenues were $2,666,000 and $9,151,000, respectively, representing a $860,000 or 48%, and $3,069,000 or 50%, increase over the comparable 2005 totals of $1,806,000 and $6,082,000, respectively. Kerastick^® unit sales to end-users were 27,480 and 95,358 for the three and nine-month periods ended September 30, 2006, respectively, including 2,400 and 12,990, respectively, sold in Canada. This represents an increase from 20,286 and 69,162 Kerastick^® units sold in the three and nine-month periods ended September 30, 2005, respectively, including 2,520 and 9,990, respectively, sold in Canada. Our average net selling price for the Kerastick^® increased to $95.96 for the first nine months of 2006 from $87.93 for the first nine months of 2005.

Our average net selling price for the Kerastick^® includes sales made directly to our end-user customers, as well as sales made to our distributors, both in the United States during 2005 and Canada during 2005 and 2006. The increase in 2006 Kerastick^® revenues was driven mainly by increased sales volumes, an increase in our average unit selling price, a reduction in our overall sales volume discount programs, and increased levels of direct distribution to customers. Effective January 1, 2006, DUSA became the sole US distributor of the Kerastick^®.

For the three and nine month periods ended September 30, 2006, BLU-U^® revenues were $569,000 and $1,778,000, respectively, representing a $17,000 or 3% decrease, and $129,000 or 7%, decrease over the comparable 2005 totals of $586,000 and $1,907,000, respectively. The decrease in 2006 BLU-U^® revenue was driven by lower overall sales volumes which were partially offset by an increase in our average selling price. In the three and nine-month periods ended September 30, 2006, there were 77 and 235 units sold, respectively, versus 82 units and 294 units in the comparable 2005 periods. The 2006 total consists of 210 units sold in the United States and 25 sold in Canada by Coherent-AMT. The 2005 total consists of 219 sold in the United States and 75 sold in Canada. Our average net selling price for the BLU-U^® increased to $7,392 for the first nine months of 2006 from $6,390 for the first nine months of 2005. The decrease in BLU-U^® units sold in the three and nine-month periods ended September 30, 2006 compared to the same periods in 2005 is due primarily to the implementation of a more focused sales strategy aimed at increasing Kerastick^® sales volumes in existing accounts; as well as, a decrease in BLU-U^® discounting programs.

During the fourth quarter of 2005, we introduced a BLU-U^® evaluation program, which, for a limited number of BLU-U^® units, allows customers to take delivery of a unit for a period of up to 4 months for private practitioners and up to one year for hospital clinics, before a purchase decision is required. At September 30, 2006, there were approximately 50 units in the field pursuant to this evaluation program. The units are classified as inventory in the financial statements and are being amortized during the evaluation period to cost of goods sold using an estimated life for the equipment of 3 years.

Non-PDT Drug Product Revenues reflect the revenues generated by the products acquired as part of our March 10, 2006 acquisition of Sirius. Total revenues for the three months ended September 30, 2006 and for the period March 10, 2006 through September 30, 2006 were $2,828,000 and $6,503,000, respectively. The substantial majority of the Non-PDT product revenues were from sales of Nicomide^®. The products acquired from Sirius all belong to the same therapeutic category, “non-photodynamic therapy dermatological treatment of acne and rosacea.”

The increase in our total revenues results from the Sirius acquisition, as well as the efforts of our sales force and related marketing and sales activities. With respect to United States sales, we increased our average selling prices, increased our direct selling efforts, became the sole US distributor of the Kerastick^®, and reduced our overall sales volume discount programs, all of which have had a positive impact on our average selling prices during 2006. However, we must increase sales significantly from these levels in order for us to become profitable. We remain confident that sales should continue to increase through increased consumption of our products by our existing customers, as well as the addition of new customers. However, should one or more generic niacinamide products remain on the market for any significant length of time, our revenues of Nicomide^® could be significantly eroded, which would make it more difficult to achieve profitability.

COST OF PRODUCT SALES AND ROYALTIES – Cost of product revenues and royalties for the three and nine-month periods ended September 30, 2006 were $2,849,000 and $7,635,000, respectively, as compared to $1,307,000 and $4,782,000 in the comparable periods in 2005. A summary of the components of cost of product revenues and royalties is provided below:

		Three Months Ended September 30,
		(Unaudited)
										Increase/
		2006				2005				(Decrease)
Kerastick® Cost of Product Revenues and Royalties
Direct Kerastick® Product costs		$	380,000			$	369,000			$	11,000
Other Kerastick® Product costs including internal costs assigned to support products			224,000				354,000				(130,000	)
Royalty and supply fees (1)			126,000				93,000				33,000

		Three Months Ended September 30,
		(Unaudited)
										Increase/
		2006				2005				(Decrease)
Subtotal Kerastick Cost of Product Revenues and Royalties			730,000				816,000				(86,000	)
BLU-U® Cost of Product Revenues
Direct BLU-U® Product Costs			263,000				284,000				(21,000	)
Other BLU-U® Product Costs including internal costs assigned to support products; as well as, costs incurred to ship, install and service the BLU-U® in physicians offices			250,000				207,000				43,000
Subtotal BLU-U® Cost of Product Revenues			513,000				491,000				22,000
TOTAL PDT DRUG & DEVICE COST OF PRODUCT REVENUES AND ROYALTIES			1,243,000				1,307,000				(64,000	)
TOTAL NON-PDT DRUG COST OF PRODUCT REVENUES AND ROYALTIES (2)			1,606,000				—				1,606,000
TOTAL COST OF PRODUCT REVENUES AND ROYALTIES		$	2,849,000			$	1,307,000			$	1,542,000

		Nine Months Ended September 30,
		(Unaudited)
										Increase/
		2006				2005				(Decrease)
Kerastick® Cost of Product Revenues and Royalties
Direct Kerastick® Product costs		$	1,318,000			$	1,339,000				($21,000	)
Other Kerastick® Product costs including internal costs assigned to support products			636,000				985,000				(349,000	)
Royalty and supply fees (1)			461,000				318,000				143,000
Subtotal Kerastick® Cost of Product Revenues and Royalties			2,415,000				2,642,000				(227,000	)
BLU-U® Cost of Product Revenues
Direct BLU-U® Product Costs			802,000				998,000				(196,000	)
Other BLU-U® Product Costs including internal costs assigned to support products; as well as, costs incurred to ship, install and service the BLU-U® in physicians offices			754,000				1,142,000				(388,000	)
Subtotal BLU-U® Cost of Product Revenues			1,556,000				2,140,000				(584,000	)
TOTAL PDT DRUG & DEVICE COST OF PRODUCT REVENUES AND ROYALTIES			3,971,000				4,782,000				(811,000	)
TOTAL NON-PDT DRUG COST OF PRODUCT REVENUES AND ROYALTIES (2)			3,664,000				—				3,664,000
TOTAL COST OF PRODUCT REVENUES AND ROYALTIES		$	7,635,000			$	4,782,000			$	2,853,000

MARGINS — Total product margins for the three and nine month periods ended September 30, 2006 were $3,214,000 and $9,797,000, respectively, as compared to $1,085,000 and $3,207,000 for the comparable 2005 periods, as shown below:

		Three Months Ended September 30,
		(Unaudited)
																		Increase/
		2006								2005								(Decrease)
Kerastick® Gross Margin		$	1,935,000				73	%		$	990,000				55	%		$	945,000
BLU-U® Gross Margin			57,000				10	%			95,000				16	%			(38,000	)
Total PDT Drug & Device Gross Margin		$	1,992,000				62	%		$	1,085,000				45	%		$	907,000
Total Non-PDT Drug Gross Margin			1,222,000				43	%			—								1,222,000
TOTAL GROSS MARGIN		$	3,214,000				53	%		$	1,085,000				45	%		$	2,129,000

		Nine Months Ended September 30,
		(Unaudited)
																		Increase/
		2006								2005								(Decrease)
Kerastick® Gross Margin		$	6,736,000				74	%		$	3,440,000				57	%		$	3,296,000
BLU-U® Gross Margin			222,000				13	%			(233,000	)			(12	%)			455,000
Total PDT Drug & Device Gross Margin		$	6,958,000				64	%		$	3,207,000				40	%			3,751,000
Total Non-PDT Drug Gross Margin			2,839,000				44	%			—								2,839,000
TOTAL GROSS MARGIN		$	9,797,000				56	%		$	3,207,000				40	%		$	6,590,000

For the three and nine month periods ended September 30, 2006 total PDT Drug and Device Product Margins were 62% and 64%, respectively, versus 45% and 40% for the comparable 2005 periods. The incremental margin was driven by positive margin gains on both the Kerastick^® and BLU-U^®.

Kerastick^® gross margins for the three and nine month periods ended September 30, 2006 were 73% and 74%, respectively, versus 55% and 57% for the comparable 2005 periods. Similar to the increase in revenues, the increase in margin is mainly attributable to an increase in our average unit selling price, increased levels of direct distribution to customers eliminating the cost of distributors; as well as a reduction in our overall sales volume discount programs. Our long-term goal is to achieve higher gross margins on Kerastick^® sales which will be significantly dependent on increased volume.

BLU-U^® margins for the three and nine month periods ended September 30, 2006 were 10% and 13%, respectively, versus 16% and (12%) for the comparable 2005 periods. The increase in margin is a result of an increase in the average selling price per unit; as well as, lower overall costs incurred to support the product line. Our short-term strategy is to at a minimum breakeven on device sales in an effort to drive Kerastick^® sales volumes.

Non-PDT Drug Product Margins reflect the margin generated by the products acquired as part of our March 10, 2006 merger with Sirius Laboratories. Total margin for the three-month period ended September 30, 2006 and the period March 10, 2006 (date of acquisition) through September 30, 2006 was 43% and 44%, respectively. Non-PDT Drug Product Margins were negatively impacted by the recording of the inventory acquired in the Sirius merger at its fair value, in accordance with purchase accounting rules. The full impact of this adjustment was recognized over the six months following the acquisition which ended in September 2006.

RESEARCH AND DEVELOPMENT COSTS — Research and development costs for the three and nine month periods ended September 30, 2006 were $1,344,000 and $4,382,000, as compared to $1,414,000 and $4,809,000 in the comparable 2005 periods. The decrease is due to decreased spending on our clinical programs. We completed both our Phase II acne study and our interim analysis study on photodamaged

skin in the first quarter of 2006. The decrease was somewhat offset by the recording of stock-based compensation expense of $101,000 and $264,000 for the three-and nine month periods ended September 30, 2006, respectively, resulting from the adoption of FAS 123R.

Research and development expenses are expected to increase once our Phase IIb clinical trial for acne commences, and to an even greater extent at such time as we may commence Phase III trials in any indication. On September 27, 2004, DUSA signed a clinical trial agreement with the National Cancer Institute, Division of Cancer Prevention, or NCI DCP, for the clinical development of Levulan^® PDT for the treatment of high-grade dysplasia within Barrett’s Esophagus. In addition, to further our objectives concerning treatment of internal indications using Levulan^® PDT, on November 4, 2004, we signed an additional clinical trial agreement with the NCI DCP for the treatment of oral cavity dysplasia. DUSA and the NCI DCP are working together to prepare overall clinical development plans for Levulan^® PDT in these indications, starting with Phase I/II trials, and continuing through Phase III studies, if appropriate. DUSA and the NCI DCP have prepared protocols for the initial Phase I/II clinical studies in both indications. The NCI DCP is currently working with DUSA and investigators to finalize the clinical trial designs. The NCI DCP will use its resources to file its own Investigational New Drug applications with the FDA. Our costs related to these studies will be limited to providing Levulan^®, laser devices, fiber optics, our proprietary light device sheath and the necessary training for the investigators involved. All other costs of these studies will be the responsibility of the NCI DCP. We have options on new intellectual property and, subject to successful clinical trial results, intend to seek FDA approvals in due course. In preparation for new Phase II clinical trials for the treatment of high-grade dysplasia associated with Barrett’s esophagus, our small single-center pilot Phase II clinical trial using our proprietary endoscopic light delivery device is continuing.

We have retained the services of a regulatory consultant to assist us with seeking foreign marketing approvals for our products, which will also cause research and development expenses to increase.

MARKETING AND SALES COSTS — Marketing and sales costs for the three and nine-month periods ended September 30, 2006 were $3,247,000 and $9,114,000, respectively, as compared to $1,804,000 and $6,886,000 for the comparable 2005 periods. These costs consist primarily of expenses such as salaries and benefits for the marketing and sales staff, commissions, and related support expenses such as travel, and telephone, totaling $2,391,000 and $6,243,000 for the three and nine-month periods ended September 30, 2006, compared to $1,566,000 and $5,256,000 in the comparable periods in 2005. The increase in this category is due to increased headcount in 2006 in comparison to 2005, primarily as the result of the Sirius acquisition. The remaining expenses consist of tradeshows, miscellaneous marketing and outside consultants totaling $733,000 and $2,600,000 for the three and nine month periods ended September 30, 2006, respectively, compared to $238,000 and $1,630,000for the comparable 2005 periods. The increased spending in this category is due primarily to additional expenses related to the Sirius acquisition. We also recorded compensation expense of $123,000 and $270,000 for the three-and nine month periods ended September 30, 2006, respectively, resulting from the adoption of FAS 123R.

GENERAL AND ADMINISTRATIVE COSTS — General and administrative costs for the three and nine-month periods ended September 30, 2006 were $2,603,000 and $8,427,000, respectively, as compared to $1,663,000 and $5,187,000 for the comparable 2005 periods. The increase is mainly attributable to incremental legal fees primarily related to the River’s Edge litigation, compensation expense of $194,000 and $818,000 for the three-and nine month periods ended September 30, 2006, resulting from the adoption of FAS 123R, and incremental costs associated with the acquisition of Sirius. General and administrative expenses are highly dependent on our legal and other professional fees, which can vary significantly from period to period particularly in light of our litigation strategy to protect our intellectual property.

LIQUIDITY AND CAPITAL RESOURCES

We believe that we have sufficient cash to continue to fund our sales and marketing expenses at current levels, planned research and development activities for our Levulan^® PDT/PD platform, and to fund operations and capital expenditures for the foreseeable future. We have invested our funds in liquid investments, so that we will have ready access to these cash reserves, as needed, for the funding of development plans on a short-term and long-term basis. At September 30, 2006, we had approximately $18,554,000 of total liquid assets, comprised of $5,139,000 of cash and cash equivalents and marketable securities available-for-sale totaling $13,415,000. As of September 30, 2006, these securities had yields ranging from 2.50% to 5.74% and maturity dates ranging from October 15, 2006 to September 15, 2010. Our net cash used in operations for the nine months ended September 30, 2006 was $8,300,000, versus $13,000,000 used in the comparable 2005 period. The year over year decrease is directly attributable to an improvement in our net loss, net of non-cash charges, primarily due to increased revenues and related product margins. We expect our cash flows to continue to improve with the growth of existing products, the introduction of new products, and the international expansion of Levulan. At the same time, we are expecting our research and development spending to increase as we execute our Phase II and potential Phase III clinical trials. However, if our cash flows from operations do not continue to improve, we may need to consider either reducing our operating expenses or raising additional capital to fund our operations.

As of September 30, 2006, working capital (total current assets minus total current liabilities) was 18,074,000, as compared to $34,889,000 as of December 31, 2005. Total current assets decreased by $14.9 million during the nine months ended September 30, 2006, due primarily to $9.3 million spent on the acquisition of Sirius, including $1.8 million of acquisition costs, as well as the continued funding of our operating loss. Total current liabilities increased by $1.9 million during the same period due primarily to an increase in accrued expenses and an increase in deferred revenue resulting from a prepaid royalty received under our patent license agreement with PhotoCure ASA pursuant to which PhotoCure will pay royalties on sales of its Metvix^® and Hexvix^® ester products as well as new products as long as we hold patents in the United States of America and certain other territories, offset in part by a decrease in accounts payable.

As stated above, we acquired all of the outstanding common stock of Sirius in March 2006 in exchange for 2,396,245 shares of DUSA common stock and cash. At closing, we paid $8.0 million less certain expenses, in cash, and 1,973,353 shares of DUSA’s common stock, no par value per share to the shareholders of Sirius and issued an additional 422,892 shares to an escrow agent to be held for up to two years subject to certain indemnification provisions of the Merger Agreement. See Note 3 to the Notes to the Condensed Consolidated Financial Statements for the effect of purchase method accounting on the value of the acquisition. We have agreed to pay additional consideration in future periods, based upon the attainment of defined operating objectives, including new product approvals or launches and the achievement of pre-determined total cumulative sales milestones for the Sirius products. The pre-determined cumulative sales milestones for the Sirius products and the related milestone payments are, as follows:

Cumulative Sales Milestone:		Additional Consideration:
$25.0 million		$1.5 million
35.0 million		$1.0 million
45.0 million		$1.0 million
Total		$3.5 million

In addition, there are three milestones related to new product approvals and/or launches each in the amount of $500,000 per milestone, or $1.5 million in the aggregate, that will be paid if the milestones are achieved. If attained, a portion of the contingent consideration is payable in cash and a portion is payable in either common stock or cash, at our sole discretion, any such payments will result in increases in goodwill at the time of the payment. As of September 30, 2006 none of these milestones had been achieved.

We are still actively seeking to further expand or enhance our business by using our resources to acquire by license, purchase or other arrangements, additional businesses, new technologies, or products in the field of dermatology. For 2006, we are focusing primarily on increasing the sales of the Levulan^®

Kerastick^® and the BLU-U^®, as well as the Non Photodynamic Therapy Drug Products, advancing our Phase II study for use of Levulan^® PDT in acne, and continuing to pursue our product development pipeline.

DUSA has no off-balance sheet financing arrangements.

CONTRACTUAL OBLIGATIONS AND OTHER COMMERCIAL COMMITMENTS

ALTANA, INC.

In September 2005, the former Sirius entered into a development and product license agreement with Altana, Inc. relating to a reformulated dermatology product. The agreement was assigned to us by virtue of the Sirius merger. According to the agreement, we will pay for all development costs. Should development efforts be successful, Altana will manufacture the product for us and we will be obligated to pay royalties, including certain minimum royalties on net sales of the product. The agreement expires six years after the first commercial sale of the product.

ACTAVIS TOTOWA, LLC

Under an agreement dated May 18, 2001, and amended on February 8, 2006, the former Sirius entered into an arrangement for the supply of Nicomide^® with Amide Pharmaceuticals, Inc., now known as Actavis Totowa, LLC. The agreement was assigned to us as part of the Sirius merger. Currently, Actavis Totowa supplies all of our requirements; however, we have the right to use a second source for a significant portion of our needs if we choose to do so. The agreement expires on February 8, 2009. During September, we reported that Actavis Totowa had received a warning letter from the FDA regarding certain regulatory observations. The primary observations were not related to Nicomide. However, with respect to Nicomide and certain other products manufactured by Actavis Totowa that would be covered under FDA’s recent compliance policy guide entitled, “Marketed New Drugs without Approved NDAs or ANDAs”, the FDA has requested that the manufacturer provide a copy of the labeling and information providing the basis for an exemption from the drug approval requirements.

HARMONY LABS, INC.

Under an agreement dated September 18, 2001, and amended on February 16, 2006 and March 10, 2006, the former Sirius entered into an arrangement for the manufacturing and supply of the AVAR^® line of products and Nicomide-T^® with Harmony Labs, Inc. The agreement was assigned to us as part of the Sirius merger. Currently, Harmony supplies all of our requirements; however, we have the right to use a second source for a significant portion of our needs if we choose to do so. The agreement expires on February 16, 2009.

L. PERRIGO COMPANY

On October 25, 2005, the former Sirius entered into a supply agreement with L. Perrigo Company for the exclusive manufacture and supply of a proprietary device/drug kit designed by Sirius pursuant to an approved ANDA owned by Perrigo. The agreement was assigned to us as part of the Sirius merger. We are responsible for all development costs and for obtaining all necessary regulatory approvals. Perrigo is entitled to royalties on net sales of the product, including certain minimum annual royalties which commenced May 1, 2006 in the amount of $250,000. The initial term of the agreement expires in July, 2011 and may be renewed based on certain minimum purchase levels and other terms and conditions.

WINSTON LABORATORIES, INC.

On or about January 30, 2006 Winston Laboratories, Inc. and the former Sirius entered into a license

agreement relating to a Sirius product, Psoriatec^® (known by Winston as Micanol) revising a former agreement. Winston Laboratories, Inc. is controlled by Dr. Joel Bernstein, a principal shareholder of the former Sirius. This agreement was assigned to us as part of the Sirius Merger. The 2006 agreement grants an exclusive license, with limitation on rights to sublicense, to all property rights, including all intellectual property and improvements, owned or controlled by Winston to manufacture, sell and distribute products containing anthralin, in the United States. We will pay royalties on net sales of the product, and certain minimum royalties are due each year to maintain the license. We have an option to purchase the product from Winston at certain times during the two-year term of the agreement. The agreement is due to expire on January 31, 2008, subject to rights to extend or terminate the agreement earlier. Minimum royalties to Winston Laboratories are $300,000 per year ending January 31, 2008.

Our contractual obligations and other commercial commitments to make future payments under contracts, including lease agreements, research and development contracts, manufacturing contracts, or other related agreements, are as follows at September 30, 2006:

		Total				1 Yr or less				2-3 Years				4-5 Years				After 5
Operating lease obligations		$	2,826,000			$	683,000			$	864,000			$	904,000			$	375,000
Purchase obligations (1,2)			2,183,000				1,326,000				857,000				—				—
Minimum royalty obligations		$	2,273,000			$	636,000			$	772,000			$	672,000			$	193,000

INFLATION

Although inflation rates have been comparatively low in recent years, inflation is expected to apply upward pressure on our operating costs. We have included an inflation factor in our cost estimates. However, the overall net effect of inflation on our operations is expected to be minimal.

ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

Our exposure to market risk for changes in interest rates relates primarily to our investment portfolio. We do not use derivative financial instruments in our investment portfolio. Our investment policy specifies credit quality standards for our investments and limits the amount of credit exposure to any single issue, issuer or type of investment. Our investments consist of United States government securities and high grade corporate bonds. All investments are carried at market value, which approximates cost.

As of September 30, 2006, the weighted average rate of return on our investments was 4.14%. If market interest rates were to change immediately and uniformly by 100 basis points from levels as of September 30, 2006, the fair market value of the portfolio would change by approximately $201,000. Declines in interest rates could, over time, reduce our interest income.

ITEM 4. CONTROLS AND PROCEDURES

We carried out an evaluation, under the direction of 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 that evaluation, the Chief Executive Officer and Chief Financial Officer concluded that our disclosure controls and procedures were effective as of September 30, 2006.

Changes In Internal Control Over Financial Reporting

Except for the integration of Sirius Laboratories, Inc. (“Sirius”) into the Company’s internal control structure, the Chief Executive Officer and Chief Financial Officer have concluded that there have been no changes in the Company’s internal control over financial reporting during the quarter ended September 30, 2006 that have materially affected, or are reasonably likely to materially affect, the Company’s internal control over financial reporting. The Company considers the acquisition of Sirius to be material to its results of operations, financial position and cash flows. As permitted by the rules and regulations of the SEC, the Company will exclude Sirius from its annual assessment for the year ending December 31, 2006.

FORWARD-LOOKING STATEMENTS

This Quarterly Report on Form 10-Q, including the Management’s Discussion and Analysis, and certain written and oral statements incorporated herein by reference of DUSA Pharmaceuticals, Inc. (referred to as “DUSA,” “we,” and “us”) contain forward-looking statements that have been made pursuant to the provisions of the Private Securities Litigation Reform Act of 1995 and Section 27A of the Securities Act of 1933, as amended. Such forward-looking statements are based on current expectations, estimates, beliefs and projections about future events, including, without limitation statements regarding our use of estimates and assumptions in the preparation of our financial statements and policies, including certain pro forma financial statements, the allocation of the purchase price of Sirius, the amortization of goodwill, intent to hold investments until fair value is recovered, and the impact on us of the adoption of certain accounting standards, belief concerning the impact of compounding pharmacies, our obligation to make certain milestone and royalty payments to third parties, our beliefs and intent regarding the third-party manufacture of our products, and the availability of inventory of our products and expectation for time and impact of being out-of-stock, the outcome and costs of litigation to which we are a party, the anticipated launch of product in Brazil, our beliefs regarding our recent merger with Sirius Laboratories, Inc. and the benefits, effects, impact and risks thereof, for off-label uses, our goal of achieving profitability and the impact of potential generic products, our beliefs regarding our sales and marketing efforts, competition with other companies, beliefs regarding improvement of cash flows, attainment of positive cash flow, the adoption of our products, and the outcome of such efforts, our beliefs regarding the use of our products and technologies for off-label uses, by third parties, our beliefs regarding our compliance with applicable laws, rules and regulations and possible need to seek FDA approval, expectations for the reexamination process of the Nicomide patent, and beliefs concerning the loss of patent protection through patent reexamination or the River’s Edge litigation, our beliefs and intentions regarding available reimbursement for our products and changes to applicable CPT codes, belief concerning adoption of our AK therapy, the possibility of adding employees, belief regarding estimates for reserves, expectation for amortization on core/developed technology, our expectation regarding the margins on our products, our beliefs regarding the current and future clinical development and testing of our potential products and technologies and the costs thereof and impact on revenues, our expectations and beliefs regarding our future sales, expenses and losses, the sufficiency of our capital resources and our needs for additional capital, expectations of royalties from PhotoCure, and the possibility of the holders of options and warrants to purchase our common stock exercising these securities. Words such as “anticipates,” “expects,” “intends,” “plans,” “believes,” “seeks,” “estimates,” or variations of such words and similar expressions, are intended to identify such forward-looking statements. These statements are not guarantees of future performance and are subject to certain risks, uncertainties and assumptions that are difficult to predict particularly in the highly regulated pharmaceutical industry in which we operate. Therefore, actual results may differ materially from those expressed or forecasted in any such forward-looking statements. Such risks and uncertainties include changing market, regulatory and marketplace conditions, actual clinical results of our trials, our ability to sell, market and develop our products and product candidates, the potential need to hire additional personnel or retain existing personnel, the impact of competitive products and pricing, the timely development, FDA approval, and market acceptance of our products, the maintenance of our patent portfolio, changes in our long and short term goals, financial and operational risks associated with our recent merger with Sirius Laboratories, Inc., the litigation process, the ability to obtain competitive levels of reimbursement by third-party payors, and other risks noted herein and in our other SEC filings from

time to time and those set forth herein under “Risk Factors” on pages 40 through 52, as well as those noted in the documents incorporated herein by reference. Unless required by law, we undertake no obligation to update publicly any forward-looking statements, whether as a result of new information, future events or otherwise. However, readers should carefully review the statements set forth in other reports or documents we file from time to time with the Securities and Exchange Commission, particularly our Quarterly Reports on Form 10-Q and any Current Reports on Form 8-K.

PART II — OTHER INFORMATION

ITEM 1. LEGAL PROCEEDINGS.

PHOTOCURE ASA

On May 30, 2006, we entered into a patent license agreement with PhotoCure ASA whereby in settlement of patent disputes we granted a non-exclusive license to PhotoCure under the patents we license from PARTEQ, the licensing arm of Queens University, Kingston, Ontario Canada for esters of aminolevulinic acid (“ALA”). Furthermore, we granted a non-exclusive license to PhotoCure for its existing formulations of its Hexvix^® and Metvix^® (known in the United States as Metvixia^®) products for any patents that may issue to DUSA or that we may license in the future. We received a $1.0 million prepaid royalty during the quarter ended June 30, 2006. PhotoCure received FDA approval to market Metvixia for treatment of actinic keratosis in July 2004 and it would be directly competitive with our Levulan Kerastick product should PhotoCure decide to begin marketing this product. While we are entitled to royalties from PhotoCure on its net sales of Metvixia, this product may adversely affect our ability to maintain or increase our market.

LEVULAN^® SUITS

Since December 2004, we filed lawsuits against physicians in several states to prevent their unlicensed use of versions of our Levulan^® brand of aminolevulinic acid HCl (ALA) produced, by third-parties for use in our patented photodynamic therapy (PDT) treatment for actinic keratosis, basal cell carcinoma, acne and other dermatological conditions. The suits allege that these physicians perform patient treatments that are covered under patents exclusively licensed by DUSA, resulting in direct infringement of these patent(s). Additionally, some physicians are also being sued for infringement of DUSA’s trademarks and for violations of the Lanham Act for using the Levulan^® brand name on their web sites and promotional materials, but performing patient treatments with ALA obtained from other sources. All of the lawsuits have settled favorably to us and the physicians have entered Consent Judgments which provide DUSA with the right to review their books and records.

More recently, we sued a chemical supplier in United States District Court for the District of Arizona alleging that it induces physicians to infringe patents licensed to us, among other things. While we believe that certain actions of compounding pharmacies and others go beyond the activities which are permitted under the Food, Drug and Cosmetic Act and have advised the FDA and local health authorities of our concerns, we cannot be certain that our lawsuits will be successful in curbing the practices of these companies or that regulatory authorities will intervene to stop their activities. In addition, there may be other compounding pharmacies which are following FDA guidelines, or others conducting illegal activities of which we are not aware, which may be negatively impacting our sales revenues.

We have also settled or obtained judgments against compounding pharmacies.

RIVER’S EDGE

On March 28, 2006, a lawsuit was filed by River’s Edge Pharmaceuticals, LLC against us alleging, among

other things, that, prior to our merger with the former Sirius Laboratories, Inc. Sirius agreed to authorize River’s Edge to market a generic version of Nicomide^®, and that the United States patent covering Nicomide^® issued to Sirius in December, 2005 is invalid. Nicomide^® is one of the key products DUSA acquired from Sirius in our merger. The declaratory judgment suit was filed in the United States District Court for the Northern District of Georgia, Gainesville Division. On June 19, 2006, the Georgia court dismissed River’s Edge complaint.

River’s Edge has also filed an application with the U.S. Patent and Trademark Office requesting reexamination of the Nicomide patent. We have notified the Patent Office that we do not object to the reexamination process and we expect the Patent Office to notify the parties about its decision to accept or deny the patent reexamination process shortly.

On April 20, 2006, we filed a patent infringement suit in the United States District Court in Trenton, New Jersey alleging that a River’s Edge niacinamide product infringes our U.S. patent 6,979,468. On May 12, 2006, the New Jersey court entered an order for preliminary injunction, which was effective May 15, 2006, enjoining River’s Edge from selling its niacinamide formula drug as a generic substitute for Nicomide^®. We have posted $750,000 in lieu of a performance bond with the Court which bears interest. The parties are in the discovery stage of the New Jersey litigation. A motion to stay this litigation while the patent reexamination process takes its course was denied. An unfavorable ruling in the Patent Office or in the New Jersey litigation with respect to the validity of the Nicomide patent would allow generic manufacturers to compete directly with us and could have a material impact on the Company’s revenues, results of operations and liquidity.

ITEM 1A. RISK FACTORS.

A description of the risk factors associated with our business is set forth below. This description includes any material changes to and supersedes the description of the risk factors associated with our business previously disclosed in Item 1.A. of our 2005 Annual Report on Form 10-K for the year ended December 31, 2005.

You should carefully consider and evaluate all of the information in, or incorporated by reference in, this Current Report on Form 10-Q. The following are among the risks we face related to our business, assets and operations. They are not the only ones we face. Any of these risks could materially and adversely affect our business, results of operations and financial condition, which in turn could materially and adversely affect the value of the securities being offered by this report.

This section of the Quarterly Report on Form 10-Q contains forward-looking statements of our plans, objectives, expectations and intentions. We use words such as “anticipate,” “believe,” “expect,” future” and “intend” and similar expressions to identify forward-looking statements. Our actual results could differ materially from those anticipated in these forward-looking statements for many reasons, including the risks factors described below and elsewhere in this report. You should not place undue reliance on these forward-looking statements, which apply only as of the date of this report.

Risks Related To DUSA

We Are Not Currently Profitable And May Not Be Profitable In The Future Unless We Can Successfully Market And Sell Significantly Higher Quantities Of Our Products.

We Have Only Limited Experience Marketing And Selling Pharmaceutical Products And, As A Result, Our Revenues From Product Sales May Suffer.

     If we are unable to successfully market and sell sufficient quantities of our products, revenues from product sales will be lower than anticipated and our financial condition may be adversely affected. We are responsible for marketing our dermatology products in the United States and the rest of the world, except Canada, and Mexico and Central and South America, where we have distributors. We are doing so without the experience of having marketed pharmaceutical products prior to 2000. In October 2003, DUSA began hiring a small direct sales force and we increased the size of our sales force to market our products in the United States. In addition, our sales personnel have only recently begun to sell and market the products we acquired in our merger with Sirius. If our sales and marketing efforts fail, then sales of the Kerastick^®, the BLU-U^®, Nicomide^® and other products will be adversely affected.

If We Cannot Improve Physician Reimbursement And/Or Convince More Private Insurance Carriers To Adequately Reimburse Physicians For Our Product Sales May Suffer.

     Without adequate levels of reimbursement by government health care programs and private health insurers, the market for our Levulan^® Kerastick^® for AK therapy will be limited. While we continue to support efforts to improve reimbursement levels to physicians and are working with the major private insurance carriers to improve coverage for our therapy, if our efforts are not successful, a broader adoption of our therapy and sales of our products could be negatively impacted. Although 2005 reimbursement changes related to AK were made, some physicians still believe that reimbursement levels do not fully reflect the required efforts to routinely execute our therapy in their practices.

     If insurance companies do not cover, or stop covering products which are currently covered, including Nicomide^®, our sales could be dramatically reduced.

Since We Now Operate The Only FDA Approved Manufacturing Facility For The Kerastick ^® And Continue To Rely Heavily On Sole Suppliers For The Manufacture Of Levulan^®, The BLU-U^®, Nicomide^® , Nicomide-T^®, the AVAR^® line of products, METED^® , Psoriacap^® and Psoriatec^®, Any Supply Or Manufacturing Problems Could Negatively Impact Our Sales.

     If we experience problems producing Kerastick^® units in our facility, or if any of our contract suppliers fail to supply our requirements for products, our business, financial condition and results of operations would suffer. Although we have received approval by the FDA to manufacture the BLU-U^® and the Kerastick^® in our Wilmington, Massachusetts facility, at this time with respect to the BLU-U, we expect to utilize our own facility only as a back-up to our current third party manufacturer or for repairs.

     During the quarter ended September, 30, 2006, the sole supplier of Nicomide^® received a warning letter from the FDA regarding certain regulatory observations. The primary observations noted in the warning letter were not related to Nicomide^®. However, with respect to Nicomide^® and certain other products manufactured by this supplier, the FDA has requested that the manufacturer provide a copy of the labeling and information providing the basis for an exemption from the drug approval requirements. The FDA regulates such products under the compliance policy guide entitled, “Marketed New Drugs without Approved NDAs or ANDAs.” DUSA worked with the manufacturer in order to respond to the FDA.

     Nicomide^® is one of the key products DUSA acquired from Sirius Laboratories, Inc. in connection with our merger completed in March, 2006. Nicomide^® is an oral prescription vitamin supplement. If the FDA is not satisfied with the response to the warning letter issued to the manufacturer of Nicomide and/or causes the manufacturer to cease operations, our revenues will be negatively affected.

     We are also working with the supplier of the AVAR^® line of products to address certain manufacturing concerns. Some of these products are on back-order while such concerns are being addressed, which could negatively affect revenues from these products. Revenues from these products are not a material percentage of our overall revenues.

     Manufacturers and their subcontractors often encounter difficulties when commercial quantities of products are manufactured for the first time, or large quantities of new products are manufactured, including problems involving:

	•		product yields,
	•		quality control,
	•		component and service availability,
	•		compliance with FDA regulations, and
	•		the need for further FDA approval if manufacturers make material changes to manufacturing processes and/or facilities.

     We cannot guarantee that problems will not arise with production yields, costs or quality as we and our suppliers seek to increase production. Any manufacturing problems could delay or limit our supplies which would hinder our marketing and sales efforts.

     If our facility, any facility of our contract manufacturers, or any equipment in those facilities is damaged or destroyed, we may not be able to quickly or inexpensively replace it. Likewise, if there are any quality or supply problems with any components or materials needed to manufacturer our products, we may not be able to quickly remedy the problem(s). Any of these problems could cause our sales to suffer.

Any Failure To Comply With Ongoing Governmental Regulations In The United States And Elsewhere Will Limit Our Ability To Market Our Products.

     The manufacture and marketing of our products are subject to continuing FDA review as well as comprehensive regulation by the FDA and by state and local regulatory authorities. These laws require, among other things:

	•		approval of manufacturing facilities, including adherence to good manufacturing and laboratory practices during production and storage,
	•		controlled research and testing of some of these products even after approval, and
	•		control of marketing activities, including advertising and labeling.

     If we, or any of our contract manufacturers, fail to comply with these requirements, we may be limited in the jurisdictions in which we are permitted to sell our products. Additionally, if we or our manufacturers fail to comply with applicable regulatory approval requirements, a regulatory agency may also:

	•		send us warning letters,
	•		impose fines and other civil penalties on us,
	•		seize our products,
	•		suspend our regulatory approvals,
	•		refuse to approve pending applications or supplements to approved applications filed by us,
	•		refuse to permit exports of our products from the United States,
	•		require us to recall products,
	•		require us to notify physicians of labeling changes and/or product related problems,
	•		impose restrictions on our operations, and/or
	•		criminally prosecute us.