UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C.  20549
____________

FORM 10-Q
(Mark One)

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

For the quarterly period ended October 31, 2006

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

For the transition period from _________________________ to ____________________

Commission File Number 1-8366

POLYDEX PHARMACEUTICALS LIMITED
(Exact Name of Registrant as Specified in Its Charter)

Commonwealth of the Bahamas
None
(State or Other Jurisdiction of Incorporation or Organization)
(I.R.S. Employer  Identification No.)


421 Comstock Road, Toronto, Ontario, Canada
M1L 2H5
(Address of Principal Executive Offices)
(Zip Code)

Registrant’s Telephone Number, Including Area Code  (416) 755-2231
 
 
Former Name, Former Address and Former Fiscal Year, if Changed Since Last Report

Indicate by check whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.
Yes x  No o

Indicate by check whether the registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer. See definition of “accelerated filer and large accelerated filer” in Rule 12b-2 of he Exchange Act. (Check one):

Large Accelerated Filer o    Accelerated Filer o    Non-Accelerated Filer x

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

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

Common Shares, $.0167 Par Value
  
3,061,896 shares
(Title of Class)
  
(Outstanding at December 14, 2006)
 
 
POLYDEX PHARMACEUTICALS LIMITED

TABLE OF CONTENTS

   
Item 1
  
   
     
 
F-1
     
 
F-3
     
 
F-4
     
 
F-5
     
 
F-6
     
Item 2
4
     
Item 3
16
     
Item 4
18
     
   
Item 1
19
     
Item 1A
19
     
Item 2
19
     
Item 3
19
     
Item 4
20
     
Item 5
20
     
Item 6
21
     
 
22-23

-2-

Cautionary Note Regarding Forward-Looking Statements

This Quarterly Report on Form 10-Q contains various “forward-looking statements” within the meaning of Section 21E of the Securities Exchange Act of 1934, as amended, which represent the Company’s expectations or beliefs concerning future events, including, but not limited to statements regarding the Company’s future growth, results of operations, liquidity and capital resources, expectations of regulatory approvals and the commencement of sales of products. The Company has tried to identify such forward-looking statements by use of words such as “believes,” “anticipates,” “intends,” “plans,” “will,” “should,” “expects” and similar expressions, but these words are not the exclusive means of identifying such statements. The Company cautions that these and similar statements in this Quarterly Report on Form 10-Q and in previously filed periodic reports including reports filed on Forms 10-K and 10-Q are further qualified by various risks, uncertainties and other factors that could cause actual results to differ materially from those expressed in, or implied by, the forward-looking statements. These factors include, without limitation, changing market conditions, the progress of clinical trials and the results obtained, the establishment of new corporate alliances, the impact of competitive products and pricing, and the timely development, regulatory approval and market acceptance of the Company’s products, as well as the other risks discussed herein, none of which can be assured. The forward-looking statements contained herein speak only as to the date of this report. Except as otherwise required by federal securities laws, the Company undertakes no obligation to publicly update or revise any forward-looking statements or the risk factors described in this Quarterly Report on Form 10-Q, whether as a result of new information, future events, changed circumstances or any other reason after the date of this report.

The accompanying unaudited condensed consolidated financial statements have been prepared in accordance with United States generally accepted accounting principles for interim financial information and the instructions to Form 10-Q and Article 10 of Regulation S-X. Accordingly, they do not include all of the information and footnotes required by generally accepted accounting principles for complete financial statements. In the opinion of management, all adjustments (consisting of normally recurring accruals) considered necessary for a fair presentation have been included.
 
PART I
FINANCIAL INFORMATION

Item 1.
Consolidated Financial Statements (unaudited).
 
POLYDEX PHARMACEUTICALS LIMITED
          
SUBSIDIARIES
          
 
          
         
(Expressed in United States dollars)
          
     
           
   
October 31
  
January 31
  
      
2006
   
2006
  
   
(Unaudited)
  
(Audited)
  
Assets
          
           
Current assets:
          
Cash and cash equivalents (note 3)
  
$
1,603,330
  
$
971,451
  
Trade accounts receivable
   
919,017
   
744,720
 
Interest receivable
    
—
    
41,511
 
Promissory note receivable (note 7)
    
—
        
Inventories:
              
Finished goods
    
1,317,418
   
1,108,626
 
Work in process
    
256,270
   
285,422
 
Raw materials
    
241,058
   
155,496
 
               
     
1,814,746
   
1,549,544
 
Prepaid expenses and other current assets
    
104,782
   
129,362
 
               
Total current assets
    
4,441,875
   
3,436,588
 
               
Property, plant and equipment, net
   
3,529,749
   
3,280,724
 
Patents and intangible assets, net
   
55,561
   
61,591
 
Assets held for sale
    
—
    
4,390
 
Investments available for sale (note 4)
    
1,742,375
   
2,638,441
 
Due from shareholder
    
459,311
   
488,711
 
   
$
10,228,871
  
$
9,910,445
  
 
 
   
October 31
  
January 31
  
     
2006
   
2006
  
   
(Unaudited)
  
(Audited)
  
Liabilities and Shareholders' Equity
          
           
Current liabilities:
          
Accounts payable
  
$
595,171
  
$
574,270
  
Accrued liabilities
    
247,363
   
246,620
 
Payroll and related taxes payable
    
92,673
   
113,530
 
Customer deposits
    
92,932
   
92,932
 
Income taxes payable
    
45,976
   
44,877
 
Current portion of long-term debt
   
34,000
   
1,011
 
Current portion of capital lease obligations
   
38,794
   
168,430
 
Current portion of due to shareholder
     
5,000
    
4,597
 
               
Total current liabilities
    
1,151,909
   
1,246,267
 
               
Long-term debt
    
402,219
   
3,748
 
Capital lease obligations
    
7,429
   
16,108
 
Due to shareholder
    
673,685
   
671,322
 
Deferred income taxes
     
197,719
     
194,938
 
               
        
1,281,052
    
886,116
 
               
Total liabilities
    
2,432,961
   
2,132,383
 
 
              
Shareholders' equity:
              
Capital stock
              
Authorized:
              
100,000 Class A preferred shares of $0.10 each
              
899,400 Class B preferred shares of $0.0167 each
              
10,000,000 common shares of $0.0167 each
              
Issued and outstanding:
              
899,400 Class B preferred shares
    
15,010
   
15,010
 
3,061,896 common shares (January 31, 2006 - 3,058,896)
    
51,003
   
50,953
 
Contributed surplus
    
23,444,369
   
23,400,259
 
Deficit
    
(16,761,729
)
  
(16,633,410
)
Accumulated other comprehensive income
     
1,047,257
    
945,250
 
          
7,795,910
    
7,778,062
 
      
$
10,228,871
   
$
9,910,445
  
               
See accompanying notes.
              
 
 
POLYDEX PHARMACEUTICALS LIMITED
SUBSIDIARIES
 
                   
 
(Expressed in United States dollars)  
  
     
 
                    
   
Three Months
  
Three Months
  
 Nine Months
  
Nine Months
  
   
Ended
  
Ended
  
 Ended
  
Ended
  
   
October 31
  
October 31
  
 October 31
  
October 31
  
         
2006
   
2005
   
 2006
   
2005
  
                    
Sales
  
$
1,366,190
  
$
1,062,075
  
$
$4,656,581
 
$
3,658,229
  
Cost of goods sold
     
1,157,654
    
989,275
    
3,896,610
   
3,336,086
 
                           
     
208,536
   
72,800
   
759,971
   
322,143
 
                           
Expenses:
                          
General and administrative
    
277,974
   
333,349
   
950,480
   
1,094,148
 
Research and development
    
35,515
   
89,955
   
201,700
   
148,858
 
Selling and promotion
    
48,277
   
25,966
   
121,782
   
80,801
 
Interest expense
   
23,668
   
20,891
   
67,556
   
60,808
 
Depreciation
    
10,345
   
12,924
   
37,533
   
36,322
 
Foreign exchange (gain)
    
176
   
(5,576
)
  
(8,071
)
  
(15,366
)
Loss (gain) on sale of assets
    
—
    
(57
)
  
(20
)
  
(3,703
)
Interest and other income
    
(39,438
)
  
(20,907
)
  
(482,670
)
  
(60,553
)
     
356,517
   
456,545
   
888,290
   
1,341,315
 
                           
Income (loss) before income taxes
    
(147,981
)
  
(383,745
)
  
(128,319
)
  
(1,019,172
)
                           
Provision for (recovery of) income taxes
    
—
    
(122,294
)
  
—
    
(193,660
)
                           
Net income (loss) for the period
    
(147,981
)
  
(261,451
)
$
(128,319
)
  
(825,512
)
                           
Unrealized gain (loss) on investments available for sale
    
(1,110
)
  
(36,044
)
  
(3,031
)
  
(31,790
)
                           
Currency translation adjustment
   
56,314
   
269,583
   
105,038
   
376,622
 
Comprehensive income (loss) for the period
  
$
(92,777
)
$
(27,912
)
$
(26,312
)
$
(480,680
)
                           
Per share information:
                          
Earnings (loss) per common share:
                          
Basic
 
$
(0.05
)
$
(0.09
)
$
$(0.04
)
$
(0.27
)
Diluted
 
$
(0.05
)
$
(0.09
)
$
$(0.04
)
$
(0.27
)
      
                           
Weighted average number of common shares used in
                          
computing net earnings per share for the period:
                          
Basic
   
3,061,896
   
3,052,296
   
3,059,646
   
3,052,296
 
Diluted
   
3,078,155
   
3,052,296
   
3,077,698
   
3,052,296
 
    
                         
See accompanying notes.
                          
 
 
POLYDEX PHARMACEUTICALS LIMITED
SUBSIDIARIES
 
                   
(Expressed in United States dollars)

      
           
   
Nine Months
  
Nine Months
  
   
Ended
  
Ended
  
   
October 31
  
October 31
  
        
2006
   
2005
  
           
Preferred Shares:
          
Balance, beginning and end of period
  
$
15,010
  
$
15,010
  
               
Common Shares:
              
Balance, beginning of period
  
$
50,953
  
$
50,676
  
Common share options exercised
    
50
   
166
 
Balance, end of period
  
$
51,003
  
$
50,842
  
               
Contributed Surplus:
              
Balance, beginning of period
  
$
23,400,259
  
$
23,303,718
  
Common share options issued
    
35,160
   
—
  
Common share options exercised
    
8,950
   
52,334
 
Balance, end of period
  
$
23,444,369
  
$
23,356,052
  
               
Deficit:
              
Balance, beginning of period
  
$
(16,633,410
)
$
(15,144,357
)
Net income (loss) for the period
    
(128,319
)
  
(825,512
)
Balance, end of period
  
$
(16,761,729
)
$
(15,969,869
)
               
Accumulated Other Comprehensive Income:
              
Balance, beginning of period
  
$
945,250
  
$
325,842
  
Unrealized loss on investments available for sale
    
(3,031
)
  
(31,790
)
Currency translation adjustment for the period
    
105,038
   
376,622
 
Balance, end of period
  
$
1,047,257
  
$
670,674
  
               
See accompanying notes.
    
 
        
 
 
POLYDEX PHARMACEUTICALS LIMITED
SUBSIDIARIES
 
                   
(Expressed in United States dollars)
      
           
   
Nine Months
  
Nine Months
  
   
Ended
  
Ended
  
   
October 31
  
October 31
  
       
2006
   
2005
  
           
Cash provided by (used in):
          
           
Operating activities:
          
Net income (loss) for the period
  
$
(128,319
)
$
(825,512
)
Add (deduct) items not affecting cash:
              
Depreciation and amortization
    
432,863
   
401,980
 
Imputed interest on long-term debt
    
—
    
1,363
 
Deferred income taxes
    
—
    
(249,311
)
Amortization of premium on investments available for sale
   
475
   
—
  
Gain on disposal of equipment
    
(20
)
  
(3,703
)
Options issued in exchange for services
    
35,160
   
—
  
Net change in non-cash working capital balances
              
related to operations
    
(350,322
)
  
329,902
 
       
(10,163
)
  
(345,281
)
               
Investing activities:
              
Additions to property, plant and equipment and patents
    
(629,228
)
  
(269,940
)
Decrease in due from shareholder
    
29,400
   
38,005
 
Decrease in accrued interest on investments
   
41,511
   
—
  
Unrealized gain (loss) on commercial paper available for sale
    
345
   
(479
)
Proceeds (Acquisition) of investments available for sale
    
922,080
   
(361,426
)
Proceeds from sale of equipment
     
4,467
    
3,703
 
        
368,575
    
(590,137
)
               
Financing activities:
              
Repayment of long-term debt
    
(13,792
)
  
(47,513
)
Repayment of capital lease obligations
    
(140,790
)
  
(119,340
)
Increase (decrease) in due to shareholder
    
2,766
   
(5,051
)
Increase in long-term bank indebtedness
    
444,761
   
—
  
Exercise of common share options
     
9,000
    
52,500
 
        
301,945
    
(119,404
)
               
Effect of exchange rate changes on cash
    
(28,478
)
  
108,331
 
               
Increase (decrease) in cash and cash equivalents
    
631,879
   
(946,491
)
               
Cash and cash equivalents, beginning of period
     
971,451
    
2,401,051
 
Cash and cash equivalents, end of period
   
$
1,603,330
   
$
1,454,560
  
               
               
Cash and cash equivalents is comprised of the following:
              
Cash
  
$
264,096
  
$
188,351
  
Cash equivalents
     
1,339,234
     
1,266,209
 
    
$
1,603,330
   
$
1,454,560
  
               
See accompanying notes.
              
 
 
1.

The information contained in the interim consolidated financial statements is condensed from that which would appear in annual consolidated financial statements. The interim consolidated financial statements included herein should be read in conjunction with the audited financial statements, and notes thereto, and other financial information contained in the 2006 Annual Report on Form 10-K for the fiscal year ended January 31, 2006 as filed by Polydex Pharmaceuticals Limited (the “Company”) with the Securities and Exchange Commission. The unaudited interim consolidated financial statements as of October 31, 2006 and 2005 include all normal recurring adjustments which management considers necessary for a fair presentation. The results of operations for the interim periods presented are not necessarily indicative of the results that may be expected for the entire fiscal year. The interim consolidated financial statements include the accounts and transactions of the Company and its majority owned subsidiaries in which the Company has equal to or more than a 50% ownership interest and exercises control.

2.
Significant Accounting Policies:

Basis of consolidation
The interim consolidated financial statements include the accounts of the Company and its subsidiaries. All inter-company accounts and transactions have been eliminated on consolidation.

Use of estimates
The preparation of consolidated financial statements in conformity with United States generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the interim consolidated financial statements and the reported amounts of revenue and expenses during the reporting period. Actual results could differ from these estimates.

Cash and cash equivalents
Cash and cash equivalents include cash and short-term deposits with maturities of less than three months at the date of purchase.

Inventories
Inventories of raw materials are stated at the lower of cost and net realizable value, cost being determined on a first-in, first-out basis. Work-in-process and finished goods are valued at the lower of cost and net realizable value, and include the cost of raw materials, direct labor and fixed and variable overhead expenses.

Investments available for sale
Investments available for sale consist of medium-term fixed income instruments, mutual funds and trust income funds and are stated at fair market value based on quoted market prices. Interest income is included in other income in the consolidated statement of operations as it is earned. Changes in market values during the holding period are reported as unrealized gain (loss) on investments available for sale and are included in other comprehensive income (loss). Realized gains (losses) are reclassified from accumulated other comprehensive income (loss) on a specific item basis when the security is sold or matured.

Property, plant and equipment and patents and intangible assets
Property, plant and equipment are recorded at cost less accumulated depreciation. Depreciation is provided on a straight-line basis over the estimated useful lives of the assets as follows:
 
Buildings   15 years
Machinery and equipment   3 to 10 years

Patents and intangible assets are recorded at cost and are amortized on a straight-line basis over their estimated useful lives of ten years. Intangible assets consist of intellectual property, government licenses and government license applications.

Useful life is the period over which the asset is expected to contribute to the Company’s future cash flows. The Company reviews the recoverability of its long-lived assets when events or changes in circumstances occur that indicate that the carrying value of the asset may not be recoverable. The assessment of possible impairment is based on the Company’s ability to recover the carrying value of the asset from the expected future pre-tax cash flows of the related operations. If these cash flows are less than the carrying value of such asset, an impairment loss is recognized for the difference between estimated fair value and carrying value.

Costs related to plant refurbishments and equipment upgrades that represent improvements to existing facilities are capitalized. Costs related to repair and maintenance of buildings and equipment are expensed. The Company has no major planned maintenance activity.

Revenue recognition
Revenue results from sales of bulk manufactured products. Revenue is recognized when title and risk of ownership of products pass to the customer. Title and risk of ownership pass to the customer pursuant to the applicable sales contract, either upon shipment of product or upon receipt by the customer.

Product sold in bulk quantities is tested, prior to release for shipment, to ensure that it meets customer specifications, and in many cases, customers receive samples for their own testing. Approval is obtained from the customer prior to shipping. Further purchases by a customer of a bulk product with the same specifications do not require approvals. Returns of bulk product are rare and generally are not accepted.

Shipping and handling costs
Shipping and handling costs incurred by the Company for shipment of products to customers are included in cost of goods sold.

Research and development
Research and development costs are expensed as incurred and are stated net of investment tax credits when earned.

Foreign currency translation
The functional currency of the Company’s Canadian operations has been determined to be the Canadian dollar. All asset and liability accounts of the Company except capital stock have been translated into United States dollars using the current exchange rates at the interim consolidated balance sheet dates. Capital stock is recorded at historical rates. Revenue and expense items are
 
translated using the average exchange rates for the year. The resulting gains and losses have been reported separately as accumulated other comprehensive income within shareholders’ equity.

Stock options
The Company has elected to follow Statement of Financial Accounting Standards No. 123(R), “Accounting for Stock-Based Compensation” (“SFAS 123(R)”). Under SFAS 123(R), compensation expense is recognized on the date of grant, based on the fair value of the options granted.

Earnings (loss) per common share
Basic earnings (loss) per common share is computed using the weighted average number of common shares outstanding of 3,061,896 for the three months ended October 31, 2006 (October 31, 2005 - 3,052,296). Diluted earnings (loss) per common share is computed using the weighted average number of common shares outstanding adjusted for the incremental shares, using the treasury stock method, attributed to outstanding options to purchase common stock. Incremental shares of nil at October 31, 2006 and October 31, 2005 were used in the calculation of diluted earnings (loss) per common share in the second quarters, as their effect was anti-dilutive. Options to purchase common shares of 35,175 were included in the computation of diluted earnings per share as at October 31, 2006. Options to purchase common shares of 46,300 at October 31, 2005 were not included in the computation of diluted earnings (loss) per common share because their effect was anti-dilutive.

3.
Cash and Cash Equivalents:

Cash and cash equivalents consist of the following:
 
   
October 31
  
January 31
  
      
2006
   
2006
  
Cash
  
$
264,096
  
$
236,422
  
Short-term deposits
     
1,339,234
     
735,029
  
      
$
1,603,330
   
$
971,451
  
 
Short-term deposits in the amount of Cdn. $1,496,034 bear interest at 4.0% to 4.06% maturing on November 15 and December 6, 2006. Short-term deposits consist of commercial paper and are available for sale and are stated at fair market value, based on quoted market prices. An unrealized gain of Cdn. $388 has been included in accumulated other comprehensive income.
 
4.
Investments Available For Sale:

Investments available for sale consist of the following:
 
   
October 31
  
January 31
  
      
2006
   
2006
  
Canadian medium-term fixed income instruments
  
$
1,078,559
  
$
2,064,492
  
Canadian income trust units and mutual funds
   
$
663,816
   
$
573,949
  
      
$
1,742,375
   
$
2,638,441
  

Canadian medium-term fixed income instruments have maturity dates extending from four months to one year and interest rates ranging from 2.86% to 4.04%. Investments available for sale are

stated at fair market value, based on quoted market prices. An unrealized loss of Cdn. $38,935 has been included in accumulated other comprehensive income.

5.
Commitments and Contingencies:

During September 2004, the Company entered into an agreement with a research organization to conduct a pilot clinical study on the use of cellulose sulphate for the treatment of bacterial vaginosis. The Company is committed to make a payment of $20,056 upon the completion of the clinical study, which is expected to occur during the fourth quarter of fiscal year 2007. In March of 2006 the Company entered into an agreement for the monitoring of the clinical trial, and is expecting to make payments in the fourth quarter of fiscal year 2007 in the amount of $31,986.

As part of the Company’s plans for refurbishment of its manufacturing operations, the Company entered into agreements for plant renovations, including facilities for the new spray dryer facility, including related electrical enhancements, in the amount of Cdn. $1,389,894. Payments for these contracts are expected to occur in the fourth quarter of fiscal year 2007 and in the first quarter of fiscal year 2008.
 
6.
Stock-based Employee Compensation:

The Company maintains an incentive share option plan for management personnel for options to purchase up to an aggregate of 1,000,000 common shares. The Company also issues options to certain consultants for services provided to the Company.

All options granted have terms of five years and vest immediately. At October 31, 2006, the Company had 42,675 options outstanding at exercise prices ranging from $2.50 to $10.01 and a weighted average exercise price of $5.27. The options, which are immediately exercisable and expire on dates between January 31, 2007 and July 31, 2011, entitle the holder of an option to acquire one common share of the Company.

The Company uses the fair value method in accordance with SFAS 123 to account for awards of stock-based employee compensation. During the nine months ended October 31, 2006, 7,500 common share stock options were granted to employees and non-employees of the Company. These options were valued at $35,160 and were charged to general and administrative expense, in accordance with SFAS 123. The fair value of these options was estimated at the date of grant using the Black-Scholes option pricing model with the following assumptions: risk-free interest rate of 5.04%; dividend yield of nil; volatility factor of the expected market price of the Company’s common stock of 0.644, and an expected life of the options of five years. No stock-based employee compensation expense was recorded during the period from February 1, 2005 to October 31, 2005, because there were no options granted during that period.

7.
Promissory Note Receivable:
 
In 1992, Veterinary Laboratories, Inc. ["Vet Labs"], an indirect subsidiary of the Company, and Sparhawk Laboratories, Inc. ["Sparhawk"] entered into the Vet Labs - Sparhawk Joint Venture [the "Joint Venture"] for the manufacture and sale of veterinary pharmaceutical products. Vet Labs and
 
Sparhawk each owned 50% of the Joint Venture. The Company controlled the Joint Venture through its control of the Joint Venture Policy Committee and therefore consolidated its assets, liabilities, revenue and expenses in these consolidated financial statements until March 4, 2004. The Company had funded the Joint Venture's losses since 1992 and, accordingly, has recorded 100% of these cumulative losses in the consolidated financial statements.

On January 13, 2004, the Company entered into an Asset Purchase Agreement with Sparhawk. Pursuant to this Asset Purchase Agreement, the Company agreed to sell the finished product veterinary pharmaceutical business, including substantially all of the assets of Vet Labs, to Sparhawk for $5,500,000 in cash. Effective March 4, 2004, this sale was completed. Simultaneously, on March 4, 2004, Chemdex, Inc. ["Chemdex"], a wholly-owned subsidiary of the Company, advanced $350,000 to Sparhawk in exchange for a promissory note bearing interest at 13% per annum and a warrant to purchase 4% of the equity of Sparhawk for no additional consideration. The promissory note was due in full on March 4, 2009. Interest was payable annually on the anniversary date, but could be deferred and added to the principal balance of the promissory note each year at Sparhawk's discretion. At April 30, 2006 interest of $6,482 (2005 - nil) was accrued and reported as interest receivable on the balance sheet. On May 31, 2006, payment in full for principal and interest was received. The warrant expired at the earlier of payment in full of the promissory note or 10 years from date of issue. The warrant became exercisable the day after the fifth anniversary from the date of issue, and therefore expired before it could be exercised. Pursuant to a definitive supply agreement [the "Supply Agreement"] entered into on March 4, 2004, Chemdex agreed to supply ferric hydroxide and hydrogenated dextran solution to Sparhawk on an exclusive basis in the United States for 10 years. Chemdex also granted to Sparhawk an exclusive license to use the drug master file to manufacture 10% bulk Iron Dextran for veterinary use, and the use of certain equipment during the 10-year period of the Supply Agreement.

The sale resulted in a gain of $2,209,471, of which $1,859,471 was recognized in the consolidated statements of operations and $350,000 was deferred. The deferred gain of $350,000 related to the promissory note receivable from Sparhawk as Sparhawk was thinly capitalized and highly leveraged. Since payment in full on the promissory note was received on May 31, 2006, the deferred gain of $350,000 was recognized at April 30, 2006 and included in other income on the statement of operations.
 
8.
Segmented Information:

All operations are carried out through Dextran Products Limited ("Dextran") in Canada and through Chemdex in the United States. Each of Dextran and Chemdex operated as separate strategic business units offering different products, until the sale of the finished product veterinary pharmaceutical business on March 4, 2004 [note 7]. Until March 4, 2004, each subsidiary comprised a reportable segment as follows:
 
Dextran -
manufactures and sells bulk quantities of dextran and several of its derivatives to large pharmaceutical companies throughout the world.

F-10
 
Chemdex -
manufactured and sold veterinary pharmaceutical products and specialty chemicals in the United States. The primary customers were distributors and private labelers, who in turn sold to the end user of the products.
 
After March 4, 2004, Chemdex only sells bulk quantities of a specific dextran derivative to Sparhawk under the Supply Agreement, as described in note 7. Management has since determined that Polydex Pharmaceuticals does not operate differing segments, and that providing such information would not be informative to readers of these financial statements. The comparative information from the prior period has therefore been restated to conform to this basis of reporting.
 
         
Nine Months
Ended
October 31
2006
   
Nine Months
Ended
October 31
2005
  
Total revenue by significant customer:
          
Customer A
  
$
975,253
  
$
859,462
  
Customer B
  
$
586,239
  
$
452,820
  
Customer C
  
$
539,442
  
$
336,000
  
Customer D
   
$
429,680
   
$
345,800
  


          
Nine Months
Ended
October 31
2006
   
Nine Months
Ended
October 31
2005
  
Sales by geographic destination:
          
Europe
  
$
1,950,368
  
$
1,535,900
  
Other
  
$
793,738
  
$
415,262
  
United States
  
$
780,007
  
$
869,561
  
Canada
  
$
695,786
  
$
367,798
  
Pacific Rim
   
$
436,682
   
$
469,708
  
      
$
4,656,581
   
$
3,658,229
  
 
F-11
 
Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations

The Company’s fiscal year ends on January 31st of each year.  In this report, fiscal year 2007 refers to the Company’s fiscal year ended January 31, 2007.  The following discussion should be read in conjunction with the October 31, 2006 interim consolidated financial statements and notes thereto included elsewhere in this report. Operating results for the nine months ended October 31, 2006 are not necessarily indicative of the results that may be expected for the fiscal year ending January 31, 2007. For further information, refer to the consolidated financial statements and footnotes thereto included in the Company’s annual report on Form 10-K for the fiscal year ended January 31, 2006.  The Company’s financial statements are prepared in accordance with United States generally accepted accounting principles.  All amounts are in United States dollars, unless otherwise denoted.
 
Overview
 
The Company is engaged in the research, development, manufacture and marketing of biotechnology-based products for the human pharmaceutical market, and also manufactures bulk pharmaceutical intermediates for the worldwide veterinary pharmaceutical industry.  The Company conducts its business operations through its subsidiaries, Dextran Products and Chemdex.

The manufacture and sale of bulk quantities of dextran and derivative products for sale to large pharmaceutical companies throughout the world is conducted through a Canadian subsidiary, Dextran Products, and Chemdex in the United States which provides ferric hydroxide and hydrogenated dextran to Sparhawk pursuant to a definitive supply agreement.
 
Management Objectives for Fiscal 2007.  In fiscal year 2007, management intends to continue to focus on the core products of Dextran Products that have historically been the backbone of the Company. Opportunities to increase distribution chains for existing Dextran products in certain overseas markets, such as India, China and Russia continue to be explored by management. Expanding current market opportunities and the potential for new market penetration has led management to make plant refurbishments and the expansion of production capacity a priority for fiscal year 2007 with respect to the Company’s manufacturing operations located in Toronto. A building permit has been approved and construction of new drying facilities started in the third quarter. It will continue through the fourth quarter and into the next fiscal year with the unit being operational in fiscal 2008.
 
Research and development of the Company’s human pharmaceutical products is coordinated at Dextran Products.  Ushercell, the Company’s leading human pharmaceutical compound, is a high molecular weight Cellulose Sulphate envisioned for topical vaginal use primarily in the prevention of transmission of AIDS and other sexually transmitted diseases, as well as unplanned pregnancies.  Multiple clinical trials have been completed, and additional trials have commenced or are being actively planned, to evaluate various aspects of the use of Cellulose Sulphate as a contraceptive gel with antiviral capabilities.  The Company is exploring the use of Ushercell as a treatment for Bacterial Vaginosis (BV), the most common vaginal disorder among reproductive-age women.  If effective, BV treatment may present an opportunity for commercial

viability of Ushercell in advance of the completion of the much lengthier required testing for its use as an antiviral or contraceptive gel.

Chemdex, Vet Labs and the Joint Venture Business
 
During approximately one month of the 2005 fiscal year, the Company also engaged in the finished product veterinary pharmaceutical business through its United States subsidiary Chemdex, which, in turn, conducted its operations through its subsidiary, Vet Labs. On December 1, 1992, Vet Labs and Sparhawk Laboratories Inc. entered into a Joint Venture for the purpose of manufacturing and selling veterinary pharmaceutical products. On January 13, 2004, the Company, Chemdex and Vet Labs entered into an Asset Purchase Agreement with Sparhawk pursuant to which the Company agreed to sell its finished product veterinary pharmaceutical business, including substantially all of the assets of Vet Labs and its ownership interest in the Joint Venture, to Sparhawk for $5,500,000 in cash. The sale was completed on March 4, 2004. Simultaneously with the closing, Chemdex advanced $350,000 to Sparhawk in exchange for an unsecured subordinated promissory note bearing interest at 13% per annum and a warrant to purchase 4% of the equity of Sparhawk. The promissory note was payable in full on March 4, 2009. Interest was payable annually, but could be deferred and added to the principal balance of the promissory note each year at Sparhawk’s discretion. At April 30, 2006, interest of $6,482 (2005 - nil) was accrued and reported as interest receivable on the balance sheet. On May 31, 2006, payment in full for principal and interest was received. The warrant expired at the earlier of payment in full of the promissory note or March 4, 2014 and therefore expired before it could be exercised. Chemdex also entered into a supply agreement with Sparhawk to supply ferric hydroxide and hydrogenated dextran solution to Sparhawk on an exclusive basis in the United States for 10 years.
 
Results of Operations
 
      
Three Months
Ended
October 31,
2006
     
Three Months
Ended
October 31,
2005
     
Variance
       
Nine Months
Ended
October 31,
2006
     
Nine Months
Ended
October 31,
2005
     
Variance
  
Net income (loss)
  
$
(147,981
)
$
(261,451
)
  
43
%
$
(128,319
)
$
(825,512
)
  
84
%
                                       
Earnings (loss) per share
  
$
(0.05
)
$
(0.09
)
  
—
  
$
(0.04
)
$
(0.27
)
  
—
  

The decrease in net loss for the third quarter of fiscal year 2007 ended October 31, 2006 compared to the net loss for the second quarter in fiscal year 2006 is due primarily to the increase in sales and gross margins, and the decrease in expenses in the quarter. The decrease in year to date net loss for fiscal year 2007 as compared to the year to date net loss for fiscal 2006 is a result of increased sales and gross margins, the decrease in expenses, and recognition of the deferred gain on the promissory note related to the sale of the veterinary products assets to Sparhawk (Note 7.).
-5-
 
  
  
Three Months Ended
October 31,
2006
   
Three Months Ended
October 31,
2005
   
Variance
    
Nine Months Ended
October 31,
2006
   
Nine Months Ended
October 31,
2005
   
Variance
   
Sales
  
$
1,366,190
  
$
1,062,075
    
29
%
$
4,656,581
  
$
3,658,229
    
27
%
 
The sales increase in the third quarter and year to date of fiscal year 2007 was attributable to pricing increases and increased demand from existing customers. The sales decrease in the third quarter of fiscal year 2006 from $1,205,859 in fiscal year 2005 was due to pricing, the timing of shipments, and the extended plant maintenance shutdown.
 
   
    
Three Months Ended
October 31,
2006
      
Three Months
Ended
October 31,
2005
      
Variance
     
Nine Months Ended
October 31,
2006
     
Nine Months
Ended
October 31,
2005
     
Variance
   
Gross profit
  
$
208,536
  
$
72,800
    
186
%
$
759,971
  
$
322,143
    
136
%
                                       
Percentage of sales
    
15.3
%
  
6.9
%
        
16.3
%
  
8.8
%
      
 
The third quarter and year to date of fiscal year 2007 increase in gross profit is a result of the increase in sales due to price increases and customer demand noted above, combined with ongoing control of direct costs by management.  The decrease in gross profit percentage during the third quarter and year to date of fiscal year 2006 from $99,960 and $1,224,989 for the three months and year to date respectively in fiscal year 2005 was a result of lower sales volumes, increased costs of raw materials, and the rise of the Canadian dollar relative to the United States dollar. In addition, significant equipment repair costs were incurred during the third quarter of fiscal year 2006 due to the extended plant maintenance shutdown.
 
  
      
Three Months Ended
October 31,
2006
       
Three Months Ended
October 31,
2005
     
Variance
        
Nine Months Ended
October 31,
2006
     
Nine Months Ended
October 31,
2005
      
Variance
  
Selling, promotion,
general and administrative expenses
  
$
326,251
  
$
359,315
    
(9
)%
$
1,072,262
  
$
1,174,949
    
(9
)%
 
The decrease during the third quarter of fiscal year 2007 in selling, promotion, general and administrative expenses is primarily due to a reduction in regulatory and reporting costs, including the elimination of last year’s costs related to repatriation. These decreases were partially offset by increased promotion costs associated with the Frost & Sullivan North American Microbicidal Technologie Product of the Year award, and management promotional activities involving overseas customers and suppliers. The decrease during the year to date of fiscal year 2007 is also due to the death benefit accrual payable to the estate of the former vice-chairman of the Company established in the first quarter of fiscal 2006.

-6-
 
Research and development
  
Three Months Ended
October 31,
2006
  
Three Months Ended
October 31,
2005
  
Variance
  
Nine Months Ended
October 31,
2006
  
Nine Months Ended
October 31,
2005
  
Variance
  
Research and development expenditures
  
$
35,515
  
$
89,955
    
(61
)%
$
201,700
  
$
148,858
    
35
%
 
The increase in research and development expenses during the year to date of fiscal year 2007 is a result of significant legal expenditures related to various patent applications worldwide and continued work on the cellulose sulphate project, including consulting fees and further costs of a pilot clinical study on the use of cellulose sulphate for the treatment of bacterial vaginosis. Both of these costs decreased in the third quarter of fiscal year 2007 compared to the third quarter of fiscal year 2006.
 
The clinical study mentioned above is related to an alternate use of cellulose sulphate and is therefore outside the scope of funding provided by the Company’s research and development partners for the investigation of this product as a contraceptive gel with antiviral properties. Expenses for this clinical study are expected to decrease during the remainder of fiscal year 2007. It is likely that further clinical studies or expenses will be incurred in fiscal year 2008.

Funding for the Company’s primary development products is provided directly by third party public and/or private sector groups to the entities carrying out such research.  The Company does not take possession or control over these funds.  The Company benefits from the results of research projects through the ownership of patents and/or licenses with respect to the products involved.  The Company has no commitments to repay the funding or to purchase the results of the research.
 
Significant funding from research and development partners, including third party public and/or private sector groups, for the current phase of the project investigating the use of cellulose sulphate as a contraceptive gel with antiviral properties project is expected to continue at necessary levels for the foreseeable future.  The Company’s total research and development expenditures are expected to increase in fiscal year 2007 over fiscal year 2006 due to additional product development activities the Company expects to perform and fund outside of its partnership relationships.
 
      
Three Months Ended
October 31,
2006
     
Three Months Ended
October 31,
2005
     
Variance
     
Nine Months Ended
October 31,
2006
     
Nine Months Ended
October 31,
2005
     
Variance
   
Depreciation and amortization expense
  
$
138,083
  
$
139,220
    
(1
)%
$
432,863
  
$
401,980
    
8
%

Depreciation and amortization was consistent for the third quarter of fiscal year 2007 compared with the third quarter of fiscal year 2006. The increase in expense in the year to date of fiscal year 2007 is primarily attributable to the increase in the value of the Canadian dollar as compared to the United States dollar.
 
        
Three Months Ended
October 31,
2006
    
Three Months
Ended
October 31,
2005
     
Variance
     
Nine Months
Ended
October 31,
2006
     
Nine Months
Ended
October 31,
2005
     
Variance
     
Interest expense
  
$
23,668
  
$
20,891
    
13
%
$
67,556
  
$
60,808
    
11
%
 
The increase in interest expense in the third quarter and year to date of fiscal year 2007 is primarily attributable to the interest on the capital equipment loan obtained in May 2006, as well as the rise in value of the Canadian dollar relative to the United States dollar. This is partially offset by the decrease in other long-term debt and capital lease obligations.
 
 
Three Months
Ended
October 31,
2006
  
Three Months
Ended
October 31,
2005
  
Variance
  
Nine Months
Ended
October 31,
2006
  
Nine Months
Ended
October 31,
2005
  
Variance
  
Foreign exchange loss (gain)
  
$
176
  
$
(5,576
)
  
103
%
$
(8,071
)
$
(15,366
)
  
(47
)%

A small foreign exchange loss was realized at Dextran Products during the third quarter of fiscal year 2007 because the value of the Canadian dollar did not fluctuate significantly compared to the United States dollar during the period, while the year to date gain reflects the increase in the Canadian dollar in the first two quarters of fiscal 2006. In addition, as at October 31, 2006 the Company had a net asset exposure to the United States dollar because its United States dollar denominated accounts receivable exceeded its inter-company payables denominated in United States dollars.
 
 
Three Months
Ended
October 31,
2006
  
Three Months
Ended
October 31,
2005
  
Variance
  
Nine months
Ended
October 31,
2006
  
Nine Months
Ended
October 31,
2005
  
Variance
  
Other income
  
$
39,438
  
$
20,907
    
89
%
$
482,670
  
$
60,553
    
697
%
 
The increase in other income in the third quarter of fiscal year 2007 is primarily related to the timing of investment gains. The significant increase in the year to date for fiscal year 2007 is due to recognition of the deferred gain on the promissory note from Sparhawk (Note 7.) in the first quarter of fiscal year 2007.
-8-
 
    
Three Months
Ended
October 31,
2006
   
Three Months
Ended
October 31,
2005
   
Variance
   
Nine Months
Ended
October 31,
2006
   
Nine Months
Ended
October 31,
2005
   
Variance
   
Provision for (recovery of) income taxes
    
—
  
$
(122,294
)
  
100
%
  
—
  
$
(193,660
)
  
100
%

The tax provision of nil for the third quarter and year to date of fiscal year 2007 resulted from the carryforward of unused tax losses, and tax credits arising from unused research and development expenditures. The Canadian operations continue to have significant research and development tax pools to offset current taxes payable.

The decrease in tax provision for the third quarter and year to date of fiscal year 2006 is a result of a decrease in taxable income. Dextran Products suffered tax losses during the first, second and third quarters of fiscal year 2006 resulting in a tax recovery.
 
Liquidity and Capital Resources
 
As of October 31, 2006, the Company had cash and cash equivalents of $1,603,330, compared to cash and cash equivalents of $971,451 at January 31, 2006.  In the third quarter of fiscal year 2007, the Company expended cash of $154,771 in its operating activities, compared to expending $251,032 for the third quarter of fiscal year 2006. The decrease in cash expended from operations during the nine months ended October 31, 2006 of fiscal 2007 as compared to the same period of fiscal 2006 is primarily due to the increased sales and gross margins and the collection of the deferred gain from Sparhawk (Note 7.) that occurred during this period. The use of cash for the nine months ended October 31, 2005 was primarily due to the loss for the period, partially offset by reductions in trade receivables, inventory and trade payables. Although significant cash was utilized for investing activities related to new equipment, cash was also generated in the second quarter of fiscal 2007 through new long term bank financing. In addition, cash equivalents benefited from the significant decline in investments available for sale. Depreciation and amortization continue to be large non-cash expenses of the Company. 
 
The Company had $3,289,966 of working capital and a current ratio of 3.9 to 1 as of October 31, 2006, compared to $2,190,321 and 2.8 to 1 as of January 31, 2006.
 
Management expects the primary source of its future capital needs to be a combination of company earnings, existing cash reserves and borrowings.  The Company believes that, based upon the current levels of revenues and spending, its existing working capital resources will be sufficient to support continuing operations for the foreseeable future.
 
At October 31, 2006, the Company had accounts receivable of $919,017 and inventory of $1,814,746, compared to $744,720 and $1,549,544 respectively, at January 31, 2006 and $726,361 and $1,360,019 respectively, at October 31, 2005.  The decrease in accounts receivable during the nine months ended October 31, 2006 is due to the timing of payments during the period. Accounts receivable and inventory levels at October 31, 2005 were lower due to decreased sales for the third quarter.
 
At October 31, 2006, the Company had accounts payable of $595,171 compared to $574,270 at January 31, 2006 and $511,421 at October 31, 2005.  The increase in accounts payable was due to timing of supplier payments. 
 
During the third quarter of fiscal year 2007, capital expenditures were $192,168 as compared to $182,398 in the third quarter of fiscal year 2006.  The majority of capital expenditures were for production equipment at the Dextran Products plant in Toronto during the year to date of fiscal 2007. Management intends to continue its plant refurbishment and expansion plans during the remainder of fiscal year 2007, and expects capital expenditures to increase during this period. In October 2006, the Company signed agreements totaling Cdn $1,389,894 for plant refurbishments including new spray dryer facilities.
 
The change in accumulated other comprehensive income of the Company is primarily attributable to the currency translation adjustment of Dextran Products.  Dextran Products’ functional currency is the Canadian dollar.  This currency translation adjustment arises from the translation of Dextran Products’ financial statements to U.S. dollars.
 
Dextran Products has a Cdn. $1,250,000 (U.S. $1,113,000) line of credit, of which none was utilized at October 31, 2006 and at January 31, 2006. This line of credit bears interest at the Canadian banks’ prime lending rate plus 0.50% (October 31, 2006 - 6.00%; January 31, 2006 - 5.25%).  Bank indebtedness is collateralized by a general security agreement over the Company’s assets and a collateral mortgage of Cdn. $500,000 on the Dextran Products building in Toronto. This line of credit is used periodically by the Company to cover temporary short-term Canadian dollar cash needs. For these short-term cash needs, the interest expense on the credit line is typically less than the transaction costs incurred in selling short-term investments.
 
The increase in long term debt during the year to date of fiscal year 2007 is due to Dextran Products obtaining a long-term loan of Cdn. $500,000 (U.S. $445,196) for the purchase of capital equipment related to the planned plant refurbishments.

The decrease in other long-term debt and capital lease obligations from January 31, 2006 is due to continuing payments by the Company.  The majority of the other long-term debt and capital lease obligations are due within one year.
 
Changes in the relative values of the Canadian dollar and the United States dollar occur from time to time and may, in certain instances, materially affect the Company’s results of operations.
 
The Company does not believe that the impact of inflation and changing prices has had a material effect on its operations or financial results at any time in the last three years.
 
Related Party Transactions
 
In August 1997, the Company loaned the late Thomas C. Usher, its Vice-Chairman, Director of Research and Development, a member of its Board of Directors and the beneficial owner of greater than 5% of the outstanding common shares of the Company, $691,500 at an interest rate equal to the prime rate of Toronto Dominion Bank plus 1.50% (the “Loan”).  The Loan was used to partially fund a $1,000,000 payment to the State of Florida in order to allow Thomas C. Usher to regain possession of 430,000 Common Shares of the Company then held by the State as collateral security relating to the liquidation of insurance companies formerly owned by Thomas C. Usher.  Repayment of the Loan is accomplished by periodic payments and through offsets by the Company against royalty payments due Thomas C. Usher pursuant to

intellectual property license agreements. The amount outstanding under the Loan as of October 31, 2006 was $317,414 as compared to $323,972 at January 31, 2006, including accrued interest.  The Company has taken a cumulative provision of $315,702 against accrued interest on the Loan at October 31, 2006, compared to a cumulative provision of $292,860 at January 31, 2006.
 
In August 1999, Thomas C. Usher personally assumed all of the assets and liabilities of Novadex Corp., including the balance of receivables (the “Receivables”) due to the Company from Novadex Corp.  The Receivables have no specific repayment terms.  The total outstanding amount of the Receivables as of October 31, 2006 and January 31, 2006 was $207,599.  Thomas C. Usher also owed $250,000 to a subsidiary of the Company, Novadex International Limited, as of October 31, 2006, pursuant to a non-interest bearing loan with no specific repayment terms.  The outstanding amount of this loan has not changed from January 31, 2006. The amounts continue to remain owing from the estate of Thomas C. Usher.
 
As of October 31, 2006, Thomas C. Usher, now through his estate, had pledged 304,909 common shares of the Company as security for these amounts owing to the Company.  These common shares had a market value of $2,394,115 at October 31, 2006, based on the closing price of the Company’s common shares on the NASDAQ Capital Market on October 31, 2006. The Company intends to continue to hold the pledged assets as collateral until the amounts owing discussed above are repaid.

The Company had a commitment to pay an amount equal to one year’s salary, $110,000, to Thomas C. Usher’s estate. The amount owing on this commitment as at October 31, 2006 was $46,046.

The Company also has an outstanding loan payable to Ruth Usher, a former director and the widow of Thomas C. Usher. The amount due from the Company pursuant to this loan increased to $678,660 at October 31, 2006 from $675,919 at January 31, 2006 due to interest charges exceeding monthly payments by the Company.
 
Off-Balance Sheet Arrangements
 
The Company has no off-balance sheet arrangements.
-11-
 
Tabular Disclosure of Contractual Obligations
 
As of October 31 2006, future minimum cash payments due under contractual obligations, including, among others, the Dextran Products line of credit, the long-term capital equipment bank loan, the loan payable to Ruth Usher, the long-term debt obligation in connection with the Chemdex redemption, research and development agreements and capital lease agreements, are as follows:

Payment due by period
  
Contractual Obligations
   
 
Total
   
Less than
1 year
   
1 - 3
years
   
3 - 5
years
   
More than
5 years
  
Long-term debt obligations (1)
  
$
1,229,407
  
$
139,952
  
$
279,888
  
$
276,120
  
$
533,447
  
Capital lease obligations (2)
    
46,398
    
35,162
    
11,236
    
—
    
—
  
Operating Lease obligations (3)
    
4,014
    
573
    
1,147
    
1,147
    
1,147
  
Purchase obligations (4)
    
1,289,593
    
1,289,593
    
—
    
—
    
—
  
Revolving loans (5)
     
—
    
—
     
—
     
—
     
—
  
Total
   
$
2,569,412
   
$
1,465,280
   
$
292,271
   
$
277,267
   
$
534,594
  
 
1.
Consists of:
 
 
(a)
Note payable in quarterly payments of Cdn. $419 (US $342), bearing interest at 10.43% and maturing December 2009; and
 
 
(b)
Amounts due to shareholder which bear interest at the U.S. bank prime lending rate plus 1.5%, with required minimum monthly payments, including interest, of $5,000; and

 
(c)
Equipment purchase term loan of Cdn. $485,348 (US $432,150) repayable to a Canadian bank in monthly payments of Cdn. $5,792 including interest at 6.95%, maturing May 2011.

2.
Consists of capital lease obligations for:
 
 
(a)
Production equipment of Cdn. $28,920 (US $25,750) repayable in monthly installments, bearing interest at 9% and maturing November 2006;
 
 
(b)
Production equipment of Cdn. $3,360 (US $2,992) repayable in monthly installments, bearing interest at 7.59% and maturing November 2006; and
 
 
(d)
Office equipment of Cdn. $19,829 (US $17,656) repayable in quarterly installments, bearing interest at 10.43% and maturing December 2009.
 
-12-
 
3.
Consists of operating lease obligations for office equipment requiring quarterly payments of Cdn. $161 (US $143).
 
4.
Consists of:
 
 
(a)
Purchase obligations of $52,042 for research and development services payable as specified milestones are achieved.
 
 
(b)
Purchase obligation of $1,237,551 for construction of the spray dryer facility as part of the plant refurbishment project.
  
5.
Consists of Canadian operating line of credit bearing interest at the Canadian banks’ prime lending rate plus 0.50%, repayable upon demand.
 
Critical Accounting Policies
 
The Company’s interim consolidated financial statements are prepared in accordance with accounting principles generally accepted in the United States, applied on a consistent basis.  The critical accounting policies include the use of estimates of allowance for doubtful accounts, the useful lives of assets and the realizability of deferred tax assets.  The Company’s accounting policies with respect to the Joint Venture and its disposition are also discussed below.
 
Management is required to make estimates and assumptions, in preparing the consolidated financial statements, that affect the reported amounts of assets and liabilities, the disclosure of contingent assets and liabilities at the date of the consolidated financial statements and the reported amounts of revenue and expenses during the periods.  The actual results could differ from these estimates.  Significant estimates made by management include the calculation of reserves for uncollectible accounts, inventory allowances, useful lives of long-lived assets and the realizability of deferred tax assets.
 
Revenue Recognition
 
Since March 4, 2004, all revenue is from sales of bulk manufactured products and is recognized when title and risk of ownership of products pass to the customer.  Title and risk of ownership pass to the customer pursuant to the applicable sales contract, either upon shipment of product or upon receipt by the customer.  Since returns are rare and generally not accepted, management has not made provision for returns.  In addition, product sold in bulk quantities is tested, prior to release for shipment, to ensure that it meets customer specifications, and in many cases, customers receive samples for their own testing.  Approval is obtained from the customer prior to shipping.
-13-
 
Allowance for Doubtful Accounts
 
Accounts receivable is stated net of allowances for doubtful accounts.  Allowances for doubtful accounts are determined by each reporting unit on a specific item basis.  Management reviews the credit worthiness of individual customers and past payment history to determine the allowance for doubtful accounts.  Since the majority of sales at Dextran Products are export, Dextran Products maintains credit insurance through a crown corporation for the majority of its customers receivables. There has been no allowance for doubtful accounts during the past two fiscal years.
 
Long-Lived Assets
 
Long-lived assets are stated at cost, less accumulated depreciation or amortization computed using the straight-line method based on their estimated useful lives ranging from three to fifteen years.  Useful life is the period over which the asset is expected to contribute to the Company’s future cash flows.  A significant change in estimated useful lives could have a material impact on the results of operations.  The Company reviews the recoverability of its long-lived assets, including buildings, equipment and other intangible assets, when events or changes in circumstances occur that indicate that the carrying value of the asset may not be recoverable.  The assessment of possible impairment is based on the Company’s ability to recover the carrying value of the asset from the expected future pre-tax cash flows (undiscounted and without interest charges) of the related operations.  If these cash flows are less than the carrying value of such asset, an impairment loss is recognized for the difference between estimated fair value and carrying value.  The measurement of impairment requires management to make estimates of these cash flows related to long-lived assets as well as other fair value determinations.
 
Deferred Tax Assets
 
The Company has recorded a valuation allowance on deferred tax assets where there is uncertainty as to the ultimate realization of the future tax deduction.  Dextran Products has incurred capital losses, which are only deductible against capital gains.  It is not certain that Dextran Products will realize capital gains in the future to use these Canadian capital loss deductions.
 
The Joint Venture
 
In 1992, Vet Labs and Sparhawk entered into the Joint Venture for the manufacture and sale of veterinary pharmaceutical products. Vet Labs and Sparhawk each owned 50% of the Joint Venture during its operation. The Joint Venture was governed by the Agreement for the Operation of Veterinary Laboratories, Inc.’s Lenexa Facility and Sparhawk Lab of KC as a Joint Venture, dated December 1, 1992, by and among Sparhawk, Chemdex and Vet Labs (the “Joint Venture Agreement”).

Pursuant to the Joint Venture Agreement, the Joint Venture Policy Committee was responsible for the overall management of the Joint Venture, including the direction and control of the persons designated with the daily management responsibilities of the Joint Venture, and the general supervision of the management and conduct of the affairs of the Joint Venture. The Policy

Committee consisted of five members, three of which were selected by Vet Labs and two of which were selected by Sparhawk. Decisions of the Policy Committee required a simple majority vote.

Because the Company controlled the operating, financing and investing decisions of the Joint Venture through Vet Labs’ control of the Policy Committee, it consolidated the Joint Venture’s assets, liabilities, revenue and expenses in the Company’s financial statements. The Company has funded the Joint Venture’s cumulative losses since 1992 and, accordingly, has recorded 100% of these losses in the consolidated financial statements.

On January 13, 2004, the Company, Chemdex and Vet Labs entered into an Asset Purchase Agreement with Sparhawk. Pursuant to the Asset Purchase Agreement, the Company agreed to sell substantially all of the assets of Vet Labs, including its interest in the Joint Venture, to Sparhawk for $5,500,000 in cash. Effective March 4, 2004, this sale was completed, and a gain of $1,859,471 was recognized. Simultaneously with the closing, Chemdex advanced $350,000 to Sparhawk in exchange for an unsecured subordinated promissory note bearing interest at 13% per annum and a warrant to purchase 4% of the equity of Sparhawk. The promissory note was payable in full on March 4, 2009. On May 31, 2006, payment in full for principal and interest was received. Interest was payable annually, but could be deferred and added to the principal balance of the promissory note each year at Sparhawk’s discretion. The warrant expired at the earlier of payment in full of the promissory note or March 4, 2014 and therefore expired before it could be exercised. Chemdex also entered into a supply agreement with Sparhawk to supply ferric hydroxide and hydrogenated dextran solution to Sparhawk on an exclusive basis in the United States for 10 years. In connection with the sale, the litigation involving the Joint Venture, Sparhawk Laboratories, Inc. v. Veterinary Laboratories, Inc., et al, Case No. 02CV07426, County of Johnson, State of Kansas, was settled, and a Motion of Approval of Settlement and Stipulation of Dismissal with Prejudice was filed with the Court on March 4, 2004.

Since Sparhawk was thinly capitalized and highly leveraged, the Company had deferred $350,000 of the gain relating to the promissory note receivable from Sparhawk. Since payment in full on the promissory note was received on May 31, 2006, the deferred gain of $350,000 was recognized at April 30, 2006 and included in other income on the statement of operations.

Changes in Accounting Policies
 
No changes in accounting principles or their application have been implemented in the reporting period that would have a material effect on reported income.
 
Item 3. Quantitative and Qualitative Disclosures About Market Risk.

Exchange Rate Sensitivity

The Company’s operations consist of manufacturing activities in the United States and Canada. The Company’s products are sold in North America, Europe and the Pacific Rim.

While the majority of the sales of Dextran Products, the Company’s Canadian operation, are denominated in United States dollars, the majority of its expenses are incurred in Canadian dollars. The majority of the assets and liabilities of Dextran Products are denominated in Canadian dollars prior to the currency translation adjustment necessary for preparation of the consolidated financial statements of the Company contained in this report. When the Canadian dollar rises in value relative to the United States dollar, the carrying value of the assets and liabilities of Dextran Products as stated in United States dollars increases. A rise in the Canadian dollar relative to the United States dollar also results in a decrease in gross margins and net income of Dextran Products. Dextran Products also experiences a foreign exchange loss when the Canadian dollar rises in relation to the United States dollar because as at October 31, 2006 it has a net asset exposure to the United States dollar resulting its large United States dollar denominated trade receivables. Similarly, a decline in the Canadian dollar relative to the United States dollar results in a foreign exchange gain and increased gross margins and net income at Dextran Products.

Management monitors currency fluctuations to ensure that an acceptable margin level at Dextran Products is maintained. Management has the ability, to some extent, to adjust sales prices to maintain an acceptable margin level.

The following table presents information about the Company’s financial instruments other than accounts receivable that are sensitive to changes in foreign currency exchange rates. All financial instruments are held for other than trading purposes. The table presents principal cash flows and related weighted average interest rates by expected maturity dates.
 
 
Expected Maturity Date
 
 
 
 
 
1/31/07
 
1/31/08
 
1/31/09
 
1/31/10
 
1/31/11
 
Thereafter
 
Total
 
Fair  Value
 
(US$ Equivalent)
Assets:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Short-term investments:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Fixed rate ($Cdn)
1,376,577
 
—
 
—
 
—
 
—
 
—
 
1,376,577
 
1,052,399
Average interest rate
3.90
%
—
  
—
  
—
  
—
  
—
  
3.90
%
 
Marketable securities: 
  
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Fixed rate ($Cdn)
1,204,845
  
—
  
—
  
—
  
—
  
—
  
1,204,845
  
1,336,513
Average interest rate
3.42
%
—
  
—
  
—
  
—
  
—
  
3.42
%
  
Liabilities:
                              
Long-term debt:
                              
Fixed rate ($Cdn)
192,898
  
39,495
  
45,487
  
42,930
  
47,219
  
275,162
  
643,193
  
634,492
Average interest rate
8.81
%
7.48
%
7.69
%
7.31
% 
7.39
 
6.95
 
7.61
%
 

 
Interest Rate Sensitivity
 
The Company has interest earning assets consisting of investment grade short-term commercial paper and medium-term fixed income instruments. A significant portion of the Company’s debt is at fixed rates. The variable rate debt represents the shareholder loan payable, which is partially offset by the shareholder loan receivable. Both of these financial instruments carry the same interest rate.  As such, the Company has no significant risk exposure to changes in interest rates.

The following table presents information about the Company’s financial instruments that are sensitive to changes in interest rates. All financial instruments are held for other than trading purposes. The table presents principal cash flows and related weighted average interest rates by expected maturity dates.

 
Expected Maturity Date
 
 
 
 
 
1/31/07
 
1/31/08
 
1/31/09
 
1/31/10
 
1/31/11
 
Thereafter
 
Total
 
Fair  Value
 
(US$ Equivalent)
Assets:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Short-term investments:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Fixed rate ($Cdn)
1,376,577
  
—
  
—
  
—
  
—
  
—
 
1,376,577
 
1,052,399
Average interest rate
3.90
%
—
  
—
  
—
  
—
  
—
  
3.90
%
 
Marketable securities:
      
 
  
 
              
 
 
Fixed rate ($Cdn)
1,204,845
 
—
  
—
  
—
  
—
  
—
  
1,204,845
  
1,336,513
Average interest rate
3.42
%
—
  
—
  
—
  
—
  
—
  
3.42
%
  
Notes receivable:
                              
Variable rate ($US)
57,452
  
63,054
  
69,201
  
75,948
  
73,236
  
—
  
338,892
  
338,892
Average interest rate
9.75
%
9.75
%
9.75
%
9.75
%
9.75
%
—
  
9.75
%
 
Liabilities:
                              
Long-term debt:
                              
Fixed rate ($Cdn)
192,898
 
39,495
  
45,487
  
42,930
  
47,219
  
275,162
  
643,193
  
634,492
Average interest rate
8.81
%
7.48
%
7.69
%
7.31
%
7.39
%
6.95
%
7.61
%
  
Variable rate ($US)
60,000
  
60,000
  
60,000
  
60,000
  
60,000
  
711,622
  
1,011,623
  
1,011,623
Average interest rate
9.25
%
9.25
%
9.25
%
9.25
%
9.25
%
9.25
  
9.25
%
 
 
-17-
 
Item 4. Controls and Procedures.

The Company completed an evaluation as of the end of the period covered by this report under the supervision and with the participation of management, including its Chief Executive Officer and Chief Financial Officer, of the effectiveness of the design and operation of its disclosure controls and procedures pursuant to Rule 13a-15 of the Securities Exchange Act of 1934. Based upon that evaluation, the Chief Executive Officer and Chief Financial Officer concluded that the Company’s disclosure controls and procedures are effective in alerting them on a timely basis of material information relating to the Company (including its consolidated subsidiaries) required to be included in its periodic Securities and Exchange Commission filings.

There have been no changes in the Company’s internal control over financial reporting identified in connection with the evaluation discussed above that occurred in the Company’s last fiscal quarter that has materially affected, or is reasonably likely to materially affect, the Company’s internal control over financial reporting.

PART II
OTHER INFORMATION

Legal Proceedings.
   
 
The Company is not a party to any pending legal proceedings.
   
Risk Factors.
   
 
There have been no material changes to the Risk Factors previously disclosed in the Company’s 10-K for the fiscal year ended January 31, 2006 and the Company's 10-Q for the quarter ended July 31, 2006.
   
   
Unregistered Sales of Equity Securities and Use of Proceeds.
   
 
Not applicable.
   
Defaults Upon Senior Securities.
   
 
Not applicable.
   
 
-19-
 
Item 4.
Submission of Matters to a Vote of Security Holders.

 
(a)
The 2006 Annual General Meeting of the Members was held on July 7, 2006.

 
(c)
No matters were voted upon at the 2006 Annual Meeting of the Members other than (i) the election of Mr. George G. Usher as a director of the Company to hold office for a three-year term expiring at the Annual General Meeting of the Members held in 2009 or until successors are duly elected and qualified, and (ii) the ratification of the appointment of Schwartz Levitsky Feldman LLP as the independent registered accounting firm of the Company. The tabulation of votes in person or by proxy at the Annual Meeting with respect to such matters are as follows:

Proposal 1 - Election of George G. Usher:

Class
  
Votes For
  
Votes Against
  
Abstentions and
Non-Votes
  
Common Shares Class B
    
2,390,698
    
119,449
    
548,749
  
Preferred Shares
     1,798,800(1 )   —     —  

(1)
Class B Preferred Shares are entitled to two (2) votes per share.
 
Proposal 2 - Ratification of Independent Registered Accounting Firm:

Class
  
Votes For
  
Votes Against
  
Abstentions and
Non-Votes
  
Common Shares Class B
    
2,393,558
    
112,104
    
553,234
  
Preferred Shares     1,798,800(1 )   —     —  

(1)
Class B Preferred Shares are entitled to two (2) votes per share.

 
(d)
Not applicable.
 
Item 5.
Other Information.
   
  Not applicable.
 
-20-
 
Item 6.
Exhibits and Reports on Form 8-K.
 
 
(a)
Exhibits

 
3.1
Memorandum of Association of Polydex Pharmaceuticals Limited, as amended to date (filed as Exhibit 3.1 to the Annual Report on Form 10-K filed April 30, 1997, and incorporated herein by reference)

 
3.2
Articles of Association of Polydex Pharmaceuticals Limited, as amended to date (filed as Exhibit 3.2 to the Quarterly Report on Form 10-Q filed September 13, 1999, and incorporated herein by reference)

 
Certification of Chief Executive Officer pursuant to Rule 13a-14(a) under the Securities Exchange Act of 1934

 
Certification of Chief Financial Officer pursuant to Rule 13a-14(a) under the Securities Exchange Act of 1934

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

 
Certification of Chief Financial Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002
 
-21-
 
SIGNATURES


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

Date: December 14, 2006
 
POLYDEX PHARMACEUTICALS LIMITED
(Registrant)
 
By:  /s/ George G. Usher
George G. Usher, Chairman, President and
Chief Executive Officer
(Principal Executive Officer)
 
By:  /s/ John A. Luce
John A. Luce, Chief Financial Officer
(Principal Financial Officer)
-22-
 
Exhibit Index

 
Certification of Chief Executive Officer pursuant to Rule 13a-14(a) under the Securities Exchange Act of 1934

 
Certification of Chief Financial Officer pursuant to Rule 13a-14(a) under the Securities Exchange Act of 1934

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

 
Certification of Chief Financial Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002
 
-23-