Results of Operations

Forward-Looking Statements

This report contains forward-looking statements made in reliance upon the safe harbor provisions of Section 27A of the Securities Act of 1933, as amended (the "Securities Act"), and Section 21E of the Securities Exchange Act of 1934, as amended (the "Exchange Act"). These statements may be identified by the use of words such as "anticipate," "estimates," "should," "expect," "project," "intend," "plan," "believe" and other words and terms of similar meaning, in connection with any discussion of our financial statements, business, results of operations, liquidity, future operating or financial performance and other future events and circumstances. Factors that could affect our forward-looking statements include, among other things:

• the expectation that our business and operations will continue as presently conducted;

• competition from existing products or new products that may emerge;

• regulatory difficulties relating to products that have already received regulatory approval;

• potential product liability claims;

• our dependency on third-party manufacturers to supply or manufacture our products;

• our ability to establish or maintain collaborations, licensing or other arrangements;

• our ability and third parties' abilities to protect intellectual property rights;

• limitations of our ability to utilize its net operating losses;

• compliance with obligations under intellectual property licenses with third parties; and

• our ability to successfully invest for future growth.

Because the information in this Quarterly Report on Form 10-Q is based solely on data currently available, it is subject to change and should not be viewed as providing any assurance regarding our future. Actual results, operations, performance, events, plans and expectations may differ materially from our current expectations and the differences may be material, individually or in the aggregate, to our business, financial condition, results of operations, liquidity and prospects. Additionally, we do not plan to update any of our forward looking statements based on changes in assumptions, changes in results or other events subsequent to the date of this Quarterly Report on Form 10-Q, other than as included in our future required SEC filings, or as may otherwise be legally required.

Results of Operations - Three months ended June 30, 2012 versus

Three months ended July 2, 2011

The following is a discussion of the results of operations for Xstelos Corp for the three months ended June 30, 2012 compared with the three months ended July 2, 2011 (in thousands) (inflation and changing prices have not had a material impact on revenues or results from operations in the two years):

                                            Three Months Ended
                                    June 30, 2012        July 2, 2011         Change          % (+-)
                                                         (Predecessor
                                                           Company)
ROYALTY REVENUE                    $         7,650     $          5,803     $     1,847            31.8 %
Operating Expenses
Selling, general and
administrative expense                       1,174                2,855          (1,681 )         -58.9 %
Depreciation and amortization                1,066                1,003              63             6.3 %
Total operating expenses                     2,240                3,858          (1,618 )         -41.9 %
OPERATING INCOME                             5,410                1,945           3,465           178.1 %
Interest expense, net                       (2,632 )             (2,938 )           306           -10.4 %
Rental revenue                                  13                    -              13           100.0 %
Loss on marketable securities                 (533 )                  -            (533 )        -100.0 %
Gain on sale of real estate                  7,652                    -           7,652           100.0 %
Loss on disposal of
non-operating assets                          (116 )                  -            (116 )        -100.0 %
EARNINGS (LOSS) FROM CONTINUING
OPERATIONS BEFORE INCOME TAXES               9,794                 (993 )        10,787         1,086.3 %
Income tax  expense (benefit)                   39              (19,529 )       (19,568 )         100.2 %
EARNINGS FROM CONTINUING
OPERATIONS                         $         9,755     $         18,536     $    (8,781 )        -47.40 %

Royalty Revenue

Royalty revenue increased $1.8 million, or 31.8%, to $7.6 million for three months ended June 30, 2012 compared with $5.8 million for three months ended July 2, 2011 due to increased sales volume by Auxilium of Testim®, of which royalty is earned.

SG&A Expenses

SG&A expenses decreased $1.7 million, or 58.9%, to $1.2 million for three months ended June 30, 2012 compared with $2.9 million for three months ended July 2, 2011. The decrease is predominately due to greater legal and professional expenses in 2011 related to the acquisition of CPEX Pharmaceuticals. Inc.

Depreciation and Amortization

Depreciation and Amortization expense increased $0.1 million, or 6.3%, to $1.1 million for three months ended June 30, 2012 compared with $1.0 million for three months ended July 2, 2011. This increase is solely due to additional depreciation expense for assets held in use, previously not depreciated, as they were classified as assets held for sale, prior to the second quarter 2012.

Operating Income

Operating income increased $3.5 million, or 178.1% to $5.4 million for three months ended June 30, 2012 compared with a $1.9 million for three months ended July 2, 2011, primarily due to the increased royalty revenue and decreased legal and professional expenses, as described above.

Interest Expense

Interest expense decreased $0.3 million, or 10.4%, to $2.6 million for three months ended June 30, 2012 compared with $2.9 million for three months ended July 2, 2011. The decrease is exclusively due to a lower principal loan balance in 2012.

Marketable Securities

The Company recorded a loss in market value of approximately $533,000 due to a decline in value of the Company's investment in marketable securities.

Sale of Real Estate

On April 27, 2012, the Company sold its Mahwah Real Estate for approximately $14.6 million less selling and other costs of approximately $0.8 million, and recognized a gain of approximately $7.7 million.

Disposal of Non-Operation Assets

The Company disposed of approximately $134,000 of furniture and equipment that were held for sale and recorded a loss, which was partially offset by a gain of approximately $18,000 from the sale of equipment that was held for sale.

Income Tax

As a result of the 2011 CPEX acquisition, the Company recorded an approximately $19.5 million net deferred tax liability, and reduced approximately $19.5 million of the valuation allowance against its NOL carryforward tax asset, which is reflected as an income tax benefit for the three months ended July 2, 2011.

Results of Operations -Six months ended June 30, 2012 versus Six months ended July 2, 2011

The following is a discussion of the results of operations for Xstelos Corp for the six months ended June 30, 2012 compared with the six months ended July 2, 2011 (in thousands) (inflation and changing prices have not had a material impact on revenues or results from operations in the two years):

                                             Six Months Ended
                                    June 30, 2012        July 2, 2011         Change          % (+-)
                                                         (Predecessor
                                                           Company)
ROYALTY REVENUE                    $        14,791     $          5,803     $     8,988           154.9 %
Selling, general and
administrative expense                       2,584                3,884          (1,300 )         -33.5 %
Depreciation and amortization                2,070                1,003           1,067           106.4 %
Total operating expenses                     4,654                4,887            (233 )          -4.8 %
OPERATING INCOME                            10,137                  916           9,221         1,066.6 %
Interest expense, net                       (5,381 )             (2,938 )        (2,443 )         -83.2 %
Rental revenue                                  13                    -              13           100.0 %
Loss on marketable securities                 (527 )                  -            (527 )         100.0 %
Gain on sale of real estate                  7,652                    -           7,652           100.0 %
Loss on disposal of
non-operating asset                           (116 )                  -            (116 )         100.0 %
EARNINGS (LOSS) FROM CONTINUING
OPERATIONS BEFORE INCOME TAXES              11,778               (2,022 )        13,800           682.5 %
Income tax expense (benefit)                   101              (19,529 )       (19,630 )        -100.5 %
EARNINGS FROM CONTINUING
OPERATIONS                         $        11,677     $         17,507     $    (5,830 )         -33.3 %

Royalty Revenue

Royalty revenue increased $9.0 million, or 154.9%, to $14.8 million for six months ended June 30, 2012 compared with $5.8 million for six months ended July 2, 2011. The increase is due to increased sales volume by Auxilium of Testim®, of which royalty is earned, and that 2011 only includes three months of royalty revenue, as CPEX was purchased on April 5, 2011.

SG&A Expenses

SG&A expenses decreased $1.3 million, or 33.5%, to $2.6 million for six months ended June 30, 2012 compared with $3.9 million for six months ended July 2, 2011. The decrease is predominately due to greater legal and professional expenses in 2011 related to the acquisition of CPEX.

Depreciation and Amortization

Depreciation and Amortization expense increased $1.1 million, or 106.4%, to $2.1 million for six months ended June 30, 2012 compared with $1.0 million for six months ended July 2, 2011. This increase is due to additional depreciation expense for assets held in use, previously not depreciated, as they were classified as assets held for sale, prior to the second quarter 2012, and that 2011 only includes three months of amortization expense of intangible assets comprised of CPEX's patents and related license agreement associated with Testim®, as CPEX was purchased on April 5, 2011.

Operating Income

Operating income increased $9.2 million, to $10.1 million for six months ended June 30, 2012 compared with a $0.9 million for six months ended July 2, 2011, primarily due to the increased royalty revenue and decreased legal and professional expenses, offset by greater amortization and depreciation expense, as described above.

Interest Expense

Interest expense increased $2.4 million, or 83.2%, to $5.4 million for six months ended June 30, 2012 compared with $2.9 million for six months ended July 2, 2011. This increase is due to the fact that 2011 only includes three months of amortization expense, offset by lower annual interest expense in 2012 due to a lower principal loan balance in 2012.

Marketable Securities

The Company recorded a loss in market value of approximately $533,000 due to a decline in value of the Company's investment in marketable securities.

Sale of Real Estate

On April 27, 2012, the Company sold its Mahwah Real Estate for approximately $14.6 million less selling and other costs of approximately $0.8 million, and recognized a gain of approximately $7.7 million.

Disposal of Non-Operation Assets

The Company disposed of approximately $134,000 of furniture and equipment that were held for sale and recorded a loss, which was partially offset by a gain of approximately $18,000 from the sale of equipment that was held for sale.

Income Tax

As a result of the 2011 CPEX acquisition, the Company recorded an approximately $19.5 million net deferred tax liability, and reduced approximately $19.5 million of the valuation allowance against its NOL carryforward tax asset, which is reflected as an income tax benefit for the six months ended July 2, 2011.

Liquidity and Capital Resources

At June 30, 2012, the Company had cash and cash equivalents of approximately $22.5 million, which, along with the royalties from Testim® pursuant to the licensing agreement with Auxilium, we believe will be sufficient to fund our operations and our cash requirements for the next twelve months, and beyond. Our cash includes balances maintained in commercial bank accounts. There can be no assurance that changes in our research and development plans or other events affecting our revenues or operating expenses will not result in the earlier depletion of our funds. In appropriate situations, which will be strategically determined, we may seek funding from other sources, including, but not limited to, contribution by others to joint ventures and other collaborative or licensing arrangements for the development, testing, manufacturing and marketing of products currently under development or sales of debt or equity securities.

On April 5, 2011, in connection with the acquisition of CPEX, FCB LLC, a wholly owned subsidiary of FCB Acquisition, which became a wholly owned subsidiary of CPEX upon FCB Acquisition's merger with and into CPEX, borrowed approximately $64 million under the Term Loan Agreement. The term loan under the Term Loan Agreement bears interest at "LIBOR" plus 16% per annum, with a minimum LIBOR rate of 1%, and matures on the earlier of January 3, 2026 or the date any of CPEX's patents that are associated with Testim®, a topical testosterone gel, expire, and contains customary events of default for loans of such nature. As part of the Term Loan Agreement, CPEX contributed to FCB LLC all of its intellectual property rights in Testim® and rights to the royalty stream pursuant to the license agreement with Auxilium, and the loan is secured by FCB LLC's interest in all such rights. Repayment of the loan is made through a waterfall arrangement whereby, if certain conditions are met, the Testim® royalty stream is distributed on a quarterly basis as follows: first to pay certain fees and expenses of Agent and FCB LLC, second to pay fees of the banks maintaining the accounts associated with the loan, third to pay any expenses of Agent used to protect the loan collateral and any other unreimbursed fees or expenses of Agent or any Lender, fourth to replenish any shortfall in the interest reserve (which is $2.5 million), fifth to pay interest due, sixth to pay 65% of the remaining royalty funds to Agent for the benefit of the Lenders as payment toward loan principal, and finally to FCB LLC for its benefit.

Our largest source and use of cash were financing and investing related to the CPEX acquisition. The Company generated positive cash flow from operations due to our acquisition of CPEX.

As of June 30, 2012 accounts receivable, consisting of a royalty receivable, totaled $7.7 million. These receivables all are generally collected within three months after the respective calendar quarter.

Net cash provided by operating activities for six months ended June 30, 2012 was $6.6 million, directly related to net earnings of $12.1 million, adding $2.1 million of amortization, which was partially offset by $7.7 million gain on sale of real estate, and increased by $0.3 million due to other miscellaneous items. Net cash used in operating activities for six months ended July 2, 2011 was $0.6 million, primarily consisting of net earnings of $17.9 million, which was partially offset by a $19.5 million deferred tax benefit, and increased by $1.0 million due to other miscellaneous items.

Cash provided by investing activities was $13.8 million for the six months ended June 30, 2012, which was primarily due to the sale of real estate, compared to a use of $59.5 million for the six months ended July 2, 2011, which was used solely used to acquire CPEX. Cash used in financing activities was $5.8 million for the six months ended June 30, 2012, which was used to repay debt under the term loan agreement related to the CPEX Transaction, compared to cash provided from financing activities of $59.2 million for the six months ended July 2, 2011, pursuant to initial debt financing related to the CPEX Transaction.

Factors that could affect our short and long term liquidity include, among other items, the amount of royalties received from Auxilium and the payment of any further dividends or distributions.

Long term debt

The term loan under the Term Loan Agreement bears interest at "LIBOR" plus 16% per annum, with a minimum LIBOR rate of 1%, and matures on the earlier of January 3, 2026 or the date any of CPEX's patents that are associated with Testim®, a topical testosterone gel, expire, and contains customary events of default for loans of such nature. The loan was issued at a discount of 2.34%. The original issue discount (OID) was $1.5 million. The OID is equal to the difference between the stated face amount of the loan and actual cash received. This OID is being amortized over the estimated life of the loan, approximately 6 years, using the effective interest rate method, and is recorded as a component within non-cash interest expense. The loan is collateralized by patents and a license agreement associated with Testim®, that were acquired in the CPEX transaction. The loan agreement requires certain financial reporting and non financial covenants.

Critical Accounting Policies, Estimates and Judgments

The preparation of these condensed consolidated financial statements requires us to make estimates and assumptions that affect the reported amounts of assets and liabilities and the disclosure of contingent assets and liabilities at the date of the condensed consolidated financial statements, as well as the reported revenues and expenses during the reporting periods. We evaluate these estimates and judgments on an ongoing basis. We base our estimates on historical experience and on various other factors that we believe are reasonable under the circumstances, the results of which form the basis for making judgments about the carrying value of assets and liabilities that are not readily apparent from other sources. Our actual results may differ from these estimates under different assumptions or conditions.

Royalties Receivable and Allowances for Doubtful Accounts

When necessary, receivable balances are reported net of an estimated allowance for uncollectible accounts. Estimated uncollectible receivables are based on the amount and status of past due accounts, contractual terms with customers, the credit worthiness of customers and the history of uncollectible accounts. Royalties receivable as of June 30, 2012, and related revenues from the date of acquisition through June 30, 2012, are royalties due from its licensee, Auxilium for sales of Testim®. All receivables are uncollateralized and therefore are subject to credit risk.

Intangible Assets

Costs incurred in connection with acquiring licenses, patents, and other proprietary rights are capitalized as intangible assets. These assets are amortized on a straight-line basis over the applicable useful life from the dates of acquisition. Such assets are reviewed whenever events or changes in circumstances indicate that the assets may be impaired, by comparing the carrying amounts to their estimated future undiscounted cash flows, and adjustments are made for any diminution in value below the carrying value.

Income Taxes

The Company records deferred tax assets and liabilities based on the differences between the book and tax bases of assets and liabilities and on operating loss carryforwards using enacted tax rates in effect for the year in which the differences are expected to reverse. A valuation allowance is provided when it is more likely than not that some portion or all of a deferred tax asset will not be realized. These amounts are adjusted, as appropriate, to reflect enacted changes in tax rates expected to be in effect when the temporary differences reverse.

The Company determined the deferred tax provision under the liability method, whereby deferred tax assets and liabilities are recognized for future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases and operating loss and tax credit carryforwards. Deferred tax assets and liabilities are measured using currently enacted tax rates.

Revenue Recognition

CPEX recognizes revenue from royalties on Auxilium's sales of Testim in accordance with The Financial Accounting Standards Board ("FASB") Accounting Standards Codification ("ASC") Topic 605-10-S99-1, which requires sales to be recorded upon delivery, provided that there is evidence of a final arrangement, there are no uncertainties surrounding acceptance, title has passed, collectability is reasonably assured and the price is fixed or determinable. Since 2003, Auxilium has sold Testim to pharmaceutical wholesalers and chain drug stores, which have the right to return purchased products prior to the units being dispensed through patient prescriptions. Based on historical experience, CPEX is able to reasonably estimate future product returns on sales of Testim and as a result, did not defer Testim royalties for the fiscal year ended December 31, 2011 or the six months ended June 30, 2012.

Recently Issued Accounting Pronouncements

In May 2011, the FASB issued amended guidance on fair value measurements. This newly issued accounting standard clarifies the application of certain existing fair value measurement guidance and expands the disclosures for fair value measurements that are estimated using significant unobservable (Level 3) inputs. This accounting standard is effective on a prospective basis for annual and interim reporting periods beginning on or after December 15, 2011. Adoption of this new guidance did not have a material impact on the Company's condensed consolidated financial statements.

In June 2011, the FASB issued authoritative guidance related to the Presentation of Comprehensive Income. This standard eliminates the current option to report other comprehensive income and its components in the statement of changes in equity. The new requirements are effective for public entities for fiscal years beginning after December 15, 2011 and interim and annual periods thereafter, with early adoption permitted. As this accounting standard only requires enhanced disclosure, the adoption of this standard did not impact the Company's financial position or results of operations.

Contingencies and Litigation

Litigation Matters

The Company is involved in various and routine litigation matters, which arise through the normal course of business. While it firmly maintains that all pending claims are meritless, the Company will, however, continue to expend costs as it vigorously defends against these claims.

Thom McAn: In connection with Xstelos Corp's discontinued operations in 1995, Xstelos Corp entered into a sublease formerly occupied by its Thom McAn stores. The lease expires effective February 1, 2014. Xstelos Corp believes that there has been a novation of its obligations under such lease and may bring litigation to have a court finally determine such issue. At this time, Xstelos Corp has not recorded a liability relating to this commitment as the probability of an unfavorable outcome is remote.

Upsher-Smith Litigation: In October 2008, CPEX and Auxilium received notice that Upsher-Smith had filed an Abbreviated New Drug Application, or ANDA containing a paragraph IV certification in which Upsher-Smith certified that it believes its proposed generic version of Testim does not infringe on the '968 Patent. The '968 Patent claims a method for maintaining effective blood serum testosterone levels for treating a hypogonadal male, and will expire in January 2025. The '968 Patent is listed for Testim® in Approved Drug Products with Therapeutic Equivalence Evaluations (commonly known as the Orange Book), published by the FDA. Upsher-Smith's paragraph IV certification sets forth allegations that the '968 Patent will not be infringed by the manufacture, use, or sale of its proposed generic product. On December 4, 2008, CPEX and Auxilium filed a Hatch-Waxman infringement lawsuit in the United States District Court for the District of Delaware against Upsher-Smith seeking injunctive and declaratory relief. The Court docketed this case as Civil Action No. 08-908-SLR. In June 2009, Upsher-Smith amended its answer to the complaint to include a defense and counterclaim of invalidity of the '968 Patent, which CPEX and Auxilium have denied. A patent issued by the U.S. Patent and Trademark Office (USPTO), such as the '968 Patent, is presumed valid. As of the date of this filing, the lawsuit remains pending; however, the case was administratively closed in December of 2011 and will remain closed until further order of the Court. In April 2012, Auxilium and CPEX received a paragraph IV notice letter for U.S. Patent Nos. 7,320,968; 7,608,605; 7,608,606; 7,608,607; 7,608,608; 7,608,609; 7,608,610; 7,935,690; and 8,063,029. At this time, only the '968 Patent is in the lawsuit.

CPEX has filed continuation and divisional applications with the USPTO relating to the '968 Patent. Nine patents, U.S. Patent Nos. 7,608,605; 7,608,606; 7,608,607; 7,608,608; 7,608,609; 7,608,610; 7,935,690; 8,063,029; and 8,178,518 were issued from these applications, which may provide further market protection. Each of these nine patents has been listed in the Orange Book with respect to Testim®.

CPEX and its affiliates will vigorously pursue the Hatch-Waxman patent infringement lawsuit. However, if CPEX is unsuccessful in obtaining an injunction to keep Upsher-Smith's proposed version of Testim® off the market until the patent protection expires, or in defending the '968 Patent covering Testim®, sales of Testim® and royalties relating to Testim® sales could be materially reduced.

Watson Litigation: On May 23, 2012, Auxilium and FCB filed a lawsuit against Watson Laboratories, Inc. (NV), a Nevada corporation; Watson Pharmaceuticals, Inc.; and Watson Pharma, Inc. (collectively, "Watson") for infringement of FCB's ten patents listed in the Orange Book as covering Testim® 1% testosterone gel. The lawsuit was filed in the United States District Court for the District of New Jersey.

Auxilium and FCB filed this lawsuit in response to a notice letter, dated April 12, 2012, sent by Watson Laboratories, Inc. (NV) regarding its filing with the FDA of ANDA No. 09-1073 for a generic 1% testosterone gel product. This letter also stated that ANDA No. 09-1073 contained Paragraph IV certifications, under 21 U.S.C. Section 355(j) of the Federal Food, Drug, and Cosmetic Act, with respect to the nine patents listed in the Orange Book on that date as covering Testim®: U.S. Patent Nos. 7,320,968; 7,608,605; 7,608,606; 7,608,607; 7,608,608; 7,608,609; 7,608,610; 7,935,690; and 8,063,029. On May 15, 2012, a new composition patent covering Testim® issued. This patent is now also listed in the Orange Book and was included in the patent infringement lawsuit filed against Watson. In total, ten Testim® patents are now listed in the Orange Book and will expire at various dates ranging from July 21, 2023 through January 18, 2025.

On July 6, 2012, Watson filed its answer to the patent infringement complaint filed by Auxilium and FCB. Watson also asserted counterclaims against Auxilium and FCB, which seek declaratory judgments that each of the ten patents-in-suit are invalid or are not infringed by Watson's proposed generic 1% testosterone gel product. Auxilium and FCB's reply to Watson's counterclaims was filed on July 30, 2012. The case is presently in the early stages of fact discovery, and a trial date has not yet been set. The parties' initial case scheduling . . .