Labopharm 6-K Current report (foreign)

Exhibit 99.2

Unaudited Interim Consolidated Financial Statements

Second Quarter - Fiscal 2010

Q2

Labopharm Inc.

INTERIM CONSOLIDATED BALANCE SHEETS

[Unaudited]

[thousands of Canadian dollars]	As at June 30, 2010 $			As at December 31, 2009 $
ASSETS
Current
Cash and cash equivalents		57,985			23,650
Marketable securities [note 4]		5,242			854
Accounts receivable		4,849			4,736
Research and development tax credits receivable		1,840			2,584
Income taxes receivable		12			223
Inventories [note 5]		3,074			2,637
Prepaid expenses and other assets		1,637			701
Total current assets		74,639			35,385
Restricted investments		146			133
Long-term investments [note 6]		18,730			2,885
Property, plant and equipment		7,952			8,575
Intangible assets		1,925			2,018
Future income tax assets		124			124
		103,516			49,120
LIABILITIES AND SHAREHOLDERS’ DEFICIENCY
Current
Accounts payable and accrued liabilities [note 7]		20,779			18,124
Current portion of deferred revenue [note 13]		7,837			2,938
Current portion of obligations under capital leases		330			309
Current portion of long-term debt [note 8]		3,762			3,558
Total current liabilities		32,708			24,929
Deferred revenue [note 13]		35,965			14,364
Obligations under capital leases		4,863			5,033
Long-term debt [note 8]		34,212			18,939
Total liabilities		107,748			63,265
Shareholders’ deficiency
Capital stock [note 9]
Common shares, no par value, unlimited authorized shares, 71,571,641 and 57,456,364 issued as at June 30, 2010 and December 31, 2009, respectively		260,266			242,316
Warrants [note 9]		6,133			937
Contributed surplus [note 9]		17,218			16,385
Deficit		(287,914	)		(273,625	)
Accumulated other comprehensive income (loss)		65			(158	)
Total shareholders’ deficiency		(4,232	)		(14,145	)
		103,516			49,120

Contingencies [note 11]

See accompanying notes

Labopharm Inc.

INTERIM CONSOLIDATED STATEMENTS OF OPERATIONS

[Unaudited]

	For the three months ended:						For the six months ended:
[thousands of Canadian dollars, except share and per share amounts]	June 30,  2010 $			June 30, 2009 $			June 30, 2010 $			June 30,  2009 $
REVENUE
Product sales [note 14]		4,296			4,827			7,524			8,629
Licensing [note 13]		1,088			1,318			1,682			2,473
Royalties		640			124			1,240			124
Services and research and development collaborations [note 14]		801			-			1,072			-
		6,825			6,269			11,518			11,226
EXPENSES
Cost of goods sold (excluding amortization) [note 5]		2,112			2,604			3,565			3,997
Research and development expenses, net [note 10]		2,053			2,658			4,218			6,531
Selling, general and administrative expenses		6,455			6,513			13,788			13,391
Financial expenses		1,213			983			2,310			1,997
Amortization of property, plant and equipment and intangible assets		426			453			860			916
Interest income [notes 6 and 14]		(220	)		(107	)		(388	)		(294	)
Foreign exchange loss (gain)		818			(1,961	)		1,453			(2,464	)
		12,857			11,143			25,806			24,074
Loss before income taxes		(6,032	)		(4,874	)		(14,288	)		(12,848	)
Income tax expense		-			-			1			-
Net loss for the period		(6,032	)		(4,874	)		(14,289	)		(12,848	)
Net loss per share - basic and diluted		(0.08	)		(0.09	)		(0.21	)		(0.23	)
Weighted average number of common shares outstanding		71,571,317			56,839,127			67,817,358			56,832,673

See accompanying notes

Labopharm Inc.

INTERIM CONSOLIDATED STATEMENTS

OF COMPREHENSIVE LOSS

[Unaudited]

	For the three months ended:						For the six months ended:
[thousands of Canadian dollars]	June 30, 2010 $			June 30,  2009 $			June 30,  2010 $			June 30,  2009 $
Net loss for the period		(6,032	)		(4,874	)		(14,289	)		(12,848	)
Unrealized net gains on marketable securities in prior periods transferred to net loss in the current period		-			(437	)		-			(1,397	)
Changes in unrealized gains or losses on marketable securities		322			(552	)		298			(542	)
Cumulative translation adjustment		(75	)		-			(75	)		-
Comprehensive loss for the period		(5,785	)		(5,863	)		(14,066	)		(14,787	)

INTERIM CONSOLIDATED STATEMENTS OF DEFICIT

[Unaudited]

For the six months ended: [thousands of Canadian dollars]	June 30,  2010 $			June 30,  2009 $
Balance, beginning of period		(273,625	)		(247,515	)
Net loss for the period		(14,289	)		(12,848	)
Balance, end of period		(287,914	)		(260,363	)

See accompanying notes

Labopharm Inc.

INTERIM CONSOLIDATED STATEMENTS OF CASH FLOWS

[Unaudited]

	For the three months ended:						For the six months ended:
[thousands of Canadian dollars]	June 30, 2010 $			June 30,  2009 $			June 30,  2010 $			June 30, 2009 $
OPERATING ACTIVITIES
Net loss for the period		(6,032	)		(4,874	)		(14,289	)		(12,848	)
Items not affecting cash
Amortization of property, plant and equipment		356			411			717			833
Amortization of intangible assets		70			42			143			83
Amortization of premiums and discounts on marketable securities		-			39			7			54
Non-cash interest income [note 6]		(100	)		-			(250	)		-
Non-cash financial expenses		233			148			467			290
Unrealized foreign exchange (gain) loss		680			(1,643	)		1,398			(835	)
Stock-based compensation		261			411			835			1,203
		(4,532	)		(5,466	)		(10,972	)		(11,220	)
Net change in other operating items		24,986			(291	)		28,599			(2,336	)
		20,454			(5,757	)		17,627			(13,556	)
INVESTING ACTIVITIES
Acquisition of marketable securities		-			(1,898	)		(5,095	)		(8,466	)
Proceeds from disposals of marketable securities		-			1,600			-			6,020
Proceeds from maturities of marketable securities		992			9,203			992			23,010
Acquisition of restricted investment		(26	)		-			(26	)		-
Issuance of term loan		(7,192	)		-			(7,192	)		-
Acquisition of property, plant and equipment		(57	)		(63	)		(153	)		(68	)
Acquisition of intangible assets		(44	)		(37	)		(50	)		(53	)
		(6,327	)		8,805			(11,524	)		20,443
FINANCING ACTIVITIES
Repayment of obligations under capital leases		(76	)		(67	)		(149	)		(131	)
Repayment of long-term debt		(1	)		-			(2	)		-
Proceeds from issuance of long-term debt		7,192			-			7,192			-
Proceeds from issuance of common shares		4			152			18,415			161
Proceeds from issuance of warrants		-			-			5,429			-
Payment of issuance costs of common shares and warrants		(251	)		-			(695	)		-
Financing costs incurred		(550	)		(354	)		(550	)		(354	)
		6,318			(269	)		29,640			(324	)
Foreign exchange gain (loss) on cash held in foreign currencies		185			(614	)		(1,408	)		(677	)
Net change in cash and cash equivalents during the period		20,630			2,165			34,335			5,886
Cash and cash equivalents, beginning of period		37,355			12,094			23,650			8,373
Cash and cash equivalents, end of period		57,985			14,259			57,985			14,259
Supplemental cash flow information:
Interest paid		755			791			1,508			1,492
Income taxes paid (recovered)		-			-			(202	)		88

See accompanying notes

Labopharm Inc.

NOTES TO INTERIM CONSOLIDATED FINANCIAL STATEMENTS [Unaudited]

June 30, 2010 [thousands of Canadian dollars, except share and per share amounts]

1. DESCRIPTION OF BUSINESS

Labopharm Inc. [the “Company”], incorporated under the Companies Act (Québec), is an international specialty pharmaceutical company focused on improving existing drugs by incorporating its proprietary and advanced controlled-release technologies. The Company develops products internally in order to enter into strategic alliances or licensing agreements with national or international pharmaceutical companies that may have the necessary resources and distribution networks to market and sell its pharmaceutical products.

2. BASIS OF PRESENTATION AND ACCOUNTING POLICIES

These unaudited interim consolidated financial statements have been prepared in accordance with Canadian generally accepted accounting principles [“Canadian GAAP”] for interim financial statements. Accordingly, they do not include all of the information and notes required by Canadian GAAP for annual financial statements and should be read in conjunction with the audited consolidated financial statements for the year ended December 31, 2009 and the accompanying notes, included in the Company’s annual report. A reconciliation of significant differences with generally accepted accounting principles in the United States [“U.S. GAAP”] is presented in note 15.

The accounting policies used in the preparation of these unaudited interim consolidated financial statements are the same as those used in the preparation of the Company’s most recent annual audited consolidated financial statements, and are set forth in notes 2 and 3 of the consolidated financial statements for the year ended December 31, 2009 included in the Company’s 2009 annual report.

The following accounting policies have been adopted during the three-month period ended June 30, 2010:

[i] Revenue recognition

Services revenue - Revenue arising from the provision of services is recognized as the services are rendered and when reasonable assurance exists regarding measurement and collectibility.

[ii] Foreign currency translation

The Company’s newly formed foreign joint venture is considered to be a self-sustaining foreign entity and is accounted for in accordance with the current rate method. Assets and liabilities denominated in foreign currencies are translated into Canadian dollars at the balance sheet date exchange rate. Revenue and expense items, including amortization, are translated into Canadian dollars at the exchange rate in effect on the dates on which such items are recognized in income during the period. Exchange gains and losses arising from the translation of the financial statements of the self-sustaining foreign entity are recognized in a separate component of shareholders' equity in accumulated other comprehensive income.

.

[iii] Principles of consolidation

The Company’s interests in joint ventures are accounted for using proportionate consolidation, resulting in the Company recognizing in its consolidated balance sheets, its share of the assets and its share of the liabilities of joint ventures; and in its consolidated statements of operations, its share of the revenue and its share of the expenses of joint ventures [note 13].

1

Labopharm Inc.

NOTES TO INTERIM CONSOLIDATED FINANCIAL STATEMENTS [Unaudited]

June 30, 2010 [thousands of Canadian dollars, except share and per share amounts]

3. CHANGES IN ACCOUNTING POLICIES

In December 2009, the Emerging Issues Committee issued Abstract EIC-175, Multiple Deliverable Revenue Arrangements. EIC-175 is an amendment of EIC-142, Arrangements with Multiple Deliverables. The revised guidance changes the determination of separate units of accounting and the allocation of the consideration to the deliverables. The criteria for identifying all deliverables in a multiple-element arrangement that represent separate units of accounting have been simplified. Entities are no longer required to have objective and reliable evidence of fair value of the undelivered item for a deliverable to qualify as a separate unit of accounting. Under EIC-175, if the Company can allocate consideration to the separate units of accounting based on vendor-specific objective evidence, third-party evidence, or estimated selling price, revenue can be recognized for the delivered elements. All other elements of the Company’s revenue recognition policy as set out in note 2 of its audited financial statements for the year ended December 31, 2009 remain the same.

The Company’s distribution and license agreements for its products typically include the following deliverables: a license for the customer to sell the product in the licensed territory, additional services to get the product approved in the licensed territory and product support throughout the term of the agreement, and supply of products during the term of the agreement. Considering that the license does not usually have a stand-alone value without the provision of services to obtain product approval in the licensed territory, the licensing of technology and the provision of services are usually combined into one unit of accounting. The supply of products is generally considered a separate unit of accounting. The Company is usually able to determine the selling price of the deliverables based on vendor-specific objective eviden ce for comparable types of multiple-deliverable arrangements. The terms of these agreements generally span over multiple years. These agreements are usually not subject to rights of return, although they may contain certain termination clauses under certain circumstances.

The Company early adopted EIC-175 in the three-month period ending June 30, 2010. Since the period of adoption is not the first reporting period in the Company’s fiscal year, EIC-175 is applied retroactively from January 1, 2010 to arrangements entered into or modified since that date. The adoption of EIC-175 did not have a material impact on the Company’s interim consolidated financial statements for the initial adoption period nor is it expected to have a material impact thereafter.

.

2

Labopharm Inc.

NOTES TO INTERIM CONSOLIDATED FINANCIAL STATEMENTS [Unaudited]

June 30, 2010 [thousands of Canadian dollars, except share and per share amounts]

4. MARKETABLE SECURITIES

Marketable securities are comprised of the following securities with an average weighted yield of 0.10% [2009 - 0.70%]:

	Amortized cost $		Gross  unrealized  gains $		Gross unrealized  losses $			Estimated fair value $
As at June 30, 2010
Maturing within one year
Government-backed commercial paper		5,102		140		-			5,242
		5,102		140		-			5,242
As at December 31, 2009
Maturing within one year
Government-backed commercial paper		1,012		-		(158	)		854
		1,012		-		(158	)		854

None of the marketable securities held as at June 30, 2010 or December 31, 2009 have been in an unrealized loss position for more than twelve months. The gross unrealized gains as at June 30, 2010 are primarily related to the marketable securities denominated in U.S. dollars and result from a favourable currency fluctuation.

During the three-month and six-month periods ended June 30, 2010, as a result of disposal or maturities of available-for-sale marketable securities and the effect of currency fluctuation, gross realized gains amounted to nil [2009 - $395 and $1,668, respectively], and gross realized losses amounted to $178 [2009 - $43 and $43, respectively], and were included in the consolidated statements of operations. The cost of a security sold or the amount reclassified out of accumulated other comprehensive income into earnings is determined by specific identification.

5. INVENTORIES

	June 30, 2010 $		December 31,  2009 $
Raw materials		1,188		1,567
Intermediate finished goods		1,582		790
Finished goods		304		280
		3,074		2,637

During the three-month and six-month periods ended June 30, 2010, inventories in the amount of $1,991 and $3,261, respectively [2009 - $2,516 and $3,905, respectively] were recognized as cost of goods sold, including provisions for write-downs to net realizable value of $7 and $8, respectively [2009 - $7 and $19, respectively].

3

Labopharm Inc.

NOTES TO INTERIM CONSOLIDATED FINANCIAL STATEMENTS [Unaudited]

June 30, 2010 [thousands of Canadian dollars, except share and per share amounts]

Reversals of write-downs recorded as a reduction of cost of goods sold for the three-month and six-month periods ended June 30, 2010, amounted to nil [2009 - $169 and $409, respectively].

6. LONG-TERM INVESTMENTS

	June 30, 2010 $		December 31, 2009 $
Long-term Notes [i]		3,135		2,885
Term loan receivable [ii]		15,595		-
		18,730		2,885

[i] Long-term Notes

As at December 31, 2008, the Company held non-bank sponsored asset-backed commercial paper [“Montreal Proposal ABCP”] with an acquisition cost of $5,640 and estimated fair value of $3,178. On January 21, 2009, the Company received in exchange of its Montreal Proposal ABCP long-term investments having a face value of $5,683, consisting of $1,748 of Class A-1 Notes, $3,187 of Class A-2 Notes, $578 of Class B Notes, and $170 of Class C Notes [collectively, the “Long-term Notes”], all issued by a trust called Master Asset Vehicle II, and $200 of accrued interest which was recorded as a reduction of fair value. No gain or additional impairment loss was recorded on the Montreal Proposal ABCP prior to the exchange, as the estimated fair value was similar to the valuation as at December 31, 2008. No gain or loss was rec ognized on the exchange as the total estimated fair value of the Long-term Notes combined with the interest payment approximated the carrying value of the Montreal Proposal ABCP investment immediately prior to the exchange.

The terms of the Long-term Notes include a floating interest rate equivalent to Bankers’ Acceptance rate less 0.50%: (i) payable on a quarterly basis for the Class A-1 Notes and Class A-2 Notes, (ii) which will be accrued for the Class B Notes and will be paid on maturity only after repayment in full of the Class A-1 Notes and Class A-2 Notes, and (iii) which will be accrued for the Class C Notes and will be paid on maturity only after repayment in full of the Class B Notes. The Long-term Notes have a legal maturity in 2056, although it is generally understood that the preponderance of the underlying assets supporting the Long-term Notes have a maturity of seven to

nine years from their issuance. The Company has designated the Long-term Notes as held-for-trading.

On June 30, 2010, the Company remeasured the estimated fair value of its Long-term Notes. The Company reviewed its assumptions to factor in new information available, as well as the changes in credit market conditions. During the three-month period ended June 30, 2010, a limited number of transactions were reported in the marketplace involving Class A-1, Class A-2, Class B and Class C Notes. Consequently, the Company did not take these transactions into account in measuring the estimated fair value of its Long-term Notes since, in its opinion, there were too few of them to meet the definition of an active market. Should these notes begin trading in an active market, the Company will review its valuation assumptions accordingly.

4

Labopharm Inc.

NOTES TO INTERIM CONSOLIDATED FINANCIAL STATEMENTS [Unaudited]

June 30, 2010 [thousands of Canadian dollars, except share and per share amounts]

6. LONG-TERM INVESTMENTS [CONT’D]

[i] Long-term Notes [Cont’d]

Given the lack of an active market, the Company currently estimates the fair value of the Long-term Notes by discounting their estimated future cash flows considering the terms of the Long-term Notes and other observable market data. The valuation technique used by the Company to estimate the fair value of the Long-term Notes is consistent with the method used at prior reporting dates. There is a significant amount of uncertainty in estimating the amount and timing of cash flows associated with the Long-term Notes. The Company estimates that the Long-term Notes will generate interest returns ranging from 0.00% to 2.00% until their maturity which is assumed to be at the end of 2016. A discount rate of 7.80% was used for the Class A-1 Notes, 10.30% for the Class A-2 Notes, and 21.30% for the Class B Notes, resulting in a weighted average discount rate of approximately 10.70%. The discount rates consider factors including yields of instruments with similar maturities and credit ratings, premiums for lack of liquidity, uncertainty of future payments and potential credit losses, lack of transparency and nature of the underlying assets. The fair value of the Class C Notes is estimated to be nil due to the significant uncertainty as to the ultimate collectability of these Notes as a result of their estimated credit risk.

As at June 30, 2010, the fair value of the Long-term Notes is estimated to be approximately $3,135. Consequently, during the three-month and six-month periods ended June 30, 2010, the Company recorded in interest income an increase in the fair value of its Long-term Notes of $100 and $250, respectively  [2009 - nil].

The following table details the change in the carrying value of the Long-Term Notes:

	$
As at December 31, 2009		2,885
Increase in estimated fair value		250
As at June 30, 2010		3,135

As the fair value of the Long-term Notes is determined using a number of assumptions and is based on the Company’s assessment of market conditions as at June 30, 2010, their fair values reported in subsequent periods may change materially. The most significant variable is the discount rate or the yield that prospective investors will require. The Company conducted a sensitivity analysis of the potential discount rates which resulted in an estimated fair value of its Long-term Notes ranging from $2,859 to $3,432. A 1.0% increase in the weighted average discount rate would decrease the fair value of the Long-term Notes by approximately $176.

[ii] Term loan receivable

The term loan receivable from a joint venture [note 14] of $15,595 [US$14,875] bears interest at the Wall Street Journal Prime Rate plus 3%, or 6.25% as at June 30, 2010, receivable semi-annually until the maturity date of the term loan on May 20, 2015.

5

Labopharm Inc.

NOTES TO INTERIM CONSOLIDATED FINANCIAL STATEMENTS [Unaudited]

June 30, 2010 [thousands of Canadian dollars, except share and per share amounts]

7. ACCOUNTS PAYABLE AND ACCRUED LIABILITIES

	June 30,  2010 $		December 31,  2009 $
Trade payables and accruals		7,925		5,433
Patent defense litigation costs		9,635		9,479
Accrued payroll and related expenses		1,964		1,903
Restructuring costs payable		-		473
Other		1,255		836
		20,779		18,124

Under a cost-sharing agreement, the patent defense litigation costs will be settled with 50% of the future royalties earned from the commercialization of the Company’s once-daily tramadol product in the U.S. until such costs are fully paid. Any unpaid balance as at December 31, 2010 will then need to be paid by the Company. The provision for patent defense litigation costs bears interest at the Wall Street Journal Prime Rate plus 2%, or 5.25% as of June 30, 2010.

8. LONG-TERM DEBT

	June 30,  2010 $			December 31,  2009 $
Term loan of US$20,000, maturing on December 1, 2012, bearing interest at 10.95%, interest-only payments until December 1, 2010 and subsequently repayable in 24 monthly payments of $978 [US$932] including principal and interest		20,968			20,988
Adjustment for the debt discount, transaction costs and value assigned to the warrants		(1,136	)		(1,040	)
		19,832			19,948
Term loan of US$14,875, bearing interest at the Wall Street Journal Prime Rate plus 3%, or 6.25%, semi-annual interest-only payments until the maturity date of May 20, 2015 [note 13]		15,595			-
Revolving credit facility, no principal repayment until maturity on June 17, 2012		2,547			2,549
		37,974			22,497
Less: current portion		3,762			3,558
		34,212			18,939

6

Labopharm Inc.

NOTES TO INTERIM CONSOLIDATED FINANCIAL STATEMENTS [Unaudited]

June 30, 2010 [thousands of Canadian dollars, except share and per share amounts]

8. LONG-TERM DEBT [CONT’D]

In May and June 2010, the Company signed fourth and fifth amendments to a term loan agreement, which was initially entered into in June 2005 and amended in December 2007, October 2008 and June 2009. The fourth amendment allowed the Company to transfer certain assets, given as collateral to the lender, to the newly formed joint venture [note 13]. The fifth amendment to the loan postpones the date from which the Company is required to begin repaying principal on the loan from July 1, 2010 to January 1, 2011, and changes the maturity date of the loan from June 1, 2012 to December 1, 2012. Both amendments have been accounted for as a modification to the term loan and, consequently, resulted in no gain or loss.

The financing fees related to the fourth and fifth amendments to the term loan amounted to $550. These costs were recorded as a reduction of the carrying value of the long-term debt and will be amortized over the remaining term of the loan using the effective interest method. As a result of the debt discount, transaction costs, and the value assigned to warrants issued as part of the term loan agreement, the effective interest rate of the amended term loan is now approximately 16.30%. The term loan is collateralized by a first rank lien on most of the Company’s assets except for a second rank lien on the Long-term Notes and excluding its intellectual property and the assets of the joint venture [note 13] which are not subject to any lien. All other terms of the amended term loan agreement remain the same.

Principal repayments of the long-term debt for the next five twelve-month periods ending June 30 are as follows:

	$
2011		4,810
2012		12,991
2013		5,714
2014		-
2015		15,595
		39,110

9. SHAREHOLDERS’ EQUITY

Capital stock transactions

During the six-month period ended June 30, 2010, pursuant to the draw-down notice presented to YA Global Master SPV LTD [the “Purchaser”] on December 20, 2009 with respect to the standby equity distribution agreement [“SEDA”], the Company received an amount of $1,000 from the Purchaser and issued 482,165 shares, for an average price of $2.07 per share after discount, thereby increasing the capital stock by $1,000. Share issuance costs amounted to $23.

In February 2010, the Company completed a secondary public offering resulting in gross proceeds of $22,751, for the issuance of 13,529,412 units. Each unit is comprised of one common share and a warrant to purchase one-half of a common share. The issuance costs of the units are estimated at $677. The net proceeds were allocated to capital stock and warrants based on their relative fair values.  The fair value of the warrants was estimated using the Black-Scholes option pricing model using a volatility of 106%, expected life of 3 years and a risk-free interest rate of 1.23%. As a result of this public offering, capital stock was increased by $16,814 and warrants increased by $5,260.

7

Labopharm Inc.

NOTES TO INTERIM CONSOLIDATED FINANCIAL STATEMENTS [Unaudited]

June 30, 2010 [thousands of Canadian dollars, except share and per share amounts]

9. SHAREHOLDERS’ EQUITY [CONT’D]

Capital stock transactions [Cont’d]

During the six-month period ended June 30, 2010, 100,000 warrants were exercised for a cash consideration of $89. In addition, capital stock was increased by $153 and warrants decreased by $64.

During the six-month period ended June 30, 2010, 3,700 [2009 - 20,600] stock options were exercised for a total cash consideration of $4 [2009 - $24], resulting in an increase in capital stock of $6 [2009 - $41] and a reduction in contributed surplus of $2 [2009 - $17].

Warrants

In December 2007, as part of an amendment to the term loan agreement, the Company issued 1,460,152 warrants to purchase one common share per warrant at an exercise price of $0.89. These warrants expire on December 28, 2012, and 795,152 warrants are outstanding and exercisable as at June 30, 2010.

As part of the public offering completed in February 2010, 13,529,412 warrants are outstanding and are exercisable starting in August 2010 (six months from original date of issuance); they expire in February 2013 (three years from original date of issuance). The combination of two warrants entitles the holder to acquire one common share upon payment of US$2.30.

Stock option plan

The changes in the number of stock options granted by the Company and their weighted average exercise prices for the six-month periods ended June 30, 2010 and 2009 are as follows:

	2010					2009
	#			$		#			$
Balance, beginning of period		4,932,483			3.71		4,081,745			4.57
Options granted		967,900			1.56		1,337,705			1.50
Options exercised		(3,700	)		0.96		(20,600	)		1.18
Options expired		(353,601	)		2.55		(355,300	)		2.26
Options forfeited		(4,199	)		1.53		(30,100	)		5.42
Balance, end of period		5,538,883			3.40		5,013,450			3.72
Options exercisable at end of period		4,478,381			3.79		3,700,111			4.43

8

Labopharm Inc.

NOTES TO INTERIM CONSOLIDATED FINANCIAL STATEMENTS [Unaudited]

June 30, 2010 [thousands of Canadian dollars, except share and per share amounts]

9. SHAREHOLDERS’ EQUITY [CONT’D]

Stock option plan [Cont’d]

The fair value of options granted was estimated at the date of grant using the Black-Scholes option pricing model, resulting in the following weighted average assumptions and weighted average grant date fair value of stock options:

	For the three months ended:						For the six months ended:
	June 30, 2010			June 30, 2009			June 30, 2010			June 30, 2009
Expected volatility		82	%		102	%		82	%		100	%
Expected life	6.0 years			5.0 years			6.0 years			5.0 years
Risk-free interest rate		3.38	%		1.83	%		3.06	%		1.85	%
Dividend yield	Nil			Nil			Nil			Nil
Weighted average grant date fair value (per option)	$	1.00		$	1.31		$	1.12		$	1.12

During the three-month and six-month periods ended June 30, 2010, a compensation expense of $261 and $835, respectively, net of estimated forfeitures, has been recognized [2009 - $411 and $1,203, respectively] for stock options granted to employees and directors, and has been charged to contributed surplus.

Additional information concerning stock options as at June 30, 2010 is as follows:

	Options outstanding						Options exercisable
Range of exercise prices	Number  of options		Weighted average  remaining  contractual  life		Weighted average  exercise price		Number of options		Weighted average exercise price
$	#		[in years]		$		#		$
0.70 to 0.96		233,195		4.6		0.91		219,861		0.92
1.21 to 1.62		2,504,438		5.9		1.48		1,507,237		1.46
1.81 to 2.57		1,141,250		4.7		2.45		1,091,283		2.46
3.94 to 3.94		35,000		0.3		3.94		35,000		3.94
6.61 to 9.72		1,625,000		2.2		7.24		1,625,000		7.24
		5,538,883		4.5		3.36		4,478,381		3.79

10. RESEARCH AND DEVELOPMENT EXPENSES, NET

Research and development expenses are presented net of estimated government assistance of $300 and $300 for the three-month periods ended June 30, 2010 and 2009 respectively, and net of estimated government assistance of $600 and $600 for the six-month periods ended June 30, 2010 and 2009, respectively.

9

Labopharm Inc.

NOTES TO INTERIM CONSOLIDATED FINANCIAL STATEMENTS [Unaudited]

June 30, 2010 [thousands of Canadian dollars, except share and per share amounts]

11. CONTINGENCIES

In 1994, concurrently with the purchase of a controlled-release technology, the Company acquired a right of first refusal with respect to an improved technology for which it agreed to pay royalties of 4% on net revenue generated from the commercialization of the 1994 purchased technology. On February 7, 2005, the Company was served with a motion to institute legal proceedings in the Québec Superior Court. The motion seeks payment of an unspecified amount of royalties said to be outstanding since 1999. The Company has always considered that no amount is owing. During the year ended December 31, 2009, informal settlement discussions were initiated between the parties, prior to incurring significant legal fees associated with the ensuing steps of the legal proceedings. The Company has consequently accrued a selling, general and admin istrative expense of $450 in the year ended December 31, 2009, which is the estimated amount it would expect to pay if a settlement is reached.

The Company had entered into a long-term supply agreement with a third-party manufacturer in anticipation of the commercialization of its products. This agreement included a clause requiring the purchase of minimum quantities of product under certain conditions. Under the terms of the agreement, any shortfall on the purchase commitments may have resulted, in certain circumstances, in an indemnification payment by the Company at the end of the term of the agreement. In August 2010, the Company and the third-party amended the terms of the agreement and the minimum purchase commitments and related indemnification payment were eliminated.

10

Labopharm Inc.

NOTES TO INTERIM CONSOLIDATED FINANCIAL STATEMENTS [Unaudited]

June 30, 2010 [thousands of Canadian dollars, except share and per share amounts]

12. FINANCIAL INSTRUMENTS

Classification of financial instruments

Financial assets and financial liabilities are measured on an ongoing basis at fair value or amortized cost. The disclosures in the “Financial instruments - Recognition and measurement” section of note 2 to the annual consolidated financial statements describe how the categories of financial instruments are measured and how income and expenses, including fair value gains and losses, are recognized. As at June 30, 2010, the classification of the financial instruments, as well as their carrying values and fair values, are shown in the table below:

	Held-for- trading $		Available- for-sale $		Loans and  receivables $		Other financial liabilities $		Total carrying  value $		Fair  value $
Financial assets
Cash and cash equivalents		57,985		-		-		-		57,985		57,985
Marketable securities		-		5,242		-		-		5,242		5,242
Accounts receivable [excluding sales tax receivable]		-		-		4,754		-		4,754		4,754
Restricted investments		-		146		-		-		146		146
Long-term Notes		3,135		-		-		-		3,135		3,135
Term loan receivable		-		-		15,595		-		15,595		15,595
		61,120		5,388		20,349		-		86,857		86,857
Financial liabilities
Accounts payable and accrued liabilities [excluding certain reserves]		-		-		-		19,223		19,223		19,223
Long-term debt		-		-		-		37,974		37,974		40,011
		-		-		-		57,197		57,197		59,234

Fair value of financial instruments

The Company has determined the estimated fair values of its financial instruments based on appropriate valuation methodologies; however, considerable judgment is required to develop these estimates. The estimated fair value amounts can be materially affected by the use of different assumptions or methodologies. The methods and assumptions used to estimate the fair value of financial instruments are described below:

• the fair value of marketable securities has been determined by reference to published price quotations in active markets (Level 1);

• given their short-term maturity, the fair value of cash and cash equivalents, accounts receivable, restricted investments and accounts payable and accrued liabilities approximates their carrying value;

• the Long-term Notes are recorded at their estimated fair value using the methods and assumptions described in note 6 (Level 3);

11

Labopharm Inc.

NOTES TO INTERIM CONSOLIDATED FINANCIAL STATEMENTS [Unaudited]

June 30, 2010 [thousands of Canadian dollars, except share and per share amounts]

12. FINANCIAL INSTRUMENTS [CONT’D]

Fair value of financial instruments [Cont’d]

• the estimated fair value of term loan receivable is approximately equivalent to its carrying value given that it carries interest at a variable rate;

• the estimated fair value of long-term debt was determined by discounting expected cash flows at rates the Company would expect in the marketplace for similar debts.

13. INTERESTS IN JOINT VENTURES

On May 20, 2010, the Company established a joint venture with Gruppo Angelini [“Angelini”] for the commercialization of OLEPTRO™ in the United States. OLEPTRO™ is a novel once-daily formulation of the antidepressant trazodone which was approved for sale in the United States by the U.S. Food and Drug Administration on February 2, 2010. The joint venture [“Angelini Labopharm”] will be 50% owned by each of the Company and Angelini [the “Partners”].

As part of the joint venture agreement, the Company granted Angelini Labopharm the exclusive right to market and sell OLEPTRO™ in the United States. In exchange, the Company received  a total consideration from Angelini Labopharm comprised of the following: (i) a 50% ownership interest in Angelini Labopharm and term loan receivable having a combined value of US$26,000 based on Angelini’s cash contribution to the joint venture; (ii) a cash payment of US$26,000 from Angelini Labopharm; and (iii) the Company is eligible to receive up to US$40,000 from Angelini Labopharm upon OLEPTRO™ achieving certain sales milestones (or US$20,000 after giving effect to the Company’s 50% participation in the joint venture).

The Partners each initially contributed US$14,000 to Angelini Labopharm to fund a total of US$28,000 in initial working capital to support the launch of OLEPTRO™. The Partners will each be entitled to 50% of the joint venture's net income and, as of September 30, 2011, all excess cash flows will be distributed to the Partners on a quarterly basis. The ongoing cash requirements of Angelini Labopharm will be reviewed on a quarterly basis and the Partners will jointly make additional contributions as required and as mutually agreed upon until June 2012.

Considering the cash received, net of the cash initially contributed to Angelini Labopharm, and the Company’s commitment to contribute additional funds, the Company has deferred the revenue in the amount of $27,199 [US$26,000], resulting from the formation of the joint venture. This amount will be recognized into revenue over a five-year period representing the expected useful life of the license. During the three- and six-month periods ended June 30, 2010, $453 of the deferred revenue was recognized in licensing revenue.

12

Labopharm Inc.

NOTES TO INTERIM CONSOLIDATED FINANCIAL STATEMENTS [Unaudited]

June 30, 2010 [thousands of Canadian dollars, except share and per share amounts]

13. INTERESTS IN JOINT VENTURES [CONT’D]

The major components of the Company’s interest in Angelini Labopharm are as follows:

	June 30, 2010 $
Consolidated balance sheet
Cash and cash equivalents		12,700
Other current assets		965
Long-term assets		46
Current liabilities		1,775
Long-term debt		15,595
Consolidated statement of operations for the three- and six-month periods ended:
Revenues		-
Selling, general, and administrative expenses		3,378
Financial expenses		108
Net loss		(3,486	)
Consolidated statement of cash flows for the three- and six-month periods ended:
Operating activities		(1,914	)
Investing activities		(46	)
Financing activities		14,644
Foreign exchange gain on cash held in foreign currencies		16

As of October 2010, Angelini Labopharm will start occupying certain facilities under an operating lease arrangement. The Company’s proportionate share of the estimated future minimum annual payments under this operating lease for the next four twelve-month periods ending June 30, are as follows:

	$
2011		75
2012		123
2013		137
2014		47
		382

13

Labopharm Inc.

NOTES TO INTERIM CONSOLIDATED FINANCIAL STATEMENTS [Unaudited]

June 30, 2010 [thousands of Canadian dollars, except share and per share amounts]

14.      RELATED PARTY TRANSACTIONS

During the three- and six-month periods ended June 30, 2010, the Company entered into the following transactions with Angelini Labopharm which represent the portion of transactions or balances not eliminated upon proportionate consolidation and are included in the consolidated statement of operations:

	For the three months ended:				For the six months ended:
	June 30, 2010 $		June 30, 2009 $		June 30, 2010 $		June 30, 2009 $
Product sales		1,016		-		1,016		-
Services revenue		649		-		649		-
Interest income		108		-		108		-

These transactions occurred in the normal course of operations and are measured at the exchange amount, which is the amount of consideration established and agreed to by the related parties.

The consolidated balance sheets include the following balances with the joint venture:

	June 30, 2010 $		December 31,  2009 $
Accounts receivable		1,768		-
Term loan receivable		15,595		-

14

Labopharm Inc.

NOTES TO INTERIM CONSOLIDATED FINANCIAL STATEMENTS [Unaudited]

June 30, 2010 [thousands of Canadian dollars, except share and per share amounts]

15.         RECONCILIATION BETWEEN ACCOUNTING PRINCIPLES GENERALLY ACCEPTED IN CANADA AND IN THE UNITED STATES

These unaudited interim consolidated financial statements were prepared in accordance with Canadian GAAP for interim financial statements. As permitted under U.S. GAAP, certain disclosures normally required in annual financial statements have been omitted. The accounting policies which the Company would adopt in order to conform to U.S. GAAP as well as certain additional disclosures required under U.S. GAAP, are the same as those presented in the Company’s most recent annual audited consolidated financial statements, and are set forth in note 27of the most recent financial statements for the year ended December 31, 2009, except as described hereafter. In the opinion of management, all normal, recurring adjustments considered necessary for a fair presentation under U.S . GAAP have been included.

[a] Patent and intellectual property costs

During the three-month and six-month periods ended June 30, 2010, the Company recorded as intangible assets internally generated patents which relate to a product approved for sale, acquired certain patents or intellectual property rights, for an amount of $35 and $41, respectively [2009 - $37 and $53, respectively] which will be amortized over a weighted average period of approximately 13 years [2009 - 11 years] under U.S. GAAP.

 [b] Derivative liability - warrants

Under Canadian GAAP, the Company recorded an increase to warrants and a reduction in the carrying value of the term loan amounting to $549, which was the estimated fair value of the 292,030 warrants which vested as a result of the amendment to the term loan agreement in June 2009. The reduction to the carrying value of the term loan will be accreted over the remaining term of the loan as a non-cash financial expense using the effective interest rate method.

Under U.S. GAAP, the above adjustment was reversed and the Company remeasured the derivative liability based on its estimated fair value as at the reporting date and recorded a gain resulting from the change in its estimated fair value amounting to $131 and $330 for the three-month and six-month periods ended June 30, 2010 [2009 - a loss of $196 and $35, respectively], and a corresponding decrease [2009 - increase] to the derivative liability.  The accreted non-cash financial expense under Canadian GAAP for the three-month and six-month periods ended June 30, 2010 in the amount of $59 and $124, respectively [2009 - nil] was reversed.

The estimated fair value of this derivative liability was determined as at June 30, 2010 and December 31, 2009 using the Black-Scholes option pricing model and the following assumptions:

	June 30, 2010			December 31,  2009
Expected volatility		124	%		122	%
Expected life	2.5 years			3.0 years
Risk-free interest rate		2.20	%		2.51	%
Dividend yield	Nil			Nil

15

Labopharm Inc.

NOTES TO INTERIM CONSOLIDATED FINANCIAL STATEMENTS [Unaudited]

June 30, 2010 [thousands of Canadian dollars, except share and per share amounts]

15.         RECONCILIATION BETWEEN ACCOUNTING PRINCIPLES GENERALLY ACCEPTED IN CANADA AND IN THE UNITED STATES [CONT’D]

The effect of the above on the Company’s consolidated financial statements as well as the other accounting policies the Company would adopt in order to conform to U.S. GAAP, as set forth in note 27 of the most recent annual financial statements for the year ended December 31, 2009, is set out below:

Reconciliation of consolidated net loss and comprehensive loss

	For the three months ended:						For the six months ended:
	June 30, 2010 $			June 30, 2009 $			June 30, 2010 $			June 30, 2009 $
Net loss for the period under Canadian GAAP		(6,032	)		(4,874	)		(14,289	)		(12,848	)
Adjustment for:
Impact of reversal of previously recorded inventory write-downs		-			(72	)		-			(13	)
Patent and intellectual property costs [a]		(8	)		(7	)		(14	)		(15	)
Change in fair value of the derivative liability - warrants [b]		131			(196	)		330			(35	)
Financial expenses [b]		59			-			124			-
Net loss for the period under U.S. GAAP		(5,850	)		(5,149	)		(13,849	)		(12,911	)
Unrealized net gains on marketable securities in prior periods transferred to net loss in the current period		-			(437	)		-			(1,397	)
Changes in unrealized losses on marketable securities		322			(552	)		298			(542	)
Cumulative translation adjustment		(75	)		-			(75	)		-
Comprehensive loss for the period under U.S. GAAP		(5,603	)		(6,138	)		(13,626	)		(14,850	)
Net loss per share under U.S. GAAP - basic and diluted		(0.08	)		(0.09	)		(0.20	)		(0.23	)

The weighted average number of common shares outstanding for purposes of determining basic and diluted net loss per share is the same as that used for Canadian GAAP purposes.

The effects of any permanent or temporary timing differences for tax purposes are not significant and therefore have not been reflected in the reconciliation.

16

Labopharm Inc.

NOTES TO INTERIM CONSOLIDATED FINANCIAL STATEMENTS [Unaudited]

June 30, 2010 [thousands of Canadian dollars, except share and per share amounts]

15.         RECONCILIATION BETWEEN ACCOUNTING PRINCIPLES GENERALLY ACCEPTED IN CANADA AND IN THE UNITED STATES [CONT’D]

Reconciliation of reported amounts on consolidated balance sheets

Material variations in selected consolidated balance sheet accounts under U.S. GAAP are as follows:

	Canadian GAAP $			Adjustments $			U.S. GAAP $
As at June 30, 2010
Inventories		3,074			(131	)		2,943
Property, plant and equipment		7,952			288			8,240
Intangible assets [a]		1,925			(293	)		1,632
Derivative liability - warrants [b]		-			199			199
LONG-TERM DEBT [B]		37,974			307			38,281
Capital stock		260,266			4,024			264,290
Warrants [b]		6,133			(549	)		5,584
Contributed surplus		17,218			6,349			23,567
Deficit		(287,914	)		(10,466	)		(298,380	)
As at December 31, 2009
Inventories		2,637			(131	)		2,506
Property, plant and equipment		8,575			334			8,909
Intangible assets [a]		2,018			(325	)		1,693
Derivative liability - warrants [b]		-			529			529
Long-term debt [b]		22,497			431			22,928
Capital stock		242,316			4,024			246,340
Warrants [b]		937			(549	)		388
Contributed surplus		16,385			6,349			22,734
Deficit		(273,625	)		(10,906	)		(284,531	)

17

Labopharm Inc.

NOTES TO INTERIM CONSOLIDATED FINANCIAL STATEMENTS [Unaudited]

June 30, 2010 [thousands of Canadian dollars, except share and per share amounts]

15.         RECONCILIATION BETWEEN ACCOUNTING PRINCIPLES GENERALLY ACCEPTED IN CANADA AND IN THE UNITED STATES [CONT’D]

Additional disclosures required under U.S. GAAP are as follows:

[i] Intangible assets

Under U.S. GAAP, cost and accumulated amortization of intangible assets as at June 30, 2010 amount to $2,247 and $615, respectively [as at December 31, 2009 - $2,206 and $513, respectively]. Amortization expense for intangible assets for the three-month and six-month periods ended June 30, 2010 amounted to $51 and $101, respectively [2009 - $49 and $98, respectively].

[ii] Joint ventures

Under Canadian GAAP, investments in jointly-controlled entities are accounted for using the proportionate consolidation method. Under U.S. GAAP, investments in jointly-controlled entities are accounted for using the equity method. Although there are material differences between these accounting methods, the Company relies on an accommodation of the United States Securities and Exchange Commission [“SEC”] permitting the Company to exclude the disclosure of such differences which affect only the display and classification of financial statement items excluding shareholders’ equity (deficiency) and net income (loss). Angelini Labopharm meets the requirements of this accommodation.

[iii] Recently adopted accounting pronouncements under U.S. GAAP

During the three-month period ended June 30, 2010, the Company early adopted Accounting Standards Update [“ASU”] No. 2009-13, Multiple-Deliverable Revenue Arrangements [“ASU 2009-13”]. ASU 2009-13 amends existing revenue recognition accounting pronouncements that are currently within the scope of Accounting Standards Codification [“ASC”] Subtopic 605-25. Since the period of adoption is not the first reporting period in the Company’s fiscal year, ASU-2009-13 is applied retroactively from January 1, 2010 to arrangements entered into or modified since that date. Disclosures required by ASU 2009-13 under U.S. GAAP mirror those required by EIC-175 under Canadian GAAP and are presented in note 3.

18

Labopharm Inc.

NOTES TO INTERIM CONSOLIDATED FINANCIAL STATEMENTS [Unaudited]

June 30, 2010 [thousands of Canadian dollars, except share and per share amounts]

15.         RECONCILIATION BETWEEN ACCOUNTING PRINCIPLES GENERALLY ACCEPTED IN CANADA AND IN THE UNITED STATES [CONT’D]

Additional disclosures required under U.S. GAAP are as follows: [Cont’d]

[iv]     Recent accounting pronouncements

In April 2010, the Financial Accounting Standards Board [“FASB”] issued ASU No. 2010-13, Stock Compensation [“ASU 2010-13”]. ASU 2010-13 amends FASB ASC Topic 718 to clarify that an employee share-based payment award with an exercise price denominated in the currency of a market in which a substantial portion of the entity's equity securities trades should not be considered to contain a condition that is not a market, performance, or service condition. Therefore, an entity would not classify such an award as a liability if it otherwise qualifies as equity. ASU 2010-13 is effective for fiscal years, and interim periods within those fiscal years, beginning on or after December 15, 2010. ASU 2010-13 should be applied by recording a cumulative-effect adjustmen t to the opening balance of retained earnings (deficit). The cumulative-effect adjustment should be calculated for all awards outstanding as of the beginning of the fiscal year in which the amendments are initially applied, as if the amendments had been applied consistently since the inception of the award. The cumulative-effect adjustment should be presented separately. Earlier application is permitted. The adoption of this standard is not expected to have a material impact on the Company’s consolidated financial statements.

In April 2010, the FASB issued ASU No. 2010-17, Revenue Recognition - Milestone Method [“ASU 2010-17”]. ASU 2010-17 provides guidance on defining a milestone and determining when it may be appropriate to apply the milestone method of revenue recognition for research or development transactions in FASB ASC Subtopic 605-25, Revenue Recognition, Multiple-Element Arrangements. An entity often recognizes these milestone payments as revenue in their entirety upon achieving a specific result from the research or development efforts. A vendor can recognize consideration that is contingent upon achievement of a milestone in its entirety as revenue in the period in which the milestone is achieved only if the milestone mee ts all criteria to be considered substantive. Determining whether a milestone is substantive is a matter of judgment made at the inception of the arrangement. ASU 2010-17 is effective for fiscal years and interim periods within those fiscal years beginning on or after June 15, 2010. Early application is permitted. Entities can apply this guidance prospectively to milestones achieved after adoption. However, retrospective application to all prior periods is also permitted. The Company is currently evaluating the impact of this standard on its consolidated financial statements.

16.         COMPARATIVE FIGURES

Certain comparative figures have been reclassified to conform to the presentation adopted in the current period.

19