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UNITED STATES

SECURITIES AND EXCHANGE COMMISSION


Washington, D.C. 20549




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Form 10-KSB



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|  |  |                                                                                       
|- |  | --------------------------------------------------------------------------------------
|þ |  | ANNUAL REPORT UNDER SECTION 13 OR 15(d)
    OF THE SECURITIES EXCHANGE ACT OF 1934    
| 
|  |  | For the fiscal year ended December 31,
    2002                                       
| 
|o |  | TRANSITION REPORT UNDER SECTION 13 OR 15(d) OF
    THE SECURITIES EXCHANGE ACT OF 1934
| 
|  |  | For the transition period
    from           to           .                           

Commission file number 000-24693

Scolr, Inc.

(Name of small business issuer in its
charter)


|                                                                                        |  |                                                
|--------------------------------------------------------------------------------------- |  | -----------------------------------------------
|Delaware(State of Incorporation)                                                        |  | 91-1689591(IRS Employer Identification
    No.)
|8340 154th Avenue N.E., Redmond, Washington(Address of principal executive
    offices) |  | 98052(Zip Code)                                

Issuers telephone number:
(425) 883-9518

Securities registered under Section 12(b)
of the Exchange Act:

None


Securities registered under Section 12(g)
of the Exchange Act:

Common stock, $.001 par value


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

Check if disclosure of delinquent filers in
response to Item 405 of Regulation S-B is not
contained in this form, and no disclosure will be contained, to
the best of registrants knowledge, in definitive proxy or
information statements incorporated by reference in Part III of
this Form
10-KSB.     þ

The issuers revenues for the fiscal year
ended December 31, 2002 were $6,514,243.

The aggregate market value of the voting stock
held by non-affiliates computed by reference to the price at
which the stock was sold, or the average bid and asked price of
such stock, as of March 21, 2003 was approximately
$17,080,708.

As of March 20, 2003, there were 21,198,947
shares outstanding of the issuers common stock.



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DOCUMENTS INCORPORATED BY REFERENCE

The Registrant has incorporated by reference into
Part III of this Form 10-KSB portions of its Proxy
Statement for the 2003 Annual Meeting of Shareholders.



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TABLE OF CONTENTS



|              |                                                                                                                         |  |  |  |  |  |  | 
|------------- | ----------------------------------------------------------------------------------------------------------------------- |  |  |  |  |  |  | 
|PART I       
|              | Item 1. Description of Business                                                                                        
|              | Item 2. Description of Property                                                                                        
|              | Item 3. Legal Proceedings                                                                                              
|              | Item 4. Submission of Matters to a Vote of Security Holders                                                            
|PART II      
|              | Item 5. Market For Common Equity And Related Stockholder Matters                                                       
|              | Item 6. Managements Discussion And Analysis Of Financial Condition And Results Of Operations                          
|              | Item 7. Financial Statements                                                                                           
|              | Item 8. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure                           
|PART III     
|              | Item 9. Directors, Executive Officers, Promoters and Control Persons; Compliance with Section 16(a) of the Exchange Act
|              | Item 10. Executive Compensation                                                                                        
|              | Item 11. Security Ownership of Certain Beneficial Owners and Management                                                
|              | Item 12. Certain Relationships and Related Transactions                                                                
|              | Item 13. Exhibits and Reports on Form 8-K                                                                              
|              | Item 14. Controls and Procedures                                                                                       
|SIGNATURES   
|EXHIBIT 10.15
|EXHIBIT 10.16
|EXHIBIT 23.1 
|EXHIBIT 24.1 
|EXHIBIT 24.2 
|EXHIBIT 24.3 
|EXHIBIT 99.1 
|EXHIBIT 99.2 



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TABLE OF CONTENTS

SCOLR, INC.

FORM 10-KSB

|         |  |                                                                                                                          |  |      |    | 
|-------- |  | ------------------------------------------------------------------------------------------------------------------------ |  | ---- | -- | 
|         |  |                                                                                                                          |  | Page
|         |  |                                                                                                                          |  |     
|Item 1.  |  | Description of Business                                                                                                  |  |      | 2  | 
|Item 2.  |  | Description of Property                                                                                                  |  |      | 10 | 
|Item 3.  |  | Legal Proceedings                                                                                                        |  |      | 11 | 
|Item 4.  |  | Submission of Matters to a Vote of Security
    Holders                                                                  |  |      | 11 | 
|Item 5.  |  | Market for Common Equity and Related Stockholder
    Matters                                                             |  |      | 11 | 
|Item 6.  |  | Managements Discussion and Analysis of
    Financial Condition and Results of Operations                                |  |      | 11 | 
|Item 7.  |  | Financial Statements                                                                                                     |  |      | 18 | 
|Item 8.  |  | Changes in and Disagreements With Accountants on
    Accounting and Financial Disclosure                                 |  |      | 19 | 
|Item 9.  |  | Directors, Executive Officers, Promoters and
    Control Persons; Compliance with Section 16 (a) of the
    Exchange Act |  |      | 19 | 
|Item 10. |  | Executive Compensation                                                                                                   |  |      | 19 | 
|Item 11. |  | Security Ownership of Certain Beneficial Owners
    and Management and Related Stockholder Matters                       |  |      | 19 | 
|Item 12. |  | Certain Relationships and Related Transactions                                                                           |  |      | 19 | 
|Item 13. |  | Exhibits and Reports on Form 8-K                                                                                         |  |      | 19 | 
|Item 14. |  | Controls and Procedures                                                                                                  |  |      | 20 | 

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PART I






|        |                        
|------- | -----------------------
|Item 1. | Description of Business

Forward-Looking Statements

Except for historical information, the matters
discussed in this document contain forward-looking statements
within the meaning of Section 37A of the Securities Act of
1933 and Section 21E of the Securities Exchange Act of
1934. These forward-looking statements involve risks and
uncertainties, including activities, events or developments that
the company expects, believes or anticipates will or may occur
in the future. A number of factors could cause actual results to
differ from those indicated in the forward-looking statements,
including but not limited to, the Companys ability to
continue to successfully market and provide its products and
services and maintain their effectiveness, the continuation of
the arrangements with the Companys product development
partners, the ability of the Company to meet its financial
projections, and general economic conditions. For a more
detailed analysis of Company risk factors, seeManagements Discussion and
Analysis of Financial Condition and Results of
Operations  Outlook  Issues and
Uncertainties contained in Item 6. Forward-looking
statements are subject to a number of assumptions, risks and
uncertainties. Readers are cautioned that such statements are
not guarantees of future performance and that actual results or
developments may differ materially from those set forth in the
forward-looking statements. The Company undertakes no obligation
to update or revise forward-looking statements whether as a
result of new information or otherwise.

Business Development

SCOLR, Inc. (the Company) was
incorporated in October 1994 in Delaware, originally under the
name Caddy Systems, Inc. From April 1995 to July 2002, the
Company operated under the name Nutraceutix, Inc. The Company
has two principal businesses: (1) the formulation and
manufacture of nutraceutical-based health and dietary
supplements for both the animal and human nutrition markets (the
Probiotics business), and (2) the formulation
and in-vitro development of controlled delivery over-the-counter
(OTC) products, prescription drugs and nutraceutical
products (the Drug Delivery business).



| |           
| | ----------
| | Probiotics

The Companys Probiotics business unit is a
leading ingredient supplier to retailers and manufacturers in
the U.S. nutraceutical market for probiotics supplements.
Nutraceuticals are biologically active materials, either derived
from plant, microbial, or animal sources or by synthesis, which
are formulated to provide specific health benefits for humans
and productivity benefits in animals. Market sources estimate
the probiotics market generates approximately $100 million
in annual sales with growth prospects of approximately 10-15%
annually.



| |              
| | -------------
| | Drug Delivery

The Companys Drug Delivery business is
centered around the development and licensing of the
Companys Controlled Delivery Technology
(CDT®), a system of three patented drug
delivery platforms for prescription drugs, OTC products, and
nutraceuticals. The basis of these platforms is technology
embodied in two issued U.S. patents acquired from Temple
University and a third issued U.S. patent developed by the
Company. The Company has collaborated with Dr. Reza
Fassihi, Professor of Biopharmaceutics and Industrial Pharmacy
at the Temple University School of Pharmacy over the last two
years to develop prototype prescription drugs, OTC products and
dietary supplements which employ the novel delivery system
concepts embodied in the three CDT® patents.

The CDT® system is designed for use in solid
oral dosage forms, the preferred route for drug administration.
This CDT® technology is designed to produce tablets or
capsules which release their active agents predictably and
programmably over a specified timeframe of up to 24 hours. For
many reasons, pharmaceutical companies increasingly prefer
controlled release rather than immediate release of the active
agent in their drugs. The advantages of controlled drug delivery
typically include improved patient compliance;

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product differentiation; greater efficacy; and,
an improved safety profile. According to the drug industry
research firm, Data Monitor, the $20 billion U.S. drug
delivery market is growing at twice the rate of the
pharmaceutical industry as a whole.


The Company believes that its CDT® drug
delivery technology enjoys many competitive advantages when
compared to other controlled delivery methodologies. CDT®
is a robust and simple technology that is low cost, easy to
manufacture (using conventional blending and compression
equipment in a two-step process), can deliver comparatively high
therapeutic payloads of active ingredient, and is
highly programmable to deliver active therapeutic agents over a
wide range of release profiles and timeframes. Finally, from a
market perspective, a technology such as CDT® allows
pharmaceutical companies to reformulate existing drugs, thereby
extending the term of their patent protection and defending
important revenue streams from existing blockbuster
drugs nearing patent expiration. According to Data Monitor,
A total of 42 out of 52 blockbuster drugs
($82 billion combined worldwide sales) will face patent
expiration by the year 2007.

In the first quarter of 2002, the Company
announced a global strategic alliance with Archer Daniels
Midland (ADM) pursuant to which the Company granted
ADM an exclusive license and right of first refusal to develop
and market certain dietary supplement and nutraceutical products
using the Companys CDT® technology. ADM introduced
the first product developed under this relationship to the
European market in October 2002. Introduction in the U.S. is
expected in the first half of 2003. The Company expects to form
other relationships in the near future that are similar to the
ADM venture. Following the recent successful completion of the
Companys CDT® proof-of-concept human
clinical trial, the Company has received expressions of interest
from several of the largest pharmaceutical companies. Virtually
all of these potential licensing partners currently have
prescription drug franchises for which they are seeking
technological enhancements (such as CDT®) to extend the
life of those franchises in the face of core patent expirations
over the next 5-10 years. The Company is now actively
pursuing collaborations with these pharmaceutical companies
under agreements seeking upfront licensing fees, royalty
payments, and milestone payments for use of the Companys
CDT® delivery technology.

The Drug Delivery business has begun generating
revenue with a modest level of near-term revenues from
CDT®-based sales to the dietary supplement markets. These
sales are being generated through existing relationships with
retailers such as Wal-Mart, Rite-Aid, and Trader Joes. The
Company expects to realize increased royalty income from the
initial CDT® dietary supplement and OTC formulations in
2003. The Company does not expect royalty income from CDT®
prescription drugs earlier than 2006.



| |                 
| | ----------------
| | Company Strategy

Given the long-term growth potential and
prospects associated with the Companys CDT® drug
delivery technology, the Company intends to focus its efforts on
the Drug Delivery business. While its Probiotics unit is a
well-established business that is expected to generate modest
cash-flow, Probiotics operates in a relatively small market with
limited growth potential. By contrast, the Companys Drug
Delivery business is an early-stage operation that has the
potential to address very large markets.

To best take advantage of the growth opportunity
in the Companys Drug Delivery business, the Company is
repositioning itself as a drug delivery company. Effective July
2002, the Company changed its corporate name from Nutraceutix,
Inc. to SCOLR, Inc., an acronym for Self Correcting Oral Linear
Release, representing the Companys lead technology in the
drug delivery arena. The name change emphasizes the
Companys shift in strategy to focus on and develop its
Drug Delivery business.

As announced in the fourth quarter of 2002, the
Company has been exploring the sale of its Probiotics business
to provide liquidity to allow the Company to pursue its Drug
Delivery business. The Company intends to continue to pursue
opportunities to sell or enter into joint venture or partnership
arrangements for its Probiotics business in an effort to provide
cash for the Company. In addition, the near-term revenues
derived from applying CDT® to nutraceutical markets will be
used to support development of the Drug Delivery business.
However, the Company will not be able to pursue licensing, joint
venture and other activities to develop its Drug Delivery
business unless it is successful in raising additional capital.
See Item 6.

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Managements Discussion and Analysis
of Financial Condition and Results of OperationsLiquidity
and Capital Resources.


The following are some of the recent milestones
achieved by the Company in its efforts to build its Drug
Delivery business:



| |   |                                                                                                                                                                                                                                  
| | - | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |  | Acquisition of exclusive licenses for U.S. Patent
    No. 6,337,091 and No. 6,090,411 for use in the
    Companys CDT® drug delivery platform.                                                                                  
|
| |  | Issuance of U.S. Patent No. 6,517,868 for
    use in the Companys CDT® drug delivery platform.                                                                                                                                  
|
| |  | Successful completion of in vitro/in vivo
    correlation trial establishing clinical proof-of-concept for
    CDT®.                                                                                                             
|
| |  | Continuation and enhancement of working
    relationship with Temple University and Dr. Fassihi, for
    partnership with both existing and new technology development.                                                          
|
| |  | Commercial production of first CDT® product
    (glucosamine).                                                                                                                                                                   
|
| |  | DEA approval for a licensee to begin scale-up of
    CDT® pseudophedrine products.                                                                                                                                               
|
| |  | Global strategic alliance with Archer Daniels
    Midland to develop and market certain dietary supplements.                                                                                                                     
|
| |  | Successful completion of production scale-up and
    commercial introduction of first Archer Daniels Midland product
    based on CDT® delivery. Royalty revenues anticipated in the
    second quarter of 2003.                 
|
| |  | Successful introduction of two additional
    CDT®-based products into more than 6,000 U.S. retail
    locations, including Wal-Mart, Rite-Aid, and Trader Joes.
    Royalty revenues anticipated in the second quarter of 2003.
|
| |  | Successful introduction of the Companys
    proprietary probiotic delivery system into the U.S. dietary
    supplement marketplace generating sales and revenues that
    commenced in the first quarter of 2003.               

Principal Products and Services



| |                         
| | ------------------------
| | Drug Delivery Technology

In December 1998, the Company entered the drug
delivery arena through an agreement with Temple University for
the Companys exclusive license of technology pertaining to
the controlled delivery of dietary supplement capsules and
tablets. The Company trademarked this technology as CDT®
Controlled Delivery Technology.

The Company considers CDT® to be distinctive
in its ability to program in-vitro release patterns for each
health supplement contained in a single tablet or capsule at a
relatively low cost of manufacture as compared to immediate
release formulations of the same active ingredient. The Company
believes that the wide applicability of its technology among the
available range of vitamin and herbal products suitable for once
or twice daily dosing or pulsed release provides a unique
commercial opportunity in the $20 billion U.S. dietary
supplement and nutraceutical market.

Controlled delivery technologies are widely
employed within the OTC and pharmaceutical industries, while
they are relatively rare within the dietary supplement industry.
In the pharmaceutical industry, sustained-release technologies
have been shown to optimize the therapeutic effectiveness,
enhance the compliance to the dosing schedule, and reduce the
frequency and severity of side effects of a single Active
Pharmaceutical Ingredient (API). The Company
believes that this unique technology will offer similar benefits
within the health and dietary supplement industry.

The controlled delivery technology was developed
at Temple University, School of Pharmacy, for the chronic
administration of calcium channel blockers such as nifedipine,
diltiazem, and verapamil which are prescribed for the long-term
management of chronic angina pectoris and benign essential
hypertension. The physicochemical properties and intrinsic
pharmacological characteristics of these drugs, such as high or
low

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solubility, limited absorption, or pre-systemic
metabolism, necessitated the development of a highly
controllable drug delivery system to provide continuous active
ingredient release with zero-order kinetics typified by precise
and reproducible performance. The first generation of this
technology is based on swellable hydrophilic matrices, which
allow for the controlled diffusion of dietary supplements from
the matrix through the tablets progressive swelling and erosion.
The CDT® tablets or capsules employ combinations of
hydrophilic polymers and poly-ionics or electrolytes specific to
each health supplement or OTC product and the desired release
profile. Depending upon the matrix composition, the selection
and ratio of polymers, ionic substrates, or electrolytes various
release patterns and rates can be achieved.


One of the most difficult challenges for a
controlled delivery technology is to produce a continuous
release with linear, zero-order kinetics of a highly soluble API
for periods up to 24 hours. Linear, zero-order kinetics means
that a precise quantity of API is released during each unit of
time over the entire course of the release pattern until 100% of
the API is released. There are no bursts or lag phases in the
release pattern. After obtaining the exclusive license for the
technology from Temple University, the Company, in collaboration
with Temple University, specifically developed continuous,
zero-order kinetics tablets of Vitamin C. Vitamin C was
considered to be a technological challenge due to its high water
solubility and high permeability. Following the Vitamin C
project, the Company and Temple University developed individual,
controlled-release, linear, zero-order kinetics tablets of
glucosamine, Calcium D-GLUCARATETM, several sports
nutrition prohormones, and diet formulations containing ephedra.
The Company believes that both the dietary supplement and
nutraceutical industries offer many opportunities to apply this
technology.

In 1999, the Company obtained a license from
Temple University to apply the technology that now comprises
U.S. Patent No. 6,337,091 (CDT® Patent
No. 1) to the manufacture of OTC products. In
September 2001, the Company acquired the exclusive license for
the rights to CDT® Patent No. 1 in prescription drugs.
The U.S. Patent and Trademark Office issued CDT® Patent
No. 1 on January 8, 2002.

In September 2000, the Company acquired the
worldwide rights to CDT® Patent No. 6,090,411
(CDT® Patent No. 2) for application in
dietary and health supplements, OTC products and prescription
drugs. CDT® Patent No. 2 was issued by the U.S. Patent
and Trademark Office on July 18, 2000. This technology
provides for the controlled and programmable release of the API
with zero-order kinetics through the dry blending and direct
compression of a salt, a polymer, and the API. The Company
believes the CDT® Patent No. 2 technology possesses
several critical and unique advantages over comparable
sustained-release technologies currently employed by the drug
delivery industry in manufacturing extended or sustained-release
products:



| |   |                                                                                                                                                                                                                                                                                                                                                                                       
| | - | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |  | The technology does not involve a granulation
    step at manufacturing; thereby, shortening process times and
    eliminating potentially toxic solvents from the manufacturing
    process. Processes are faster and easily validated.                                                                                                                                              
|
| |  | The technology involves the development of the
    desired release pattern through the dry blending of a selected
    salt and polymer in various ratios in order to create a dry
    matrix. The resulting matrix is directly compressible on all
    currently available tableting equipment routinely used in the
    pharmaceutical industry.                                     
|
| |  | The technology and its applicability to dietary
    supplements, OTC products or prescription pharmaceuticals are
    extremely rugged and flexible; the in-vitro dissolution results
    are not affected by drug solubility, pH, tablet size or
    configuration, tablet hardness, or friability.                                                                                  
|
| |  | The technology has a patent life of 20 years.                                                                                                                                                                                                                                                                                                                                         
|
| |  | The technology is a 2 step process involving GRAS
    (Generally Regarded as Safe) excipients in novel quantities and
    using standard pharmaceutical processing equipment and
    technology; thereby, enabling the manufacturer of CDT®
    products to produce controlled release products at approximately
    the same costs as immediate release formulations of the same API.

The Company believes that the technology embodied
in the CDT® Patent No. 2 demonstrates significant
advantages over current sustained-release technologies that
involve multiple polymer systems, coated beads or

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coated tablets. The Companys licensed
technology is easily manufactured on conventional pharmaceutical
equipment with fewer processing steps. Furthermore, it is
applicable to a wider range of APIs, dietary supplements
and OTC products than other technologies. The Company believes
that the CDT® Patent No. 2 provides for rapid product
formulation and development leading to faster submissions to the
regulatory authorities, faster time to market, and less
expensive manufacturing.


On February 12, 2003, the U.S. Patent and
Trademark Office issued U.S. Patent No. 6,517,868
(CDT® Patent No. 3) to the Company for its
amino acid CDT® drug delivery platform for pharmaceutically
active compounds. Although this is the Companys third
CDT® patent, it is the first issued directly to the Company.

Designed as a simpler solution to certain
difficult formulation issues, CDT® Patent No. 3
extends the Companys capabilities to include poorly
soluble drugs which are difficult and costly to formulate and
produce with currently available manufacturing techniques and
processes. CDT® Patent No. 3, in conjunction with
CDT® Patent No. 1 and CDT® Patent No. 2,
combine to create a range of modified oral drug delivery systems
that address significant hurdles of oral drug delivery,
including zero order kinetics, poorly soluble active ingredients
and ingredients difficult to tablet. The Company believes the
CDT® technology accomplishes this at reasonable cost and
time savings to the manufacturer.

In an effort to take advantage of the faster
time-to-market in the dietary supplement industry, several
nutraceutical products employing CDT® technology were
introduced in late 2002. The first commercial introduction of an
OTC product utilizing CDT® is expected in late 2003 and
CDT®-based prescription drugs are planned for after 2005.



| |                                                             
| | ------------------------------------------------------------
| | Nutraceutical-Based Dietary Supplements For
    Human Health

Specific nutraceuticals have been shown to affect
bodily functions in targeted ways, such as joint health
(glucosamine and chondroitin) or by lowering cholesterol and
menopausal symptoms (soy isoflavones). The active ingredients in
nutraceuticals may include complex mixtures of organic
molecules, small molecules, oligosaccharides, lactic acid
probiotics, fungi, minerals, and other microbial secondary
metabolites.

Lactobacillus acidophilus cultures are classic
specialty food additives, which have long been components of
yogurt and fermented food. Published literature has shown lactic
acid bacteria to exert positive gastrointestinal health benefits
beyond their nutritional value. The Company has developed a
proprietary tableting technology for the delivery of lactic acid
bacteria in a trademarked dietary supplement, LIVE-BAC®
probiotic caplets.

The Company believes that the market for
nutraceuticals and probiotics, in particular, will continue to
expand due to the on-going identification of disease processes
coupled with an aging population increasingly motivated to
preserve good health. The development and identification of new
nutraceutical products may require combining interdisciplinary
technologies including plant science, microbiology,
biochemistry, and nutrition.



| |                                                                              
| | -----------------------------------------------------------------------------
| | Nutraceutical-Based Productivity
    Supplements for the Agriculture Industry

Through 2002, the Company had two primary
agriculture product lines which it manufactured and sold:
(1) Lactobacillus acidophilus products, which are used to
enhance feed efficiency in feedlot cattle, and (2) silage
inoculum products, which are used to preserve the nutritional
value of stored forages. In the first quarter of 2003, the
Company sold all rights, proprietary interests, know-how and
intellectual property related to these product lines for cash
and other considerations. There will be no future revenues from
these products.

The Company continues to manufacture microbial
products for several agriculture companies on a private label
and OEM basis at its fermentation plant located in Redmond,
Washington. These microbial products are mainly silage
inoculums. The Company has over 18 years of experience in
microbial fermentation.



| |              
| | -------------
| | Manufacturing

In December 1999, the Company opened a second
fermentation facility in Redmond, Washington in response to
increased demand for probiotic products. The new facility
combined with the Companys

6



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manufacturing facility located at corporate
headquarters to effectively double the Companys output of
bulk microbial raw material.




| |                                                  
| | -------------------------------------------------
| | Private Label Health Supplement
    Manufacturing

The Company manufactures private label health
supplements incorporating its patented and proprietary
technologies or the probiotics produced in its Redmond,
Washington fermentation facilities. Finished goods production
takes place at its encapsulating, tableting, bottling, and
labeling facility in Lafayette, Colorado.

The LIVE-BAC® caplet process is based upon
our patent pending CRYOTABLETTINGTM technology that
results in extended shelf life of tablets or caplets containing
lactic acid bacteria. Caplets of probiotics manufactured using
the LIVE-BAC® process have demonstrated superior viability
and shelf life as compared to conventional capsules.

The Companys experience and capabilities in
both drug delivery systems and probiotic food additives has
resulted in the mutual application of technology toward a
cost-effective probiotic delivery system: the Company has a
patent-pending BIO-TRACTTM G.I., with
SCBioRxTM technology. This application of the
Companys SCBioRxTM technology allows
lyophilized probiotic bacteria to be tableted within a polymer
matrix that protects the enclosed bacteria until the optimal
time of release, while also maintaining the viability of the
bacteria during the manufacturing process. Developed as a
delivery system for pharmaceuticals, SCBioRx self-correcting
matrix technology moderates the swelling and erosion kinetics of
non-ionic polymers, thus enabling programmed release of the
bacteria from the dosage form upstream of the strain-specified
attachment region within the gastrointestinal tract. The Company
expects to enter into production and commercialization with an
established partner in the U.S. nutraceutical market during mid
2003.

In December 1998, the Company entered into an
exclusive marketing agreement with MET-Rx USA, Inc.
(MET-Rx) of Irvine, California, and developed, on a
non-exclusive basis, controlled delivery products. Prohormones
and weight-loss products were released in April 1999. However,
after MET-Rx was acquired in 2000, its new parent company
discontinued the products due to uncertainties over the
continued sales of dietary supplements containing either
prohormones or ephedra alkaloids. The Company will not receive
any future revenues from its relationship with MET-Rx or the
products developed for MET-Rx. See Managements
Discussion and Analysis of Financial Condition and Results of
Operations contained in Item 6.

Marketing, Sales and Distribution

In the human dietary supplement market, the
Company relies on its sales and marketing personnel to sell
lactic acid bacteria, LIVE-BAC® products and nutraceuticals
incorporating the Companys patented and proprietary drug
delivery technologies. In 2002, the Company relied on three
internal sales and marketing executives assisted by independent
brokers to sell its OEM or private label products containing
probiotics to major nutraceutical and agriculture companies
involved in marketing these products to the consumer. In
addition, the Companys efforts have been directed at
partnering with major nutraceutical and pharmaceutical companies
to co-develop unique and distinctive dietary supplements, OTC
products, and prescription drugs incorporating the
Companys patented and proprietary delivery technology.

Competition

The principal markets in which the Companys
products are sold are both competitive and fragmented. The
Company faces significant competition in manufacturing and
product development in both the human food supplement and drug
delivery markets.

The Companys major competitors in the
microbial products market who manufacture lactic acid bacteria
for human dietary supplements include Chris Hansen, Rhodia,
Lallemand, Institut Rosell, BioGaia and Harmonium International,
Inc.

The Company believes that its primary competitive
advantage results from patented and proprietary technologies,
which are not available from other suppliers, including
LIVE-BAC® caplets, CRYOTABLETTINGTM technology,
CDT® controlled delivery technology, and lactic acid
bacteria technology. Additionally,

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the Company believes that other principal
competitive factors in the sale of health supplements are
quality, technology, manufacturing, timely delivery of products,
and service. In general, the Companys competitors have
significantly more resources than the Company; however, the
Company believes that its patented and proprietary technologies
offset some of the advantages held by these competitors.


In the drug delivery field, the Companys
major competitors include Alza Corporation, Biovail, Inc.,
Skyepharma PLC, Elan, Andrx, Inc., Impax Laboratories, Inc.,
Labopharm, and KV Pharmaceuticals, Inc. The successful
development and commercialization of major controlled delivery
prescription drugs can take five to seven years and millions of
dollars of research and clinical trials. The Company believes
that these major competitors are better funded and equipped to
fully realize the potential from new and unique patented drug
delivery systems and are in possession of significantly stronger
financial and R&D resources. However, the Company believes
that its three CDT® patents provide certain advantages in
the drug delivery industry including quicker product
development, faster to market capabilities, and lower cost of
manufacturing.

Sources and Availability of Raw Materials and
Principal Suppliers

With the exception of lactic acid cultures and
probiotic blends, the Company obtains all of its raw materials
for the manufacture of its products from outside sources. The
Company generally does not have contracts with entities or
persons committing such suppliers to provide the materials
required for the production of its products.

Significant Customers and Suppliers

In 2002, the Company received approximately 60%
of its total revenues from four customers: Rexall Sundown (23%),
Supplement Sciences (20%), NBTY (10%) and Trader Joes
(8%). With the uncertainty in the nutraceutical markets in
general, the Company expects sales revenue fluctuations due to
market conditions and the performance of its major customers.

Intellectual Property

The Company currently holds two U.S. patents for
controlled delivery technologies licensed exclusively from
Temple University (CDT® Patents No. 1 and 2) and one
patent for a third controlled delivery patent assigned to the
Company by the inventors, Dr. Fassihi and Dr. Thomas
Durig (CDT® Patent No. 3). Each of these patents has a
duration of twenty years and does not expire sooner than 2021.
Additionally, the Company filed patent applications in 2001 for
its CRYOTABLETTINGTM process for micro-organisms,
ReHydraid Sports Drink and Oral Rehydration System, and a
Controlled Release delivery system for Micro-organisms and
Biologicals. As of December 2002, the Company also held two U.S.
patents and one Canadian patent pertaining to COBACTIN®
feed additives. However, the COBACTIN® patents were
assigned as part of an asset sale in the first quarter of 2003.

As of December 2002, the Company had
approximately eight federal trademark registrations and seven
trademark applications pending with the U.S. Patent and
Trademark Office. The Companys policy is to pursue
registrations for all of the trademarks associated with its key
products and technologies. Following is a list of the
Companys registered and pending U.S. trademarks as of
December 2002: CDT®, BIO TECHNIQUES®, BIOPOWER®,
COBACTIN®, COBACTIN II®, COBACTIN PLUS®,
LIVE-BAC®, NUTRACEUTIX®, BIO-TRACTTM,
CRYOTABLETTINGTM, D-GLUTM
CARATETM, REHYDRAIDTM,
SCBioRxTM and SCOLRTM. All trademarks
associated with COBACTIN® and BIOPOWER® were assigned
as part of an asset sale in the first quarter of 2003.

The Company pays certain royalties to the
original developers of certain of its agriculture products. See
Note P of Notes to Financial Statements
contained in Item 7. The Company is also obligated to pay
an annual license maintenance fee, share certain up-front
payments from customers, and pay royalties based on customer
sales derived from its use of CDT®Patent Nos. 1-3.

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Government Regulation

The Company must receive separate regulatory
approval for each of our product candidates before the Company
or its collaborators can sell them in the United States or
internationally. The manufacture and sale of OTC and
prescription drugs in the U.S. and internationally is governed
by a variety of statutes, regulations and policies which
require, among other things:



| |                                                                                                                                                                                                                                                                                                                                      
| | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | 1.     approval of
    manufacturing facilities and practices;                                                                                                                                                                                                                                                                       
|
| | 2.     controlled
    research and testing of products;                                                                                                                                                                                                                                                                              
|
| | 3.     review and
    approval of submissions containing manufacturing, preclinical,
    and clinical data in order to obtain marketing approval based on
    establishing the safety and efficacy of the product for each use
    sought, including adherence to Good Manufacturing Practices
    during production and storage; and
|
| | 4.     control of
    marketing activities, including advertising and labeling.                                                                                                                                                                                                                                                      

Research and Development

In 2000, the Company reorganized its research and
development capabilities and structure in order to focus on its
exploitation of the newly acquired CDT® Patent No. 2
and the opportunities presented in the OTC and prescription drug
markets for drug delivery.

In 2002 and 2001, the Company spent $540,826
(approximately 8% of revenues) and $420,542 (approximately 5% of
revenues), respectively, on product research and development.
The Company believes this level of research and development
spending is the minimal amount necessary to enable the Company
to move forward with its existing drug delivery technology in
the dietary supplement market. To fully realize the potential of
the Companys three issued CDT® patents in the
pharmaceutical and OTC markets, the Company will need to devote
significantly increased resources to research and development.
To accomplish these objectives, the Company will be required to
raise additional capital. See Item 6.
Managements Discussion and Analysis of Financial
Condition and Results of Operations  Liquidity and Capital
Resources.

Furthermore, increased research and development
spending will be required to both replace existing technologies
with newer, state of the art technologies, and to create an
effective drug delivery development unit within the Company.



| |                              
| | -----------------------------
| | Microbial Product Development

The Company has conducted research into the role
of resident bacteria that are normally found in the
gastrointestinal tract of humans and the delivery of viable
lactic acid bacteria in supplemental form. This research has
also resulted in the development of the LIVE-BAC® process
and CRYOTABLETTINGTM technology for tableting lactic
acid bacteria in order to extend shelf life at room temperature
and to preserve microorganism viability at room temperature. The
LIVE-BAC® process has been shown through in-vitro studies
to yield a caplet/tablet with significantly superior shelf life
as compared to conventional capsules. The shelf life of lactic
acid bacteria in dietary supplement form has been historically
problematic. The Company is continuing its efforts to develop
new applications of its LIVE-BAC® technology.

The Companys developed
BIO-TRACTTM G.I., with SCBioRxTM
technology during 2002. The SCBioRxTM technology
allows probiotic bacteria to bypass the stomach acids and be
released from the tablet in the upper intestine. The Company
intends to continue research into its proprietary drug delivery
technologies and its applications to probiotic bacteria.



| |                              
| | -----------------------------
| | Health Supplement Development

The Company develops products requested by
private label customers and/or develops new product concepts
that it then licenses to the customers. The Company also
actively seeks and reviews new nutraceutical materials and drug
delivery technologies developed at universities or by
independent researchers with the view to acquiring the
intellectual property. The Company then conducts applied
research on the

9



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intellectual property in order to develop a
commercial product or application which we license to
co-developers or commercial partners.


The Company intends to further exploit its
intellectual property position within the nutraceutical and
sports nutrition markets in 2003 and beyond. Historical sales of
patented and proprietary drug delivery technology within the
sports nutrition market have demonstrated this market
segments ready acceptance of Company technologies and
their successful commercial applications.



| |                                       
| | --------------------------------------
| | Pharmaceutical Product
    Development

The Company plans to simultaneously conduct
research and development, including clinical trials, on a number
of pharmaceutical projects. These projects will be very costly,
and will likely increase our research and development costs
significantly. The Company will need additional capital
resources to undertake these projects. If the Company fails to
raise the capital necessary to fund our pharmaceutical product
development operations, we will be unable to advance our
technology, development programs and clinical trials. See
Item 6. Managements Discussion and Analysis of
Financial Condition and Results of Operations 
Liquidity and Capital Resources.

Compliance with Environment Laws

The Company is subject to federal, state, local
and other laws and regulations governing the use, manufacture,
storage, handling, and disposal of materials and certain waste
products. The risk of accidental contamination or injury from
these materials cannot be completely eliminated. In the event of
an accident, we could be held liable for any damages that result
and any such liability could exceed our resources. There can be
no assurance that the Company will not be required to incur
significant costs to comply with environmental laws and
regulations in the future, or that our operations, business, or
assets will not be materially adversely affected by current or
future environmental laws or regulations.

Employees

As of December 31, 2002, the Company
employed 42 full time employees, consisting of two executives,
23 production personnel, three sales and marketing personnel,
three research and development personnel, seven quality control
personnel and four administrative personnel. None of the
Companys employees are represented by labor unions. The
Company believes its relationship with employees is good.




Item 2.     Description
of Property

The Companys corporate headquarters,
including administrative offices, production and research and
development facilities are located approximately fifteen miles
northeast of Seattle at 8340 154th Avenue N.E., Redmond,
Washington 98052. The property, consisting of 15,893 square
feet, is leased for a term of sixty (60) months terminating
on November 30, 2003 at an average annual rent of $290,808.
The production facility includes equipment for fermentation,
formulation, packaging and storage. The Company leases an
additional building consisting of 1,879 square feet for off-site
storage and product blending, located approximately one-half
mile from the corporate headquarters at 14822 NE 95th Street,
Redmond, Washington. The storage space is leased through
July 31, 2003 at an average annual rent of $25,500 per
year. In November 1999, a third property of 9,620 square feet
located at 9625 153rd Avenue SE, Redmond, Washington was leased
for a term of sixty (60) months at an average annual rent
of $106,295 per year.

The Companys tableting and encapsulating
facility is located approximately 25 miles from Denver at 1400
and 1420 Overlook Drive, Lafayette, Colorado 80026. The premises
consist of two stand-alone buildings for a total of 28,800
square feet. The main building is used primarily for
manufacturing and contains machinery for the blending and
finishing of raw materials into tablets or capsules and also
contains some minimal office space. The second building is
warehouse space used for raw material and packaging storage. The
property is leased for a term of sixty (60) months with a
lease termination date of July 31, 2006 and an average
annual rent of $257,877 per year.

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The Company believes all lease property is in
good and satisfactory condition, and is suitable for the
Companys business needs for the term of the respective
leases.




Item 3.     Legal
Proceedings

The Company is not presently a party to any
material litigation not in the regular course of business.




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

No matters were submitted to the Companys
shareholders during the quarter ended December 31, 2002.




PART II






|        |                                                             
|------- | ------------------------------------------------------------
|Item 5. | Market For Common Equity And Related
    Stockholder Matters

The Companys Common Stock, $.001 par value,
is traded in the over-the-counter market (OTC Bulletin Board
Symbol: SCLL). The following table sets forth the
range of high ask and low bid prices for the Companys
Common Stock on a quarterly basis for the past two full years,
as reported by the National Quotation Bureau (which reflect
inter-dealer prices, without retail mark-up, mark-down, or
commission and may not necessarily represent actual
transactions). The foregoing and following information should
not be taken as an indication of the existence of an established
public trading market for the Companys Common Stock.

COMMON STOCK

|                                        |  |          |      |         |  |  |      | 
|--------------------------------------- |  | -------- | ---- | ------- |  |  | ---- | 
|                                        |  | High Ask |      | Low Bid
|                                        |  |          |      |        
|Period  Fiscal Year 2002               |  |          |      |         |  |  |      | 
|First Quarter ending March 31, 2002     |  |          | 1.55 |         |  |  | 0.52 | 
|Second Quarter ending June 30, 2002     |  |          | 1.60 |         |  |  | 0.90 | 
|Third Quarter ending September 30, 2002 |  |          | 1.18 |         |  |  | 0.77 | 
|Fourth Quarter ending December 31, 2002 |  |          | 1.28 |         |  |  | 0.72 | 

|                                        |  |          |      |         |  |  |      | 
|--------------------------------------- |  | -------- | ---- | ------- |  |  | ---- | 
|                                        |  | High Ask |      | Low Bid
|                                        |  |          |      |        
|Period  Fiscal Year 2001               |  |          |      |         |  |  |      | 
|First Quarter ending March 31, 2001     |  |          | 1.03 |         |  |  | 0.30 | 
|Second Quarter ending June 30, 2001     |  |          | 0.75 |         |  |  | 0.55 | 
|Third Quarter ending September 30, 2001 |  |          | 0.68 |         |  |  | 0.35 | 
|Fourth Quarter ending December 31, 2001 |  |          | 0.91 |         |  |  | 0.35 | 

The approximate number of record holders of the
Companys Common Stock as of December 31, 2002 was
1,356 inclusive of those brokerage firms and/or clearinghouses
holding the Companys common shares for their clientele
(with each such brokerage house and/or clearing house being
considered as one holder).

The Company has not paid or declared any
dividends upon its Common Stock since its inception and does not
contemplate or anticipate paying any dividends upon its Common
Stock in the foreseeable future.






|        |                                                                                          
|------- | -----------------------------------------------------------------------------------------
|Item 6. | Managements Discussion And Analysis
    Of Financial Condition And Results Of Operations

Critical Accounting Policy Judgments and
Estimates

The preparation of financial statements in
accordance with accounting principles generally accepted in the
United States requires that we make estimates and judgments
which affect the reported amounts of assets, liabilities,
revenues and expenses and related disclosures of contingent
assets and liabilities. On an ongoing basis, the Company
evaluates its estimates, including those related to sales,
receivables, bad debts, inventories, intangible assets, income
taxes, contingencies such as litigation, and contract terms. We
base our estimates on

11



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historical experience and other assumptions that
we believe are reasonable under the circumstances. Actual
results may differ from these estimates under different
assumptions or conditions.


The Company believes the following critical
accounting policies affect the more significant judgments and
estimates used in the preparation of its financial statements:

Revenue Recognition:Revenues from Research and Development contracts, license fees
and cost reimbursement contracts are recognized systematically
over the period that the fees or payments are earned. Revenues
from milestone payments representing completion of separate and
substantive earnings processes are recognized when the milestone
is achieved and the amounts are due and payable. Revenues from
royalties are recognized when earned and are considered
collectible. Revenue from the sale of product is recognized upon
shipment.

Allowance for Doubtful
Accounts:The Company bases the
allowance for doubtful accounts receivable on our assessment of
the collectibility of specific customer accounts and the aging
of accounts receivable.

Inventory Reserve:The Company bases the inventory reserves on the potential of the
inventory becoming obsolete or slow moving. Inventory that is
considered obsolete is written-off.

Intangible assets:Intangible assets are stated at cost and amortized to operations
over their estimated useful lives or statutory lives, whichever
is shorter. The Company evaluates its intangible assets annually
to determine potential impairment by examining the carrying
amount of the assets to determine if the carrying amount is
recoverable, and by comparing the carrying amount of the assets
fair market value.

Net Revenues

Net revenues decreased 20% or $1,676,257 to
$6,514,243 for the year ended December 31, 2002 from net
revenues of $8,190,500 for the year ended December 31,
2001. An analysis of the Companys revenue-generating
centers is outlined below:

Revenue Generating Centers

The Company operates two primary
revenue-generating centers:



| |                                                                                       
| | --------------------------------------------------------------------------------------
| | 1.     Manufacturing
    Center  consisting of two sub-centers as outlined
    below:



| |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                              
| | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | A.     Dietary
    Supplement Manufacturing  The Company
    manufactures dietary supplement products, on an OEM or private
    label basis, containing LIVE-BAC® caplets or CDT®
    Controlled Delivery Technology and, as described below,
    previously manufactured Calcium D-GLUCARATETM.
    Revenues are realized from the sales of LIVE-BAC® caplets,
    dietary supplements incorporating CDT® technology or
    manufacturing of tablets, capsules, herbal pre-blends, or
    natural product pre-blends for inclusion into food products or
    private label finished goods. The tableting, encapsulation and
    packaging operations are located in the Companys
    Lafayette, CO manufacturing facility.
|
| | B.     Fermentation 
    The Company manufactures and sells viable (live) freeze dried
    microorganisms on a private label and OEM basis. Revenues are
    also realized from the sale of COBACTIN® microbial feed
    additive products for feedlot and dairy cattle and sales of Bio
    Power silage inoculants. The fermentation plants are located in
    Redmond, WA.                                                                                                                                                                                                                                                                                                                                               



| |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                
| | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | 2.     Licensing
    Fees, Research & Development Contracts and Royalties
    Center  The Company generates Licensing Fees and
    Research & Development contracts for the formulation of
    Controlled Delivery Technology prescription drugs,
    over-the-counter (OTC) products, and dietary supplements.
    The licensing agreements and Research & Development
    contracts include royalty revenues that are expected to be
    recognized in future years. The Company believes that contracts
    for prescription drugs may result in royalty revenues starting
    in 2006. Contracts for dietary supplements and OTC products are
    expected to result in royalty revenues starting in 2003.

12



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Manufacturing Revenues

The Companys manufacturing revenues
decreased 18% or $1,431,249 to $6,459,251 for the year ended
December 31, 2002 from revenues of $7,890,500 for the year
ended December 31, 2001. The decrease in revenues during
2002 is primarily attributable to the discontinuation of certain
products or sales to specific customers as described below.
Sales of products which the Company continues to manufacture
increased during 2002.

Dietary supplement manufacturing revenues
decreased 34% or $1,670,481 to $3,305,976 for the year ended
December 31, 2002 from revenues of $4,976,457 for the year
ended December 31, 2001. Approximately $586,362 of this
decrease is attributable to the discontinuation of sales of
Calcium D glucarate in accordance with an agreement with
the licensor effective September 19. 2001. In addition,
during 2002 the Company did not sell any products to Odwalla,
Inc. which was acquired in November 2001 by Coca Cola. Sales to
Odwalla, Inc. for the year ended December 31, 2001 were
$694,053.

As a result of regulatory issues, including
regulatory review by the FDA and the unavailability of insurance
on products containing ephedra, the Company discontinued all
products containing ephedra. Sales for ephedra based products
for the year ended December 31, 2002 were $353,307 as
compared to $1,205,811 for the year ended December 31,
2001. There will be no future sales of ephedra based products.

Fermentation revenues increased 8% or $239,232 to
$3,153,275 for the year ended December 31, 2002 from
revenues of $2,914,043 for the year ended December 31,
2001. Sales to new customers and increased sales to existing
customers account for the increase in fermentation sales and
compensated for the loss of revenues associated with a decrease
of revenues from Microcell products and COBACTIN® pursuant
to an agreement with MicroCell dated December 4, 2001.
There will be no future revenues from Microcell or royalties
from COBACTIN®. See Note O of Notes to
Financial Statement. Revenues of Microcell products to
Biotal decreased 70% or $228,068 to $95,603 for the year ended
December 31, 2002 from revenues of $323,671 for the year
ended December 31, 2001. COBACTIN® Royalties decreased
100% to $0 for the year ended December 31, 2002 from
$252,125 for the year ended December 31, 2001.

Licensing Fees, Research & Development
Contracts and Royalties

Licensing fees and Research & Development
contract revenues for the year ended December 31, 2002 were
$54,000 as compared to $300,000 for the year ended
December 31, 2001. Management anticipates future growth in
revenues derived from drug delivery technology licensing fees
and research & development contracts. The licensing
agreements and Research & Development contracts include
royalty revenues that will be recognized in future years. The
supply of CDT® products to Wal-Mart and Trader Joes
and the sub-licensing agreement with ADM for dietary supplements
and OTC products based on the Companys CDT®
technology are expected to result in royalty revenues beginning
in the second half of 2003. Licensing agreements and contracts
for prescription drugs may result in research &
development milestone payments after 2003 and royalty revenues
after 2005.

Gross Profit

Gross profit decreased 17% or $276,153 to
$1,377,634 for the year ended December 31, 2002 compared to
$1,653,787 for the year ended December 31, 2001. The
decrease in gross profit for the year ended December 31,
2002 compared to the year ended December 31, 2001 is
primarily due to the decrease in revenues.

Selling and Marketing Expenses

Selling and marketing expenses decreased 37% or
$217,101 to $372,722 for the year ended December 31, 2002
from $589,823 for the year ended December 31, 2001.
Additional personnel may be needed in the future as the Company
increases its selling efforts in support of the ADM global
strategic alliance, the commercialization of new formulations
employing CDT® technology under the manufacturing &
distribution arrangement with Numico North America, as well as
the new probiotic delivery system, SCBioRxTM.

13



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Research & Development
Expenses

Research & Development expenses
increased 29% or $120,284 to $540,826 for the year ended
December 31, 2002 from $420,542 for the year ended
December 31, 2001. The increase for the year ended
December 31, 2002 is attributable to the Companys
successful first human clinical trial conducted as an in
vitro/in vivo proof of concept study to support its patented
CDT® drug delivery systems.

General and Administrative Expenses

General and administrative expenses increased 34%
or $621,134 to $2,470,292 for the year ended December 31,
2002 compared to $1,849,158 for the year ended December 31,
2001. The increase is mainly the result of additional
shareholder relations expense (including costs associated with
the issuance of warrants) and increased legal expenses. The
Company anticipates that legal and accounting costs associated
with compliance with Sarbanes-Oxley will increase in future
years.

Operating Profit/ Loss

Operating loss for the year ended
December 31, 2002 was $2,006,206 as compared to an
operating loss of $1,205,736 for the year ended
December 31, 2001. The increased losses for the year ended
December 31, 2002 is primarily the result of decreased
revenues resulting from the discontinuation of ephedra based
products, the MICROCELL/ COBACTIN® agreement, Calcium
D-GLUCARATETM agreement and loss of sales to Odwalla,
Inc. as described above.

Interest Expense

Interest expense increased 1% or $4,439 to
$328,923 for the year ended December 31, 2002 compared to
$324,484 for the year ended December 31, 2001.

Other Income/ Expense

Other expense was $222,199 for the year ended
December 31, 2002 compared to other income of $957,178 for
the year ended December 31, 2001. During the quarter ended
March 31, 2001, the Company entered into a separation
agreement with its former Chief Scientific Officer and its Vice
President of Administration, Secretary and Treasurer. In
conjunction with the agreements, the Company recorded severance
costs of approximately $159,152, which is reflected in Other
Expense for the year ended December 31, 2002. See
Note M of Notes to Financial Statements.During the
quarter ended September 30, 2001, the Company entered into
an agreement with the licensor of patented calcium
D-GLUCARATETM that resulted in other income of
$480,614. See Note N of Notes to Financial Statements.During the year ended December 31, 2001, The Company
entered an agreement with Biotal to terminate the manufacturing
contract for Micro-Cell Microbial Feed Additive resulting in the
recognition of other income of $750,000. See Note O of
Notes to Financial Statements.

Net Earnings

The net loss for the year ended December 31,
2002 was $2,557,328 compared to a net loss of $573,042 for the
year ended December 31, 2001.

Liquidity and Capital Resources

As of December 31, 2002 the Company had
negative working capital of $41,868 as compared to a negative
working capital of $559,003 at December 31, 2001. The
Company finances its operations and capital requirements
primarily through borrowing, sales of the Companys
securities and cash provided by operations. The decrease in
negative working capital at December 31, 2002 is primarily
the result of financing activities and is offset by the net loss
for the year ended December 31, 2002. As described below,
the Company has an immediate need for additional financing.

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The Company has a $1,100,000 line of credit with
a finance company that is secured by its assets. At
December 31, 2002, the Company had borrowed $296,387 on its
line of credit. The Companys ability to borrow against
this line is limited by the Companys current accounts
receivable balance and restrictions imposed by the lender.

On September 30, 2002, the Company obtained
a $1 million loan from an existing shareholder. The loan is
secured by a second lien on the Companys assets and bears
interest at a rate of 8% per annum. The loan is due on
September 30, 2004 but is subject to mandatory prepayment
upon completion of the sale of substantially all the assets of
the Companys Probiotic business. In conjunction with the
loan, the Company granted the lender warrants to purchase
750,000 shares of common stock for $0.50 per share exercisable
over a ten year period. The loan was discounted for the relative
fair value of the warrants totaling approximately $331,000 which
is being recognized as interest expense over the loan term. The
Company also obtained working capital through the sale of
2,583,330 shares of Common Stock for $1,445,000 during the
year ended December 31, 2002.

The Company requires substantial additional
funding to support its current operations as well as development
of its Drug Delivery business. The Company is exploring sale and
joint venture opportunities involving its Probiotic business to
obtain funds to allow the Company to focus on developing and
expanding its Drug Delivery business.

The Company is currently seeking additional debt
and/or equity financing. Such financing may involve the issuance
of securities with preferential rights to Company revenues and
assets or debt securities collateralized by the Companys
assets. Also, the Company may sell additional shares of its
stock which would have a dilutive impact on the Companys
existing shareholders. The inability to raise additional capital
would require us to delay, reduce or eliminate some of our
business operations, including the pursuit of licensing,
strategic alliances and development of our Drug Delivery
business. Such delays will adversely affect our ability to take
advantage of opportunities in the Drug Delivery business, our
future prospects and results of operations.

Recently Issued Accounting Standards

The FASB issued SFAS No. 145,
Rescission of FASB Statements No. 4, 44, and 64,
Amendment of FASB Statement No. 13, and Technical
Corrections, on April 30, 2002. Statement
No. 145 rescinds Statement No. 4, which required all
gains and losses from extinguishments of debt to be aggregated
and, if material, classified as an extraordinary item, net of
related income tax effect. Upon adoption of Statement
No. 145, companies will be required to apply the criteria
in APB Opinion No. 30, Reporting the Results of
Operations  reporting the Effects of Disposal of a
Segment of a Business, and Extraordinary, Unusual and
Infrequently Occurring Events and Transactions in
determining the classification of gains and losses resulting
from the extinguishments of debt. Statement No. 145 is
effective for fiscal years beginning after May 15, 2002.
The initial application of SFAS 145 did not have a material
effect on the Companys financial statements.

In June 2002, the FASB issued SFAS No. 146,
Accounting for Costs Associated with Exit or Disposal
Activities. This standard requires companies to recognize
costs associated with exit or disposal activities when they are
incurred rather than at the date of a commitment to an exit or
disposal plan. Examples of costs covered by the standard include
lease termination costs and certain employee severance costs
that are associated with a restructuring, discontinued
operation, plant closing, or other exit or disposal activity.
SFAS No. 146 is to be applied prospectively to exit or
disposal activities initiated after December 31, 2002. The
initial application of SFAS 146 did not have a material
effect on the Companys financial statements.

In December 2002, the FASB issued SFAS
No. 148, Accounting for Stock-Based
Compensation  Transition and Disclosure. This
standard amends FASB Statement No. 123, Accounting for
Stock-Based Compensation, to provide alternative methods of
transition for a voluntary change to the fair value based method
of accounting for stock-based employee compensation. In
addition, this Statement amends the disclosures in both annual
and interim financial statements about the method of accounting
for stock-based employee compensation and the effect of the
method used on reported results. The amendments to
Statement 123 of this Statement shall be effective for
financial statements for fiscal years ending after

15



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December 15, 2002. The initial application
of SFAS 148 is not expected to have a material effect on
the Companys financial statements.


In November 2002, the Emerging Issues Task Force
reached a consensus opinion on EITF 00-21, Revenue
Arrangements with Multiple Deliverables. The consensus
provides that revenue arrangements with multiple deliverables
should be divided into separate units of accounting if certain
criteria are met. The consideration for the arrangement should
be allocated to the separate units of accounting based on their
relative fair values, with different provisions if the fair
value of all deliverables are not known or if the fair value is
contingent on delivery of specified items or performance
conditions. Applicable revenue recognition criteria should be
considered separately for each separate unit of accounting.
EITF 00-21 is effective for revenue arrangements entered
into in fiscal periods beginning after June 15, 2003.
Entities may elect to report the change as a cumulative effect
adjustment in accordance with APB Opinion 20, Accounting
Changes. The initial application of EITF 00-21 is not
expected to have a material effect on the Companys
financial statements.

Significant Obligations and
Commitments

|                        |       |           |           |             |  |             |         |           |  |   |           |           | 
|----------------------- | ----- | --------- | --------- | ----------- |  | ----------- | ------- | --------- |  | - | --------- | --------- | 
|                        |       | Amount    |           |             |  |            
|Contractual obligations |       | Committed |           | Fiscal 2003 |  | Fiscal 2004
|                        |       |           |           |             |  |            
|Long term debt          |       | $         | 1,225,520 |             |  | $           | 168,870 |           |  | $ | 1,056,650 |          
|Line of credit          |       | $         | 296,387   |             |  | $           | 296,387 |           |  |   |          |          
|Leases                  |       | $         | 1,825,249 |             |  | $           | 805,861 |           |  | $ | 543,281   |          
|                        | Total |           | $         | 3,347,156   |  |             | $       | 1,271,118 |  |   | $         | 1,599,931 | 

Outlook  Issues and
Uncertainties

Potential
Sales and Earning Volatility

The Companys sales and earnings continue to
be subject to potential volatility based upon, among other
things: (i) the adverse effect of distributors or the
Companys failure, and allegations of their failure, to
comply with applicable regulations, which have in the past and
could again in the future result in the removal of certain
products from sale in certain countries, either temporarily or
permanently; (ii) the negative impact of changes in or
interpretations of regulations that may limit or restrict the
sale of certain of the Companys products, the expansion of
its operations into new markets and the introduction of its
products into each such market; (iii) acquisition,
consolidation or sale of key customers; (iv) the inability
of the Company to introduce new products or the introduction of
more products by the Companys competitors;
(v) general conditions in the nutritional supplement
industry; (vi) consumer perceptions of the Companys
products and operations and (vii) the general condition and
viability of key customers businesses which may be
unrelated to any relationship between the Company and the key
customer. In particular, because consumers ingest the
Companys products, the Company is highly dependent upon
consumers perception of the safety and quality of its
products. As a result, substantial negative publicity concerning
one or more of the Companys products or other nutritional
supplements similar to the Companys products could
adversely affect the Companys results of operations or
financial condition.

Dependence on
Customers

In 2002, the Company received approximately 60%
of its total revenues from four customers: Rexall Sundown (23%),
Supplement Sciences (20%), NBTY (10%) and Trader Joes
(8%). The loss of any of these customers could have a materially
adverse effect on the Company.

Dependence on
Key Personnel

The Company believes that its success depends to
a significant extent on the existing management, the President
and CEO, David Howard, the Vice President of Operations, Steve
Moger, and the Director of Product Development, Steve Turner.
The future success of the Company will depend, as well, upon its
ability

16



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##### Table of Contents



to retain and attract key personnel in the
future; both, in the dietary supplement and nutraceutical unit
and the drug delivery technology unit.


Absence of
Clinical Studies

Although many of the ingredients of the
Companys products are vitamins, minerals, herbs, and other
substances for which there is a long history of human
consumption, some of the Companys products contain
innovative ingredients. While the Company believes all of its
products to be safe when taken as directed, there is little
long-term experience with human consumption of certain of these
innovative product ingredients in a concentrated form.
Accordingly, no assurance can be given that the Companys
products, even when used as directed, will have the effects
intended. Although the Company tests the formulation and
production of its products to ensure that they are safe when
consumed, as directed, the Company has not sponsored clinical
trials on the long-term effect of human consumption.

With respect to the registration, approval, and
commercialization of the CDT® drug delivery technology, the
Company realizes that all analytic work completed to-date has
involved in-vitro scientific studies and one Proof of Concept
human clinical trial. Additional human clinical bioavailability
and bio-equivalence trials must be conducted in order to fully
validate the asset value and commercial advantages associated
with U.S. Patents 6,337,091, 6,090,411 and 6,517,868. Until such
clinical trials are performed, there can be no assurances that
the patented CDT® technologies possess the necessary
correlation between the available in-vitro analytic work and
their performance in human subjects to become commercially
viable technologies and products attractive to major
pharmaceutical and OTC companies.

Regulatory
Risks

In the future, the Company may be subject to
additional laws or regulations administered by the FDA or other
federal, state or foreign regulatory authorities, the repeal of
laws or regulations which the Company considers favorable, such
as the DSHEA, or more stringent interpretations of current laws
or regulations. The Company is unable to predict the nature of
such future laws, regulations or interpretations, nor can it
predict what effect additional governmental regulations or
administrative orders, when and if promulgated, would have on
its business. They could, however, require the reformulation of
certain products to meet new standards, the recall or
discontinuance of certain products not able to be reformulated,
imposition of additional record keeping requirements, and
expanded documentation of the properties of certain products, or
expanded or different labeling, or scientific substantiation.
Any or all of such requirements could have a material adverse
effect on the Companys results of operations and financial
condition.

Potential
Effect of Unfavorable Publicity

The Company believes that the nutritional
supplement, OTC, and pharmaceutical markets are affected by
national media attention regarding the consumption of dietary
supplements, OTC products and prescription drugs. There can be
no assurance that future scientific research or publicity will
be favorable to these industries or any particular product, or
consistent with earlier research or publicity. Future reports of
research that are perceived less favorable or that question such
earlier research could have a material adverse effect on the
Company. Because of the Companys dependence upon consumer
perceptions, adverse publicity associated with illness or other
adverse effects resulting from the consumption of the
Companys products or any similar products distributed by
other companies could have a material adverse impact on the
Company. Such adverse publicity could arise even if the adverse
effects associated with such products resulted from failure to
consume such products as directed. In addition, the Company may
not be able to counter the effects of negative publicity
concerning the efficacy of its products.

Dependence on
New Products

The Company believes its ability to grow in its
existing markets is partially dependent upon its ability to
introduce new and innovative products into such markets.
Although the Company seeks to introduce additional products each
year in its existing markets, the success of new products is
subject to a number of

17



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##### Table of Contents



conditions, including developing products that
will appeal to customers and comply with existing regulations at
the time of introduction. There can be no assurance that the
Companys efforts to develop innovative new products will
be successful, that customers will accept new products, or that
the Company will obtain regulatory approvals of such new
products, if required. In addition, no assurance can be given
that new products currently experiencing strong popularity and
rapid growth will maintain their sales over time.


Dependence on
Suppliers

There can be no assurance that suppliers will
provide the raw materials needed by the Company in the
quantities requested or at a price the Company is willing to
pay. Because the Company does not control the actual production
of these raw materials, it is also subject to delays caused by
interruption in production of materials based on conditions not
wholly within its control. The inability of the Company to
obtain adequate supplies of raw materials for its products at
favorable prices, or at all, as a result of any of the foregoing
factors or otherwise, could have a material adverse effect on
the Company.

Dependence on
Licensees

The Company believes its ability to grow in its
existing markets is in part dependent on the success of the
companies which sub-license the Companys technology. The
Company has no direct or indirect control over the conduct of
the licensees business or their operations. There is no
assurance that adverse events in the licensees businesses
would not negatively affect the Company.

Dependence on
Intellectual Property

The Companys success will depend; in part,
on its ability to obtain patents, maintain trade secret
protection and operate without infringing the proprietary rights
of others or having others infringe our rights. The Company has
filed and is actively pursuing patent applications in the US and
other jurisdictions. The patent positions of pharmaceutical,
nutraceutical, and bio-pharmaceutical firms, including the
Companys, is uncertain and involves complex legal and
factual questions for which important legal issues are largely
unresolved. In addition, the coverage claimed in a patent
application can be significantly reduced before a patent is
issued. There can be no assurance that any of our patent
applications will result in the issuance of patents, that the
Company will be able to develop additional proprietary products
and processes that are patentable, that patents issued to the
Company will provide adequate protection or any competitive
advantages, that such patents will not be successfully
challenged by third parties, that the patents of others will not
impede our or our collaborators ability to commercialize the
technology.

Part of the Companys intellectual property
is in the form of trade secrets and know-how and may not be
protected by patents. There can be no assurance that we will be
able to protect our trade secrets. To help protect the
Companys rights, we require employees, consultants,
advisors, and collaborators to enter into confidentiality
agreements. There can be no insurance that these agreements will
provide meaningful protection for our trade secrets, know-how,
or other proprietary information in the event of any
unauthorized use or disclosure.




Item 7.Financial
Statements

See Financial Statements and Notes to
Financial Statementsset forth on pages F-1
through F-16 of this Annual Report on Form 10-KSB.

18



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##### Table of Contents






Item 8.Changes
in and Disagreements with Accountants on Accounting and
Financial Disclosure

None.




PART III




Item 9.Directors,
Executive Officers, Promoters and Control Persons; Compliance
with Section 16(a) of the Exchange Act

The Company will file a definitive proxy
statement (Proxy Statement) relating to its 2003
Annual Meeting of Shareholders pursuant to and in accordance
with section 240.14a-101 within 120 days after the end
of the fiscal year covered by this form. The information
required by this item is incorporated by reference to the Proxy
Statement under the headings Directors and Executive
Officersand Section 16(a) Beneficial
Ownership Reporting Compliance.




Item 10.Executive
Compensation

The information required by this item is
incorporated by reference to the Proxy Statement under the
heading Executive Compensationand
Director Compensation.




Item 11.Security
Ownership of Certain Beneficial Owners and
Management

The information required by this item is
incorporated by reference to the Proxy Statement under the
heading Security Ownership of Certain Beneficial Owners
and Management and Related Stockholder Matters.




Item 12.Certain
Relationships and Related Transactions

The information required by this item is
incorporated by reference to the Proxy Statement under the
heading Certain Relationships and Related
Transactions.




Item 13.Exhibits
and Reports on Form 8-K

(a) Exhibits: The following exhibits are
filed as part of this report:

|        |       |             |  |                                                                                                                                                                           
|------- | ----- | ----------- |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|Exhibit |       |            
|Number  |       | Description
|        |       |            
|        | 3.1   |             |  | Certificate of Incorporation as amended on
    July 31, 2002(5)                                                                                                           
|        | 3.2   |             |  | Amended Bylaws(4)                                                                                                                                                         
|        | 10.1  |             |  | Central Soya Company Licensing Voting Agreement(1)                                                                                                                        
|        | 10.2  |             |  | Building Lease  8340 154th Avenue NE,
    Redmond, WA (Corporate headquarters/ manufacturing facility)(1)                                                                
|        | 10.3  |             |  | Building Lease  14810 NE 95th St.,
    Redmond, WA(1)                                                                                                                    
|        | 10.4  |             |  | Building Lease  1420 Overlook Drive,
    Lafayette, CO (Tableting, encapsulating, bottling plant)(1)                                                                     
|        | 10.5  |             |  | Building Lease  1420 Overlook Drive,
    Lafayette, CO (Remainder of building for additional tableting,
    encapsulating, bottling and warehouse)(1)                    
|        | 10.6  |             |  | Building Lease  1400 Overlook Drive,
    Lafayette, CO (Warehouse)(1)                                                                                                    
|        | 10.7  |             |  | Employment Agreement with William D.
    St. John(1)                                                                                                                      
|        | 10.8  |             |  | Stock Option Plan(1)                                                                                                                                                      
|        | 10.9  |             |  | Building Lease  1400 and 1420 Overlook
    Drive, Lafayette, CO (Tableting, encapsulation, bottling plant
    and warehouse) (Supersedes Exhibits 10.4, 10.5 and 10.6)(2)
|        | 10.11 |             |  | Rexall Showcase Agreement(2)                                                                                                                                              
|        | 10.12 |             |  | Building Lease  9625 153rd Avenue NE,
    Redmond, WA (Manufacturing Facility)(3)                                                                                        

19



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|        |       |             |  |                                                                                                                                                                       
|------- | ----- | ----------- |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------
|Exhibit |       |            
|Number  |       | Description
|        |       |            
|        | 10.13 |             |  | Promissory Note to Clyde Berg in the principal
    amount of $1 million together with related Security
    Agreement and Warrant Agreement dated September 30, 2002(6)
|        | 10.14 |             |  | Loan and Security Agreement between the Company
    and Access Business Finance LLC dated as of April 30,
    2002(6)                                                 
|        | 10.15 |             |  | Exclusive Patent License Agreement with
    Archer-Daniels-Midland Company                                                                                            
|        | 10.16 |             |  | Letter Agreement between the Company and Dunsford
    Hill Capital Partners                                                                                           
|        | 23.1  |             |  | Consent of Grant Thornton LLP, Independent
    Certified Public Accountants                                                                                           
|        | 24.1  |             |  | Power of Attorney of Herbert L. Lucas                                                                                                                                 
|        | 24.2  |             |  | Power of Attorney of Randall Caudill                                                                                                                                  
|        | 24.3  |             |  | Power of Attorney of Daniel B. Ward                                                                                                                                   
|        | 99.1  |             |  | Certification pursuant to 18 U.S.C.
    Section 1350, as adopted pursuant to Section 906 of
    the Sarbanes-Oxley Act of 2002                                        
|        | 99.2  |             |  | Certification pursuant to 18 U.S.C.
    Section 1350, as adopted pursuant to Section 906 of
    the Sarbanes-Oxley Act of 2002                                        



---



|    |                                                                                                                                                              
|--- | -------------------------------------------------------------------------------------------------------------------------------------------------------------
|(1) | Incorporated by reference to the Registration
    Statement on Form 10-SB (Reg. No. 000-24693) filed by
    the Company on July 27, 1998.                    
|   
|(2) | Incorporated by reference to Amendment No. 1
    to the Registration Statement on Form 10-SB (Reg.
    No. 000-24693) filed by the Company on March 25, 1999.
|   
|(3) | Incorporated by reference to Registrants
    Form 10-KSB for the fiscal year ended December 31,
    2000.                                                   
|   
|(4) | Incorporated by reference to Registrants
    Form 10-KSB for the fiscal year ended December 31, 2001                                                        
|   
|(5) | Incorporated by reference to Registrants
    Form 10-QSB for the quarterly period ending June 30,
    2002.                                                 
|   
|(6) | Incorporated by reference to Registrants
    Form 10-QSB for the quarterly period ending
    September 30, 2002                                             



| |     |                                                                                                                                                  
| | --- | -------------------------------------------------------------------------------------------------------------------------------------------------
| | (b) | Reports on Form 8-K: The Company filed
    Reports on Form 8-K dated October 1, 2002 and
    November 1, 2002 reporting information under Item 5.




Item 14.Controls
and Procedures

Within the 90 days prior to the date of this
report, the Company carried out an evaluation, under the
supervision and with the participation of the Companys
management, including the Companys Chief Executive Officer
and Chief Financial Officer, of the effectiveness of the design
and operation of the Companys disclosure controls and
procedures pursuant to Rule 13a-14 under the Securities
Exchange Act of 1934, as amended. Based upon that evaluation,
the Chief Executive Officer and Chief Financial Officer
concluded that the Companys disclosure controls and
procedures are effective in timely alerting them to material
information relating to the Company required to be included in
the Companys periodic SEC filings.

There have been no significant changes in the
Companys internal controls or in other factors which could
significantly affect internal controls subsequent to the date
the Company carried out its evaluation.

20



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SIGNATURES

In accordance with Section 13 or 15(d) of
the Exchange Act, the registrant caused this report to be signed
on its behalf by the undersigned, thereunto duly authorized.



| |            
| | -----------
| | SCOLR, INC.



| |     |                    
| | --- | -------------------
| | By: | /s/ DAVID T. HOWARD

| |                                   
| | ----------------------------------
| |                                   
| | David T. Howard                   
| | President, Chief Executive Officer

March 29, 2003

In accordance with the Exchange Act, this report
has been signed below by the following persons on behalf of the
registrant and in the capacities and on the dates indicated.

|     |  |                                       |  |                                                                                   |  |               
|---- |  | ------------------------------------- |  | --------------------------------------------------------------------------------- |  | --------------
|    
|By:  |  | /s/ DAVID T. HOWARDDavid T. Howard    |  | President, Chief Executive Officer (Principal
    Executive Officer) and Director |  | March 29, 2003
|    
|By:  |  | /s/ STEVEN H. MOGERSteven H. Moger    |  | Chief Financial Officer (Principal Financial and
    Accounting Officer)          |  | March 29, 2003
|    
|By:  |  | */s/ HERBERT L. LUCASHerbert L. Lucas |  | Director                                                                          |  | March 29, 2003
|    
|By:  |  | */s/ RANDALL CAUDILLRandall Caudill   |  | Director                                                                          |  | March 29, 2003
|    
|By:  |  | */s/ DANIEL B. WARDDaniel B. Ward     |  | Director                                                                          |  | March 29, 2003
|    
|*By: |  | /s/ DAVID T. HOWARD                   |  | Attorney-In-Fact                                                                  |  | March 29, 2003

21



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##### Table of Contents



CERTIFICATION

I, David T. Howard, President and Chief
Executive Officer, certify that:



| |                                                                                                                                                                                                                                                                                                                                                        
| | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | 1.     I have reviewed
    this annual report on Form 10-KSB of SCOLR, Inc.;                                                                                                                                                                                                                                                                           
|
| | 2.     Based on my
    knowledge, this annual report does not contain any untrue
    statement of a material fact or omit to state a material fact
    necessary to make the statements made, in light of the
    circumstances under which such statements were made, not
    misleading with respect to the period covered by this annual
    report;
|
| | 3.     Based on my
    knowledge, the financial statements, and other financial
    information included in this annual report, fairly present in
    all material respects the financial condition, results of
    operations and cash flows of the registrant as of, and for, the
    periods presented in this annual report;                       
|
| | 4.     The
    registrants other certifying officer and I are responsible
    for establishing and maintaining disclosure controls and
    procedures (as defined in Exchange Act Rules 13a-14 and
    15d-14) for the registrant and we have:                                                                                                        



| |                                                                                                                                                                                                                                                                                                                
| | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | a) Designed such disclosure controls and
    procedures to ensure that material information relating to the
    registrant, including its consolidated subsidiaries, is made
    known to us by others within those entities, particularly during
    the period in which this annual report is being prepared;
|
| | b) Evaluated the effectiveness of the
    registrants disclosure controls and procedures as of a
    date within 90 days prior to the filing date of this annual
    report (the Evaluation Date); and                                                                                                      
|
| | c) Presented in this annual report our
    conclusions about the effectiveness of the disclosure controls
    and procedures based on our evaluation as of the Evaluation Date;                                                                                                                                



| |                                                                                                                                                                                                                                                                     
| | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | 5.     The
    registrants other certifying officer and I have disclosed,
    based on our most recent evaluation, to the registrants
    auditors and the audit committee of registrants board of
    directors (or persons performing the equivalent function):



| |                                                                                                                                                                                                                                                                                                                      
| | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | a) All significant deficiencies in the design or
    operation of internal controls which could adversely affect the
    registrants ability to record, process, summarize and
    report financial data and have identified for the
    registrants auditors any material weaknesses in internal
    controls; and
|
| | b) Any fraud, whether or not material, that
    involves management or other employees who have a significant
    role in the registrants internal controls; and                                                                                                                                                    



| |                                                                                                                                                                                                                                                                                                                                                                                                                     
| | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | 6.     The
    registrants other certifying officer and I have indicated
    in this annual report whether or not there were significant
    changes in internal controls or in other factors that could
    significantly affect internal controls subsequent to the date of
    our most recent evaluation, including any corrective actions
    with regard to significant deficiencies and material weaknesses.



| |     |                                                                                       
| | --- | --------------------------------------------------------------------------------------
| | By: | /s/ DAVID T. HOWARD 
     ______________________________________ 
     David T. Howard

| |                                   
| | ----------------------------------
| | President, Chief Executive Officer
| | (Principal Executive Officer)     

March 28, 2003



---



##### Table of Contents



CERTIFICATION

I, Steven H. Moger, Chief Financial Officer,
certify that:



| |                                                                                                                                                                                                                                                                                                                                                        
| | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | 1.     I have reviewed
    this annual report on Form 10-KSB of SCOLR, Inc.;                                                                                                                                                                                                                                                                           
|
| | 2.     Based on my
    knowledge, this annual report does not contain any untrue
    statement of a material fact or omit to state a material fact
    necessary to make the statements made, in light of the
    circumstances under which such statements were made, not
    misleading with respect to the period covered by this annual
    report;
|
| | 3.     Based on my
    knowledge, the financial statements, and other financial
    information included in this annual report, fairly present in
    all material respects the financial condition, results of
    operations and cash flows of the registrant as of, and for, the
    periods presented in this annual report;                       
|
| | 4.     The
    registrants other certifying officer and I are responsible
    for establishing and maintaining disclosure controls and
    procedures (as defined in Exchange Act Rules 13a-14 and
    15d-14) for the registrant and we have:                                                                                                        



| |                                                                                                                                                                                                                                                                                                                
| | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | a) Designed such disclosure controls and
    procedures to ensure that material information relating to the
    registrant, including its consolidated subsidiaries, is made
    known to us by others within those entities, particularly during
    the period in which this annual report is being prepared;
|
| | b) Evaluated the effectiveness of the
    registrants disclosure controls and procedures as of a
    date within 90 days prior to the filing date of this annual
    report (the Evaluation Date); and                                                                                                      
|
| | c) Presented in this quarterly report our
    conclusions about the effectiveness of the disclosure controls
    and procedures based on our evaluation as of the Evaluation Date;                                                                                                                             



| |                                                                                                                                                                                                                                                                     
| | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | 5.     The
    registrants other certifying officer and I have disclosed,
    based on our most recent evaluation, to the registrants
    auditors and the audit committee of registrants board of
    directors (or persons performing the equivalent function):



| |                                                                                                                                                                                                                                                                                                                      
| | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | a) All significant deficiencies in the
    design or operation of internal controls which could adversely
    affect the registrants ability to record, process,
    summarize and report financial data and have identified for the
    registrants auditors any material weaknesses in internal
    controls; and
|
| | b) Any fraud, whether or not material, that
    involves management or other employees who have a significant
    role in the registrants internal controls; and                                                                                                                                                    



| |                                                                                                                                                                                                                                                                                                                                                                                                                     
| | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | 6.     The
    registrants other certifying officer and I have indicated
    in this annual report whether or not there were significant
    changes in internal controls or in other factors that could
    significantly affect internal controls subsequent to the date of
    our most recent evaluation, including any corrective actions
    with regard to significant deficiencies and material weaknesses.



| |     |                    
| | --- | -------------------
| | By: | /s/ STEVEN H. MOGER

| |                                   
| | ----------------------------------
| | Steven H. Moger                   
| | President, Chief Executive Officer
| | (Principal Executive Officer)     

March 28, 2003



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##### Table of Contents



CONTENTS

|                                                   |                                   |      |     |     | 
|-------------------------------------------------- | --------------------------------- | ---- | --- | --- | 
|                                                   |                                   | Page
|                                                   |                                   |     
|Report of Independent Certified Public Accountants |                                   |      | F-2 |    
|Financial Statements                               |                                   |      |     |    
|                                                   | Balance Sheets                    |      |     | F-3 | 
|                                                   | Statements of Operations          |      |     | F-4 | 
|                                                   | Statement of Stockholders Equity |      |     | F-5 | 
|                                                   | Statements of Cash Flows          |      |     | F-6 | 
|                                                   | Notes to Financial Statements     |      |     | F-7 | 

F-1



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##### Table of Contents



REPORT OF INDEPENDENT CERTIFIED PUBLIC
ACCOUNTANTS

Board of Directors and Stockholders

SCOLR, Inc.


We have audited the accompanying balance sheets
of SCOLR, Inc. (a Delaware Corporation) as of December 31,
2002 and 2001, and the related statements of operations,
stockholders equity and cash flows for the years then
ended. These financial statements are the responsibility of the
Companys management. Our responsibility is to express an
opinion on these financial statements based on our audits.

We conducted our audits in accordance with
auditing standards generally accepted in the United States of
America. Those standards require that we plan and perform the
audit to obtain reasonable assurance about whether the financial
statements are free of material misstatement. An audit includes
examining, on a test basis, evidence supporting the amounts and
disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant
estimates made by management, as well as evaluating the overall
financial statement presentation. We believe that our audits
provide a reasonable basis for our opinion.

In our opinion, the financial statements referred
to above, present fairly, in all material respects, the
financial position of SCOLR, Inc. as of December 31, 2002
and 2001, and the results of its operations and its cash flows
for the years then ended, in conformity with accounting
principles generally accepted in the United States of America.

The accompanying financial statements have been
prepared assuming that the Company will continue as a going
concern. As shown in the financial statements, the Company
incurred a loss of $2,557,328 during the year ended
December 31, 2002, and has an accumulated deficit of
$12,830,343. These factors, among others, as discussed in
note B to the financial statements, raise substantial doubt
about the Companys ability to continue as a going concern.
Managements plans in regard to these matters are also
described in note B. The financial statements do not
include any adjustments that might result from the outcome of
this uncertainty.

/s/ GRANT THORNTON,LLP

Seattle, Washington

February 14, 2003

F-2



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##### Table of Contents



SCOLR, INC.

BALANCE SHEETS

ASSETS

|                                                                |                                                                                               |                            |           |             |           |   |           |             |           | 
|--------------------------------------------------------------- | --------------------------------------------------------------------------------------------- | -------------------------- | --------- | ----------- | --------- | - | --------- | ----------- | --------- | 
|                                                                |                                                                                               |                           
|                                                                |                                                                                               | December 31,              
|                                                                |                                                                                               |                           
|                                                                |                                                                                               | 2002                       |           | 2001       
|                                                                |                                                                                               |                            |           |            
|CURRENT ASSETS                                                  |                                                                                               |                            |           |             |           |   |           |            
|                                                                | Cash                                                                                          |                            | $         | 257,382     |           |   | $         | 93,082      |          
|                                                                | Accounts receivable, less allowance for doubtful
    accounts of $12,524 and $0, respectively |                            |           | 486,417     |           |   |           | 974,840     |          
|                                                                | Current portion of notes receivable                                                           |                            |           | 166,154     |           |   |           | 184,490     |          
|                                                                | Inventories                                                                                   |                            |           | 493,541     |           |   |           | 745,098     |          
|                                                                | Prepaid expenses                                                                              |                            |           | 242,272     |           |   |           | 163,956     |          
|                                                                |                                                                                               |                            |           |             |           |   |           |            
|                                                                |                                                                                               | Total current assets       |           |             | 1,645,766 |   |           |             | 2,161,466 | 
|PROPERTY AND EQUIPMENT  net                                    |                                                                                               |                            | 1,494,315 |             |           |   | 1,706,977 |            
|OTHER ASSETS                                                    |                                                                                               |                            |           |             |           |   |           |            
|                                                                | Intangible assets  net                                                                       |                            |           | 818,371     |           |   |           | 853,681     |          
|                                                                | Noncurrent portion of notes receivable                                                        |                            |           | 55,385      |           |   |           | 221,539     |          
|                                                                |                                                                                               |                            |           |             |           |   |           |            
|                                                                |                                                                                               | $                          | 4,013,837 |             |           | $ | 4,943,663 |            
|                                                                |                                                                                               |                            |           |             |           |   |           |            
|LIABILITIES AND STOCKHOLDERS
    EQUITY                       
|CURRENT LIABILITIES                                             |                                                                                               |                            |           |             |           |   |           |            
|                                                                | Line of credit                                                                                |                            | $         | 296,387     |           |   | $         | 1,118,282   |          
|                                                                | Current maturities of long-term obligations                                                   |                            |           | 168,870     |           |   |           | 255,030     |          
|                                                                | Current maturities of capital lease obligations                                               |                            |           | 215,347     |           |   |           | 221,267     |          
|                                                                | Accounts payable  trade                                                                      |                            |           | 782,385     |           |   |           | 728,117     |          
|                                                                | Accrued liabilities                                                                           |                            |           | 124,645     |           |   |           | 147,773     |          
|                                                                | Deferred revenue                                                                              |                            |           | 100,000     |           |   |           | 250,000     |          
|                                                                |                                                                                               |                            |           |             |           |   |           |            
|                                                                |                                                                                               | Total current liabilities  |           |             | 1,687,634 |   |           |             | 2,720,469 | 
|LONG-TERM OBLIGATIONS, less current maturities                  |                                                                                               |                            | 56,650    |             |           |   | 209,363   |            
|CAPITAL LEASE OBLIGATIONS, less current maturities              |                                                                                               |                            | 327,273   |             |           |   | 433,636   |            
|SHAREHOLDER LOAN PAYABLE, less discount on debt
    of $289,627 |                                                                                               |                            | 710,373   |             |           |   |          |            
|COMMITMENTS AND CONTINGENCIES                                   |                                                                                               |                            |          |             |           |   |          |            
|STOCKHOLDERS EQUITY                                            |                                                                                               |                            |           |             |           |   |           |            
|                                                                | Preferred stock, authorized 5,000,000 shares,
    $.01 par value, none issued or outstanding  |                            |           |            |           |   |           |            |          
|                                                                | Common stock, authorized 30,000,000 shares,
    $.001 par value                               |                            |           | 21,199      |           |   |           | 18,008      |          
|                                                                | Additional contributed capital                                                                |                            |           | 14,041,051  |           |   |           | 11,871,184  |          
|                                                                | Accumulated other comprehensive income                                                        |                            |           |            |           |   |           | (35,982     | )        
|                                                                | Stock subscription                                                                            |                            |           |            |           |   |           | 120,000     |          
|                                                                | Subscription receivable                                                                       |                            |           |            |           |   |           | (120,000    | )        
|                                                                | Accumulated deficit                                                                           |                            |           | (12,830,343 | )         |   |           | (10,273,015 | )        
|                                                                |                                                                                               |                            |           |             |           |   |           |            
|                                                                |                                                                                               | Total stockholders equity |           |             | 1,231,907 |   |           |             | 1,580,195 | 
|                                                                |                                                                                               |                            |           |             |           |   |           |            
|                                                                |                                                                                               | $                          | 4,013,837 |             |           | $ | 4,943,663 |            
|                                                                |                                                                                               |                            |           |             |           |   |           |            

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

F-3



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##### Table of Contents



SCOLR, INC.

STATEMENTS OF OPERATIONS

|                       |                                 |                          |                                      |           |            |            |           |           |            |          |  
|---------------------- | ------------------------------- | ------------------------ | ------------------------------------ | --------- | ---------- | ---------- | --------- | --------- | ---------- | -------- | -
|                       |                                 |                         
|                       |                                 | Years Ended December 31,
|                       |                                 |                         
|                       |                                 | 2002                     |                                      | 2001     
|                       |                                 |                          |                                      |          
|Net revenues           |                                 | $                        | 6,514,243                            |           |            | $          | 8,190,500 |          
|Cost of revenues       |                                 |                          | 5,136,609                            |           |            |            | 6,536,713 |          
|                       |                                 |                          |                                      |           |            |            |           |          
|                       |                                 | Gross profit             |                                      |           | 1,377,634  |            |           |           | 1,653,787  |         
|Operating expenses     |                                 |                          |                                      |           |            |            |           |          
|                       | Marketing and selling           |                          |                                      | 372,722   |            |            |           | 589,823   |           
|                       | Research and development        |                          |                                      | 540,826   |            |            |           | 420,542   |           
|                       | General and administrative      |                          |                                      | 2,470,292 |            |            |           | 1,849,158 |           
|                       |                                 |                          |                                      |           |            |            |           |          
|                       |                                 |                          | 3,383,840                            |           |            |            | 2,859,523 |          
|                       |                                 |                          |                                      |           |            |            |           |          
|                       |                                 | Operating loss           |                                      |           | (2,006,206 | )          |           |           | (1,205,736 | )       
|Other income (expense) |                                 |                          |                                      |           |            |            |           |          
|                       | Interest expense                |                          |                                      | (328,923  | )          |            |           | (324,484  | )         
|                       | Severance costs                 |                          |                                      | (159,152  | )          |            |           | (306,436  | )         
|                       | D-GLUCARATETMagreement          |                          |                                      |          |            |            |           | 480,614   |           
|                       | Micro-Cell/ COBACTIN® agreement |                          |                                      |          |            |            |           | 750,000   |           
|                       | Other                           |                          |                                      | (63,047   | )          |            |           | 33,000    |           
|                       |                                 |                          |                                      |           |            |            |           |          
|                       |                                 |                          | (551,112                             | )         |            |            | 632,694   |          
|                       |                                 |                          |                                      |           |            |            |           |          
|                       |                                 |                          | NET LOSS                             |           | $          | (2,557,328 | )         |           | $          | (573,042 | )
|                       |                                 |                          |                                      |           |            |            |           |          
|                       |                                 |                          | Net loss per share                   |           | $          | (0.13      | )         |           | $          | (0.03    | )
|                       |                                 |                          |                                      |           |            |            |           |          
|                       |                                 |                          | Net loss per share assuming dilution |           | $          | (0.13      | )         |           | $          | (0.03    | )
|                       |                                 |                          |                                      |           |            |            |           |          

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

F-4



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##### Table of Contents



SCOLR, INC.

STATEMENT OF STOCKHOLDERS
EQUITY

Years Ended December 31, 2002 and
2001


|                                                                                               |  |              |            |             |  |                     |        |        |  |              |            |             |  |         |         |       |  |   |          |   |  |   |          |   |  |   |             |   |  |   |            |  
|---------------------------------------------------------------------------------------------- |  | ------------ | ---------- | ----------- |  | ------------------- | ------ | ------ |  | ------------ | ---------- | ----------- |  | ------- | ------- | ----- |  | - | -------- | - |  | - | -------- | - |  | - | ----------- | - |  | - | ---------- | -
|                                                                                               |  |              |            |             |  |                     |        |        |  |              |            |             |  |        
|                                                                                               |  | Common Stock |            | Additional  |  | Accumulated         |        |        |  |              |            |             |  |        
|                                                                                               |  |              |            | Contributed |  | Other Comprehensive |        | Stock  |  | Subscription |            | Accumulated |  |        
|                                                                                               |  | Shares       |            | Amount      |  | Capital             |        | Income |  | Subscription |            | Receivable  |  | Deficit |         | Total
|                                                                                               |  |              |            |             |  |                     |        |        |  |              |            |             |  |         |         |      
|Balance at January 1, 2001                                                                     |  |              | 17,803,289 |             |  | $                   | 17,803 |        |  | $            | 11,791,389 |             |  | $       | (32,285 | )     |  | $ |         |   |  | $ |         |   |  | $ | (9,699,973  | ) |  | $ | 2,076,934  |  
|Issuance of common stock for cash                                                              |  |              | 205,000    |             |  |                     | 205    |        |  |              | 79,795     |             |  |         |        |       |  |   |         |   |  |   |         |   |  |   |            |   |  |   | 80,000     |  
|Unrealized losses on available-for-sale security                                               |  |              |           |             |  |                     |       |        |  |              |           |             |  |         | (3,697  | )     |  |   |         |   |  |   |         |   |  |   |            |   |  |   | (3,697     | )
|Issuance of subscription agreement for note
    receivable                                     |  |              |           |             |  |                     |       |        |  |              |           |             |  |         |        |       |  |   | 120,000  |   |  |   | (120,000 | ) |  |   |            |   |  |   |           |  
|Net loss for the year                                                                          |  |              |           |             |  |                     |       |        |  |              |           |             |  |         |        |       |  |   |         |   |  |   |         |   |  |   | (573,042    | ) |  |   | (573,042   | )
|                                                                                               |  |              |            |             |  |                     |        |        |  |              |            |             |  |         |         |       |  |   |          |   |  |   |          |   |  |   |             |   |  |   |            |  
|Balance at December 31, 2001                                                                   |  |              | 18,008,289 |             |  |                     | 18,008 |        |  |              | 11,871,184 |             |  |         | (35,982 | )     |  |   | 120,000  |   |  |   | (120,000 | ) |  |   | (10,273,015 | ) |  |   | 1,580,195  |  
|Issuance of common stock for cash, net of fees of
    $4,963                                   |  |              | 2,890,658  |             |  |                     | 2,891  |        |  |              | 1,574,040  |             |  |         |        |       |  |   |         |   |  |   |         |   |  |   |            |   |  |   | 1,576,931  |  
|Impairment of available for sale security                                                      |  |              |           |             |  |                     |       |        |  |              |           |             |  |         | 35,982  |       |  |   |         |   |  |   |         |   |  |   |            |   |  |   | 35,982     |  
|Fair value of warrants issued with debt                                                        |  |              |           |             |  |                     |       |        |  |              | 331,002    |             |  |         |        |       |  |   |         |   |  |   |         |   |  |   |            |   |  |   | 331,002    |  
|Fair value of warrants issued for services                                                     |  |              |           |             |  |                     |       |        |  |              | 145,125    |             |  |         |        |       |  |   |         |   |  |   |         |   |  |   |            |   |  |   | 145,125    |  
|Issuance of common stock for stock subscription
    and note receivable exchanged for services |  |              | 300,000    |             |  |                     | 300    |        |  |              | 119,700    |             |  |         |        |       |  |   | (120,000 | ) |  |   | 120,000  |   |  |   |            |   |  |   | 120,000    |  
|Net loss for the year                                                                          |  |              |           |             |  |                     |       |        |  |              |           |             |  |         |        |       |  |   |         |   |  |   |         |   |  |   | (2,557,328  | ) |  |   | (2,557,328 | )
|                                                                                               |  |              |            |             |  |                     |        |        |  |              |            |             |  |         |         |       |  |   |          |   |  |   |          |   |  |   |             |   |  |   |            |  
|Balance at December 31, 2002                                                                   |  |              | 21,198,947 |             |  | $                   | 21,199 |        |  | $            | 14,041,051 |             |  | $       |        |       |  | $ |         |   |  | $ |         |   |  | $ | (12,830,343 | ) |  | $ | 1,231,907  |  
|                                                                                               |  |              |            |             |  |                     |        |        |  |              |            |             |  |         |         |       |  |   |          |   |  |   |          |   |  |   |             |   |  |   |            |  

The accompanying notes are an integral part of
this financial statement.

F-5



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##### Table of Contents



SCOLR, INC.

STATEMENTS OF CASH FLOWS

|                                            |                                                                                              |                                                |                                          |                                                         |         |          |           |          |         |          |          |  
|------------------------------------------- | -------------------------------------------------------------------------------------------- | ---------------------------------------------- | ---------------------------------------- | ------------------------------------------------------- | ------- | -------- | --------- | -------- | ------- | -------- | -------- | -
|                                            |                                                                                              |                                               
|                                            |                                                                                              | Years ended December 31,                      
|                                            |                                                                                              | 2002                                           |                                          | 2001                                                   
|                                            |                                                                                              |                                                |                                          |                                                        
|Increase (Decrease) in Cash                 |                                                                                              |                                                |                                          |                                                         |         |          |           |         
|Cash flows from operating activities:       |                                                                                              |                                                |                                          |                                                         |         |          |           |         
|                                            | Net loss                                                                                     |                                                | $                                        | (2,557,328                                              | )       |          | $         | (573,042 | )      
|                                            | Adjustments to reconcile net loss to net cash
    provided by (used in) operating activities |                                                |                                          |                                                         |         |          |           |          |        
|                                            |                                                                                              | Depreciation and amortization                  |                                          |                                                         | 489,300 |          |           |          | 461,505 |         
|                                            |                                                                                              | Amortization of discount on debt               |                                          |                                                         | 41,375  |          |           |          |        |         
|                                            |                                                                                              | Loss on sale of equipment                      |                                          |                                                         | 38,045  |          |           |          |        |         
|                                            |                                                                                              | Settlement of accounts payable                 |                                          |                                                         |        |          |           |          | (83,160 | )       
|                                            |                                                                                              | Warrants and common stock granted for services |                                          |                                                         | 265,125 |          |           |          |        |         
|                                            |                                                                                              | Impairment of available-for-sale security      |                                          |                                                         | 35,982  |          |           |          |        |         
|                                            |                                                                                              | Changes in assets and liabilities              |                                          |                                                         |         |          |           |          |         |         
|                                            |                                                                                              |                                                | Accounts receivable                      |                                                         |         | 488,423  |           |          |         | 489,552  |         
|                                            |                                                                                              |                                                | Notes receivable                         |                                                         |         | 184,490  |           |          |         | (394,470 | )       
|                                            |                                                                                              |                                                | Inventories                              |                                                         |         | 251,557  |           |          |         | 588,879  |         
|                                            |                                                                                              |                                                | Prepaid expenses                         |                                                         |         | (78,316  | )         |          |         | (60,293  | )       
|                                            |                                                                                              |                                                | Accounts payable                         |                                                         |         | 54,268   |           |          |         | (26,549  | )       
|                                            |                                                                                              |                                                | Accrued liabilities and deferred revenue |                                                         |         | (173,128 | )         |          |         | 282,596  |         
|                                            |                                                                                              |                                                |                                          |                                                         |         |          |           |         
|                                            |                                                                                              |                                                |                                          | Net cash provided by (used in) operating
    activities |         |          | (960,207  | )        |         |          | 685,018  |  
|                                            |                                                                                              |                                                |                                          |                                                         |         |          |           |         
|Cash flows from investing activities:       |                                                                                              |                                                |                                          |                                                         |         |          |           |         
|                                            | Proceeds from sale of equipment                                                              |                                                |                                          | 49,504                                                  |         |          |           |         |        
|                                            | Purchase of equipment and furniture                                                          |                                                |                                          | (44,170                                                 | )       |          |           | (45,249  | )      
|                                            | Patent and technology rights expenditures                                                    |                                                |                                          | (154,140                                                | )       |          |           | (212,753 | )      
|                                            |                                                                                              |                                                |                                          |                                                         |         |          |           |         
|                                            |                                                                                              |                                                |                                          | Net cash used in investing activities                   |         |          | (148,806  | )        |         |          | (258,002 | )
|                                            |                                                                                              |                                                |                                          |                                                         |         |          |           |         
|Cash flows from financing activities:       |                                                                                              |                                                |                                          |                                                         |         |          |           |         
|                                            | Payments on long-term obligations and capital
    lease obligations                          |                                                |                                          | (606,663                                                | )       |          |           | (549,587 | )      
|                                            | Proceeds from long-term obligations                                                          |                                                |                                          | 124,940                                                 |         |          |           | 103,630  |        
|                                            | Proceeds from shareholder loan payable                                                       |                                                |                                          | 1,000,000                                               |         |          |           |         |        
|                                            | Net payments on line of credit                                                               |                                                |                                          | (821,895                                                | )       |          |           | (66,218  | )      
|                                            | Net proceeds from issuance of common stock, net
    of costs                                 |                                                |                                          | 1,576,931                                               |         |          |           | 80,000   |        
|                                            |                                                                                              |                                                |                                          |                                                         |         |          |           |         
|                                            |                                                                                              |                                                |                                          | Net cash provided by (used in) financing
    activities |         |          | 1,273,313 |          |         |          | (432,175 | )
|                                            |                                                                                              |                                                |                                          |                                                         |         |          |           |         
|Net increase (decrease) in cash             |                                                                                              |                                                | 164,300                                  |                                                         |         |          | (5,159    | )       
|Cash at beginning of year                   |                                                                                              |                                                | 93,082                                   |                                                         |         |          | 98,241    |         
|                                            |                                                                                              |                                                |                                          |                                                         |         |          |           |         
|Cash at end of year                         |                                                                                              | $                                              | 257,382                                  |                                                         |         | $        | 93,082    |         
|                                            |                                                                                              |                                                |                                          |                                                         |         |          |           |         
|Cash paid during the year for:              |                                                                                              |                                                |                                          |                                                         |         |          |           |         
|                                            | Interest                                                                                     |                                                | $                                        | 287,548                                                 |         |          | $         | 324,484  |        
|                                            |                                                                                              |                                                |                                          |                                                         |         |          |           |         
|Noncash investing and financing activities: |                                                                                              |                                                |                                          |                                                         |         |          |           |         
|                                            | Additions to equipment under capital lease
    obligations                                   |                                                | $                                        | 130,567                                                 |         |          | $         | 77,539   |        
|                                            | Issuance of subscription agreement for note
    receivable                                   |                                                | $                                        |                                                        |         |          | $         | 120,000  |        
|                                            | Issuance of warrants in conjunction with debt                                                |                                                | $                                        | 331,002                                                 |         |          | $         |         |        
|                                            | Issuance of common stock for stock subscription                                              |                                                | $                                        | 120,000                                                 |         |          | $         |         |        

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

F-6



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##### Table of Contents



SCOLR, INC.

NOTES TO FINANCIAL STATEMENTS

December 31, 2002 and 2001

Note A  Summary of Significant
Accounting Policies

SCOLR, Inc. (the Company) is a biopharmaceutical
company that develops and manufactures pharmaceutical,
over-the-counter, and nutritional products. SCOLR is active in
two marketplaces: controlled delivery technologies and
nutraceuticals; including dietary supplements, probiotics, and
specialty food ingredients. The Company uses its patented
CDT® controlled delivery technologies to develop products
and license technology to pharmaceutical and nutritional product
companies. The Company also manufactures and packages
probiotics, develops proprietary nutritional product
formulations, and offers specialty nutraceutical ingredients,
including several that utilize CDT® technologies. The
Companys customers are located throughout the United
States.

A summary of the Companys significant
accounting policies consistently applied in the preparation of
the accompanying financial statements follows.



|   |                    
|-- | -------------------
|1. | Accounts Receivable

The majority of the Companys accounts
receivable are due from companies in the human and agricultural
nutraceutical industries. Credit is extended based on evaluation
of a customers financial condition and, generally,
collateral is not required. Accounts receivable are due within
30 days and are stated at amounts due from customers net of
an allowance for doubtful accounts if considered necessary.
Accounts outstanding longer than the contractual payment terms
are considered past due. The Company determines its allowance by
considering a number of factors, including the length of time
trade accounts receivable are past due, the Companys
previous loss history, the customers current ability to
pay its obligation to the Company, and the condition of the
general economy and the industry as a whole. The Company
writes-off accounts receivable when they become uncollectible,
and payments subsequently received on such receivables are
credited to the allowance for doubtful accounts.



|   |            
|-- | -----------
|2. | Inventories

Inventories are stated at the lower of cost or
market; cost is determined using the first-in, first-out method.
The Company has established an allowance for potentially
obsolete and slow moving items.



|   |                       
|-- | ----------------------
|3. | Property and Equipment

Property and equipment are stated at cost, less
accumulated depreciation and amortization. Depreciation and
amortization are provided for in amounts sufficient to relate
the cost of depreciable assets to operations over their
estimated service lives. Leasehold improvements are amortized
over the lives of the respective leases or the service lives of
the improvements, whichever is shorter. Leased property under
capital leases is amortized over the service lives of the assets
as the leases substantially transfer ownership and have bargain
purchase options. The straight-line method of depreciation is
followed for substantially all assets for financial reporting
purposes. The estimated useful lives in determining depreciation
and amortization are as follows:

|                                             |  |          
|-------------------------------------------- |  | ---------
|Furniture and fixtures                       |  | 3-5years 
|Machinery and equipment                      |  | 3-10years
|Leasehold improvements                       |  | 3 years  
|Machinery and equipment under capital leases |  | 3-10years

The Company uses accelerated depreciation methods
for tax purposes.

F-7



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##### Table of Contents



SCOLR, INC.


NOTES TO
FINANCIAL STATEMENTS  (Continued)



|   |                  
|-- | -----------------
|4. | Intangible Assets

Intangible assets include capitalized technical
and product rights, patents and trademarks. Technical and
product rights and patents and trademarks are stated at cost and
amortized to operations over their estimated useful lives or
statutory lives, whichever is shorter. The Company evaluates its
technical and product rights and patents and trademarks annually
to determine potential impairment by examining the carrying
amount of the assets to determine if the carrying amount is
recoverable, and by comparing the carrying amount to the assets
fair market value.



|   |                    
|-- | -------------------
|5. | Revenue Recognition

The Company generates revenue from technology
licenses, collaborative research and development arrangements,
and cost reimbursement contracts. Revenue under technology
licenses and collaborative agreements typically consists of
nonrefundable and/or guaranteed technology license fees,
technology access fees, and various milestone and future product
royalty payments. Revenues from license fees, option fees and
up-front payments, which are received in connection with other
rights or services that represent continuing obligations of the
Company, are recognized systematically over the period that the
fees or payments are earned. Revenues from milestone payments
representing completion of separate and substantive earnings
processes are recognized when the milestone is achieved and
amounts are due and payable. Revenues from royalties are
received from related and third parties for sales of products
that include technology developed or licensed by the Company.
Revenues are recognized when due and amounts are considered
collectible. Revenue from the sale of nutraceutical products is
recognized upon shipment to the customer.



|   |                                   
|-- | ----------------------------------
|6. | Research and Development
    Costs

All expenditures for research and development are
expensed in the year incurred.



|   |                                      
|-- | -------------------------------------
|7. | Other Comprehensive Income
    (Loss)

Other comprehensive income (loss) includes
unrealized losses on an equity security classified as
available-for-sale. Available for sale securities are reported
at fair value, based on quoted market prices, with the net
unrealized gains or losses reported as other comprehensive
income or loss in stockholders equity. During 2002, the
Company determined that a security classified as available for
sale suffered a decline in fair value, which is other than
temporary. The Company wrote the security down to its estimated
fair value and recognized a $35,982 loss. The loss is included
in other expense in the Statement of Operations for the year
ended December 31, 2002.



|   |                              
|-- | -----------------------------
|8. | Earnings (loss) per
    share

Basic earnings (loss) per share are based on
the weighted average number of shares outstanding during the
year and income available to common shareholders. Earnings
(loss) per share assuming dilution are based on the
assumption that outstanding stock options and warrants were
exercised. The weighted average shares for computing basic
earnings (loss) per share were 20,124,161 and 17,803,851
for the years ended December 31, 2002 and 2001,
respectively. At December 31, 2002, there were
3,257,105 shares of potentially issuable common stock.
Because of the net loss for the year ended December 31,
2002, potentially issuable common stock was not included in the
calculation of diluted loss per share as their inclusion would
be anti-dilutive.

F-8



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SCOLR, INC.


NOTES TO
FINANCIAL STATEMENTS  (Continued)

The following table illustrates the effect on net
loss and loss per share if the Company had applied the fair
value recognition provisions of SFAS 123 using the
assumptions described in Note R to its stock-based awards.

|                                                                                    |  |      |            |      |  |   |          |  
|----------------------------------------------------------------------------------- |  | ---- | ---------- | ---- |  | - | -------- | -
|                                                                                    |  | 2002 |            | 2001
|                                                                                    |  |      |            |     
|Net loss, as reported                                                               |  | $    | (2,557,328 | )    |  | $ | (573,042 | )
|Total stock-based compensation expense determined
    under fair-value-based method |  |      | (127,091   | )    |  | $ | (127,592 | )
|Pro forma net loss                                                                  |  | $    | (2,684,419 | )    |  | $ | (700,634 | )
|Net loss per share as reported                                                      |  | $    | (0.13      | )    |  | $ | (0.03    | )
|Pro forma net loss per share                                                        |  | $    | (0.13      | )    |  | $ | (0.04    | )



|   |                         
|-- | ------------------------
|9. | Stock-Based Compensation

The Company has a stock-based employee
compensation plan, which are described more fully in
note R. The Company applies APB Opinion 25,
Accounting for Stock Issued to Employees, and related
Interpretations in accounting for its plans. Because the
exercise price of the Companys common stock options equals
the market price of the underlying stock on the date of the
grant, no corresponding compensation expense has been recognized.



|    |                 
|--- | ----------------
|10. | Use of Estimates

In preparing the Companys financial
statements in conformity with accounting principles generally
accepted in the United States of America, management is required
to make estimates and assumptions that affect the reported
amounts of assets and liabilities, the disclosure of contingent
assets and liabilities at the date of the financial statements,
and the reported amounts of revenues and expenses during the
reporting period. Actual results could differ from those
estimates.



|    |                  
|--- | -----------------
|11. | Reclassifications

Certain reclassifications have been made to the
2001 financial statements to conform to the 2002 presentation.



|    |                              
|--- | -----------------------------
|12. | New Accounting Pronouncements

The FASB issued SFAS No. 145,
Rescission of FASB Statements No. 4, 44, and 64,
Amendment of FASB Statement No. 13, and Technical
Corrections, on April 30, 2002. Statement
No. 145 rescinds Statement No. 4, which required all
gains and losses from extinguishments of debt to be aggregated
and, if material, classified as an extraordinary item, net of
related income tax effect. Upon adoption of Statement
No. 145, companies will be required to apply the criteria
in APB Opinion No. 30, Reporting the Results of
Operations  reporting the Effects of Disposal of a
Segment of a Business, and Extraordinary, Unusual and
Infrequently Occurring Events and Transactions in
determining the classification of gains and losses resulting
from the extinguishments of debt. Statement No. 145 is
effective for fiscal years beginning after May 15, 2002.
The initial application of SFAS 145 did not have a material
effect on the Companys financial statements.

In June 2002, the FASB issued SFAS No. 146,
Accounting for Costs Associated with Exit or Disposal
Activities. This standard requires companies to recognize
costs associated with exit or disposal activities when they are
incurred rather than at the date of a commitment to an exit or
disposal plan. Examples of costs covered by the standard include
lease termination costs and certain employee severance costs
that are associated with a restructuring, discontinued
operation, plant closing, or other exit or disposal activity.
SFAS

F-9



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SCOLR, INC.


NOTES TO
FINANCIAL STATEMENTS  (Continued)

No. 146 is to be applied prospectively to
exit or disposal activities initiated after December 31,
2002. The initial application of SFAS 146 did not have a
material effect on the Companys financial statements.

In December 2002, the FASB issued SFAS
No. 148, Accounting for Stock-Based
Compensation  Transition and Disclosure. This
standard amends FASB Statement No. 123, Accounting for
Stock-Based Compensation, to provide alternative methods of
transition for a voluntary change to the fair value based method
of accounting for stock-based employee compensation. In
addition, this Statement amends the disclosures in both annual
and interim financial statements about the method of accounting
for stock-based employee compensation and the effect of the
method used on reported results. The amendments to
Statement 123 of this Statement shall be effective for
financial statements for fiscal years ending after
December 15, 2002. The initial application of SFAS 148
is not expected to have a material effect on the Companys
financial statements.

In November 2002, the Emerging Issues Task Force
reached a consensus opinion on EITF 00-21, Revenue
Arrangements with Multiple Deliverables. The consensus
provides that revenue arrangements with multiple deliverables
should be divided into separate units of accounting if certain
criteria are met. The consideration for the arrangement should
be allocated to the separate units of accounting based on their
relative fair values, with different provisions if the fair
value of all deliverables are not known or if the fair value is
contingent on delivery of specified items or performance
conditions. Applicable revenue recognition criteria should be
considered separately for each separate unit of accounting.
EITF 00-21 is effective for revenue arrangements entered
into in fiscal periods beginning after June 15, 2003.
Entities may elect to report the change as a cumulative effect
adjustment in accordance with APB Opinion 20, Accounting
Changes. The initial application of EITF 00-21 is not
expected to have a material effect on the Companys
financial statements.

Note B  Management
Plans

The Company has $257,382 of cash at
December 31, 2002, used cash from operations of $960,207,
and has a net loss of $2,557,328 for the year ended
December 31, 2002. The Companys current liabilities
exceed its current assets, resulting in a working capital
deficit of $41,868 as of December 31, 2002. The
accompanying financial statements have been prepared in
conformity with accounting principles generally accepted in the
United States of America, which contemplate the continuation of
the Company as a going concern. The financial statements do not
include any adjustments to reflect the possible effects on the
recoverability and classification of assets and liabilities that
may result from the outcome of this uncertainty.

During 2002, the Company raised approximately
$1,580,000 in a private placement of securities and received
$1,000,000 loan from a shareholder. The Company will need to
raise substantial additional capital to fund its operations and
may seek such additional funding through private equity or debt
financing. There can be no assurance that such funding will be
available on acceptable terms, if at all. The Companys
inability to raise capital in the near future would require the
Company to reduce or eliminate substantial parts of its
operations.

Note C  Accounts
Receivable

Accounts receivable consist of the following at
December 31:

|                                        |  |      |         |      |  |   |         | 
|--------------------------------------- |  | ---- | ------- | ---- |  | - | ------- | 
|                                        |  | 2002 |         | 2001
|                                        |  |      |         |     
|Trade receivables                       |  | $    | 498,941 |      |  | $ | 974,840 | 
|Less allowance for doubtful receivables |  |      | (12,524 | )    |  |   |        | 
|                                        |  |      |         |      |  |   |         | 
|Net receivables                         |  | $    | 486,417 |      |  | $ | 974,840 | 
|                                        |  |      |         |      |  |   |         | 

F-10



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##### Table of Contents



SCOLR, INC.


NOTES TO
FINANCIAL STATEMENTS  (Continued)

Changes in the Companys allowance for
doubtful accounts are as follows at December 31:

|                  |                      |      |        |        |   |   |       |          |  
|----------------- | -------------------- | ---- | ------ | ------ | - | - | ----- | -------- | -
|                  |                      | 2002 |        | 2001  
|                  |                      |      |        |       
|Beginning Balance |                      | $    |       |        |   | $ | 5,312 |         
|                  | Bad debt expense     |      |        | 18,051 |   |   |       | 103,027  |  
|                  | Accounts written-off |      |        | (5,527 | ) |   |       | (108,339 | )
|                  |                      |      |        |        |   |   |       |         
|Ending Balance    |                      | $    | 12,524 |        |   | $ |      |         
|                  |                      |      |        |        |   |   |       |         

Note D  Notes
Receivable

Notes receivable consist of the following at
December 31:

|                                                                                                    |  |      |         |      |  |   |         | 
|--------------------------------------------------------------------------------------------------- |  | ---- | ------- | ---- |  | - | ------- | 
|                                                                                                    |  | 2002 |         | 2001
|                                                                                                    |  |      |         |     
|Note receivable for D-GLUCARATETMagreement; with monthly payments of $13,846 through April
    2004 |  | $    | 221,539 |      |  | $ | 400,000 | 
|Other                                                                                               |  |      |        |      |  |   | 6,029   | 
|                                                                                                    |  |      |         |      |  |   |         | 
|                                                                                                    |  |      | 221,539 |      |  |   | 406,029 | 
|Less current portion                                                                                |  |      | 166,154 |      |  |   | 184,490 | 
|                                                                                                    |  |      |         |      |  |   |         | 
|                                                                                                    |  | $    | 55,385  |      |  | $ | 221,539 | 
|                                                                                                    |  |      |         |      |  |   |         | 

Aggregate maturities of notes receivable are as
follows:

|                         |       |   |         |         | 
|------------------------ | ----- | - | ------- | ------- | 
|Year Ending December 31, |       |  
|                         |       |  
|2003                     |       | $ | 166,154 |        
|2004                     |       |   | 55,385  |        
|                         |       |   |         |        
|                         | Total |   | $       | 221,539 | 
|                         |       |   |         |        

Note E  Inventories

Inventories consist of the following at
December 31:

|                                                  |  |      |         |      |  |   |           | 
|------------------------------------------------- |  | ---- | ------- | ---- |  | - | --------- | 
|                                                  |  | 2002 |         | 2001
|                                                  |  |      |         |     
|Raw materials                                     |  | $    | 270,165 |      |  | $ | 698,801   | 
|Work in progress                                  |  |      | 206,386 |      |  |   | 388,427   | 
|Finished goods                                    |  |      | 52,467  |      |  |   | 115,169   | 
|                                                  |  |      |         |      |  |   |           | 
|                                                  |  |      | 529,018 |      |  |   | 1,202,397 | 
|Less allowance for obsolete and slow moving items |  |      | 35,477  |      |  |   | 457,299   | 
|                                                  |  |      |         |      |  |   |           | 
|                                                  |  | $    | 493,541 |      |  | $ | 745,098   | 
|                                                  |  |      |         |      |  |   |           | 

F-11



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SCOLR, INC.


NOTES TO
FINANCIAL STATEMENTS  (Continued)

Note F  Property and
Equipment

Property and equipment consist of the following
at December 31:

|                                                                                  |  |      |           |      |  |   |           | 
|--------------------------------------------------------------------------------- |  | ---- | --------- | ---- |  | - | --------- | 
|                                                                                  |  | 2002 |           | 2001
|                                                                                  |  |      |           |     
|Furniture and fixtures                                                            |  | $    | 70,129    |      |  | $ | 62,843    | 
|Machinery and equipment                                                           |  |      | 2,104,984 |      |  |   | 1,890,873 | 
|Leasehold improvements                                                            |  |      | 71,962    |      |  |   | 71,961    | 
|Machinery and equipment under capital leases                                      |  |      | 966,278   |      |  |   | 1,347,877 | 
|                                                                                  |  |      |           |      |  |   |           | 
|                                                                                  |  |      | 3,213,353 |      |  |   | 3,373,554 | 
|Less accumulated depreciation and amortization                                    |  |      | 1,437,172 |      |  |   | 1,305,893 | 
|Less accumulated amortization of machinery and
    equipment under capital leases |  |      | 281,866   |      |  |   | 360,684   | 
|                                                                                  |  |      |           |      |  |   |           | 
|                                                                                  |  | $    | 1,494,315 |      |  | $ | 1,706,977 | 
|                                                                                  |  |      |           |      |  |   |           | 

Note G  Intangible Assets

Intangible assets consist of the following at
December 31:

|                              |  |      |           |      |  |   |           | 
|----------------------------- |  | ---- | --------- | ---- |  | - | --------- | 
|                              |  | 2002 |           | 2001
|                              |  |      |           |     
|Technical and product rights  |  | $    | 2,237,444 |      |  | $ | 2,237,444 | 
|Patents and trademarks        |  |      | 899,528   |      |  |   | 745,386   | 
|                              |  |      |           |      |  |   |           | 
|                              |  |      | 3,136,972 |      |  |   | 2,982,830 | 
|Less accumulated amortization |  |      | 2,318,600 |      |  |   | 2,129,149 | 
|                              |  |      |           |      |  |   |           | 
|                              |  | $    | 818,371   |      |  | $ | 853,681   | 
|                              |  |      |           |      |  |   |           | 

Note H  Line of Credit

In December 2001, the bank with which the Company
had a $1,600,000 line of credit agreement informed the Company
it would not renew the line of credit expiring in May 2002. As a
result, on April 30, 2002, the Company entered into a new
secured line of credit agreement for a term of one year with a
borrowing base equal to the lesser of 90% of eligible trade
receivables or $1,100,000, bearing interest at the rate of prime
plus 8% (12.25% at December 31, 2002). The line of credit
is collateralized by the Companys assets, including
accounts receivable, inventories and equipment and expires on
April 30, 2003. At December 31, 2002, the available
credit under the line of credit agreement was approximately
$96,000.

F-12



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##### Table of Contents



SCOLR, INC.


NOTES TO
FINANCIAL STATEMENTS  (Continued)

Note I  Long-Term
Obligations

Long-term obligations consist of the following at
December 31:

|                                                                                                                                                                     |  |      |         |      |  |   |         | 
|-------------------------------------------------------------------------------------------------------------------------------------------------------------------- |  | ---- | ------- | ---- |  | - | ------- | 
|                                                                                                                                                                     |  | 2002 |         | 2001
|                                                                                                                                                                     |  |      |         |     
|Notes payable for equipment; with monthly
    installments totaling $13,801, including 16.4% interest;
    collateralized by production equipment; due in 2003       |  | $    | 96,707  |      |  | $ | 232,988 | 
|Notes payable to third party for leasehold
    improvement advance, payable in 34 monthly installments of
    $3,695 including 15.5% interest, due in 2004           |  |      | 75,856  |      |  |   | 105,882 | 
|Note payable to a third party for payment of
    legal settlement; payable in 36 monthly installments of
    $5,000 beginning April 3, 2000; no stated interest rate |  |      | 10,000  |      |  |   | 70,000  | 
|Note payable to a third party; with monthly
    installments of $1,643, including interest at 12.7%;
    collateralized by equipment; due in 2004                    |  |      | 26,800  |      |  |   | 42,046  | 
|Other notes payable                                                                                                                                                  |  |      | 16,157  |      |  |   | 13,477  | 
|                                                                                                                                                                     |  |      |         |      |  |   |         | 
|                                                                                                                                                                     |  |      | 225,520 |      |  |   | 464,393 | 
|Less current maturities                                                                                                                                              |  |      | 168,870 |      |  |   | 255,030 | 
|                                                                                                                                                                     |  |      |         |      |  |   |         | 
|                                                                                                                                                                     |  | $    | 56,650  |      |  | $ | 209,363 | 
|                                                                                                                                                                     |  |      |         |      |  |   |         | 

Aggregate maturities of long-term obligations are
as follows:

|                         |  |   |         | 
|------------------------ |  | - | ------- | 
|Year Ending December 31, |  |  
|                         |  |  
|2003                     |  | $ | 168,870 | 
|2004                     |  |   | 56,650  | 
|                         |  |   |         | 
|                         |  | $ | 225,520 | 
|                         |  |   |         | 

Note J  Shareholder Loan Payable
and Warrant Issuance

On September 30, 2002, the Company received
a $1,000,000 secured loan from an existing shareholder. The loan
is due on September 30, 2004 and bears interest at a rate
of 8% which is due monthly beginning November 1, 2002. The
loan is secured by substantially all of the assets of the
Company. In conjunction with the loan, the Company granted
warrants to purchase 750,000 shares of common stock at $0.50 per
share exercisable for ten years. The loan was discounted for the
relative fair value of the warrants totaling approximately
$331,000, which is being recognized as interest expense over the
loan term. The fair value of warrants was determined using the
Black-Scholes option-pricing model with the following
assumptions: volatility of 79%, risk-free interest rate of 3%,
expected life of ten years and 0% dividend yield. At
December 31, 2002, the balance of the loan was $710,373,
net of a discount of $289,627. Interest expense recognized from
the amortization of the discount during the year ended
December 31, 2002 is $41,375.

Note K  Lease Obligations

The Company conducts a substantial portion of its
operations utilizing leased manufacturing and office facilities,
expiring through 2006. Some of the operating leases provide that
the Company pay taxes, maintenance, insurance and other
occupancy expense applicable to leased premises. The Company
also leases machinery and equipment under capital leases
expiring through 2006.

F-13



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##### Table of Contents



SCOLR, INC.


NOTES TO
FINANCIAL STATEMENTS  (Continued)

The following is a schedule by years of future
minimum lease payments together with the present value of the
minimum payments under capital and operating leases as of
December 31, 2002:

|                                        |  |         |         |           |  |   |           | 
|--------------------------------------- |  | ------- | ------- | --------- |  | - | --------- | 
|                                        |  | Capital |         | Operating
|Year Ending December 31,                |  | Leases  |         | Leases   
|                                        |  |         |         |          
|2003                                    |  | $       | 282,963 |           |  | $ | 522,898   | 
|2004                                    |  |         | 245,753 |           |  |   | 297,528   | 
|2005                                    |  |         | 121,758 |           |  |   | 216,153   | 
|2006                                    |  |         | 9,254   |           |  |   | 128,942   | 
|                                        |  |         |         |           |  |   |           | 
|Future minimum lease payments           |  |         | 659,728 |           |  | $ | 1,165,521 | 
|                                        |  |         |         |           |  |   |           | 
|Less amount representing interest       |  |         | 117,108 |           |  |   |           | 
|                                        |  |         |         |           |  |   |           | 
|Present value of minimum lease payments |  | $       | 542,620 |           |  |   |           | 
|                                        |  |         |         |           |  |   |           | 
|Current maturities                      |  | $       | 215,347 |           |  |   |           | 
|Long-term maturities                    |  |         | 327,273 |           |  |   |           | 
|                                        |  |         |         |           |  |   |           | 
|                                        |  | $       | 542,620 |           |  |   |           | 
|                                        |  |         |         |           |  |   |           | 

Rent expense for leased facilities and equipment
was $708,284 and $734,474 for the years ended December 31,
2002 and 2001, respectively.

Note L  Income Taxes

The Company accounts for income taxes using the
liability method as prescribed by Statement of Financial
Accounting Standards No. 109, Accounting for Income
Taxes.

The income tax provision reconciled to the tax
computed at the statutory federal rate was approximately as
follows at December 31:

|                                               |  |      |          |      |  |   |          |  
|---------------------------------------------- |  | ---- | -------- | ---- |  | - | -------- | -
|                                               |  | 2002 |          | 2001
|                                               |  |      |          |     
|Tax benefit at statutory rate                  |  | $    | (869,500 | )    |  | $ | (194,800 | )
|Permanent differences                          |  |      | 2,400    |      |  |   | 5,300    |  
|Expiration of net operating losses and credits |  |      | 400,500  |      |  |   | 520,400  |  
|Increase (decrease) in valuation allowance     |  |      | 466,600  |      |  |   | (330,900 | )
|                                               |  |      |          |      |  |   |          |  
|                                               |  | $    |         |      |  | $ |         |  
|                                               |  |      |          |      |  |   |          |  

F-14



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##### Table of Contents



SCOLR, INC.


NOTES TO
FINANCIAL STATEMENTS  (Continued)

Deferred tax assets and liabilities consist of
the approximately following at December 31:

|                       |                                            |      |   |            |   |   |   |            |  
|---------------------- | ------------------------------------------ | ---- | - | ---------- | - | - | - | ---------- | -
|                       |                                            | 2002 |   | 2001      
|                       |                                            |      |   |           
|Current asset, net     |                                            |      |   |            |   |   |   |           
|                       | Inventory and accounts receivable reserves |      | $ | 16,300     |   |   | $ | 155,500    |  
|                       | Other accrued liabilities                  |      |   | 29,100     |   |   |   | 51,900     |  
|                       | Other                                      |      |   | 12,200     |   |   |   |           |  
|                       | Warrants issued for services and interest  |      |   | 63,400     |   |   |   |           |  
|                       | Less valuation allowance                   |      |   | (121,000   | ) |   |   | (207,400   | )
|                       |                                            |      |   |            |   |   |   |           
|                       |                                            | $    |  |            |   | $ |  |           
|                       |                                            |      |   |            |   |   |   |           
|Non-current asset, net |                                            |      |   |            |   |   |   |           
|                       | Net operating loss carry forwards          |      | $ | 2,060,400  |   |   | $ | 1,503,600  |  
|                       | Depreciation and amortization              |      |   | (144,600   | ) |   |   | (174,900   | )
|                       | Other tax credits                          |      |   | 2,600      |   |   |   | 36,700     |  
|                       | Less valuation allowance                   |      |   | (1,918,400 | ) |   |   | (1,365,400 | )
|                       |                                            |      |   |            |   |   |   |           
|                       |                                            | $    |  |            |   | $ |  |           
|                       |                                            |      |   |            |   |   |   |           

The Company has established a valuation allowance
of $2,039,400 and $1,572,800 as of December 31, 2002 and
2001, respectively, due to the uncertainty of future utilization
of net operating loss carryforwards and realization of other
deferred tax assets.

At December 31, 2002, an operating loss
carryforward of approximately $6,060,000 expiring through 2022
is available to offset future taxable income. Net operating loss
carryforwards of approximately $1,077,000 and $1,371,700 expired
during 2002 and 2001, respectively. Investment tax credits and
research and experimentation tax credits totaling $2,500
expiring through 2003 are also available. Tax credits of
approximately $34,200 and $54,100 expired during 2002 and 2001,
respectively. If ownership changes should occur, there may be
certain limitations on the use of these carryforwards, as
defined by Internal Revenue Code Section 382.

Note M  Separation
Agreement

The Company entered into a separation agreement
with its former Chief Scientific Officer and a separation
agreement with its former Vice President of Administration,
Secretary and Treasurer, both of which became fully binding on
the parties on March 31, 2001 and effective as of
January 15, 2001. At December 31, 2002 and 2001, the
Company recorded severance costs totaling $159,152 and $306,436,
respectively.

Under this agreement the Company is to pay the
former Chief Scientific Officer $12,500 a month through
January 15, 2004. If this individual earns an income during
the three-year period from January 15, 2001 through
January 15, 2004, then the amounts earned will offset
payments due him. For the first twelve months of the agreement,
no amounts offset the monthly payments. Beginning with the
period ended January 15, 2002 and for each twelve-month
period thereafter, the former Chief Scientific Officer is to
provide the Company with an accounting of income earned during
the preceding twelve months. The amount earned will then be used
to offset future payments. As future payments are contingent
upon the earnings of this individual, no liability has been
established at December 31, 2002 for the preceding twelve
months.

Note N 
D-GlucarateTMAgreement

On September 19, 2001, the Company entered
into an agreement with its licensor of patented calcium
D-GLUCARATETM. Under the terms of the agreement, the
Company will discontinue all sales, marketing,

F-15



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##### Table of Contents



SCOLR, INC.


NOTES TO
FINANCIAL STATEMENTS  (Continued)

and distribution activities related to Calcium
D-GLUCARATETM. In return, the Company received a
$400,000 non-interest bearing note receivable and the
forgiveness of certain accounts payable totaling $83,160. As a
result of this transaction, the Company recognized income of
$480,614 for the year ended December 31, 2001, which is
included in other income in the Statement of Operations. The
first payment of $40,000 under the note receivable was paid in
February 2002, and monthly payments of $13,846 will be due
thereafter through April 2004.

Note O  Micro-Cell®/
Cobactin® Agreement

On December 4, 2001, the Company entered
into an agreement with Biotal, Inc. (Biotal) and Danstar Ferment
AG (Danstar) whereby the Company assigned to Danstar its rights
and obligations under the Product Marketing and Manufacturing
Agreement dated August 19, 1999 between the Company and
Biotal. Under the terms of the new agreement, the Company sold
its rights to produce Micro-Cell® microbial beef feed
additive. The Company retains the intellectual property rights
and production of its Cobactin® microbial feed additive
product, while Biotal will have the exclusive rights to
distribute the product. In accordance with the agreement, the
Company received a $750,000 payment, which is included in other
income in the Statement of Operations for the year ended
December 31, 2001.

Note P  Technical Rights,
Patent License and Royalty Agreements

During 2001, the Company amended its 2000
agreement with Temple University (Temple) to obtain exclusive
worldwide license of licensed products, with the right to
sublicense. Under the terms of the agreements with Temple, the
Company is required to make minimum annual royalty payments
totaling $55,000.

Under a technical and product rights agreement
from a limited partnership, which has now been dissolved, the
Company has full and exclusive rights, title and interest to use
and market products developed from the Feed Additives agreement.
Under the Feed Additives agreement, the Company is required to
make royalty payments to the former partners of the Feed
partnership on sales of Feed Additives until December 31,
2010. During 2002 and 2001, royalty expense for Feed Additives
amounted to $64,929 and $38,423, respectively. In February 2003,
the Company sold it feed additive product line to a third party
for $230,000. The assets included inventories and intellectual
property of the feed additive product line.

On March 25, 2002, the Company entered into
an Exclusive Patent License Agreement with
Archer-Daniels-Midland Company (ADM). Under the terms of the
agreement, the Company will grant ADM an exclusive license to
manufacture, use, sell and offer to sell products covered by
certain patents owned by the Company. ADM will pay the Company a
running royalty on a quarterly basis. During the year ended
December 31, 2002, the Company realized $54,000 in contract
revenue relating to this agreement.

Note Q  Retirement Plan

The Company has a defined contribution 401(k)
retirement plan (the Plan) which covers all employees. The
Company will match 25% of employee contributions, up to 8% of
employee contributions. The Company contributed $21,740 and
$12,269 to the Plan for the years ended December 31, 2002
and 2001, respectively.

Note R  Stock
Options

Under the terms of the Companys 1995 Stock
Option Plan, officers, directors, employees and others related
to the Company may be granted incentive stock options or
nonqualified stock options to purchase up to an authorized
4,000,000 shares of common stock. The options are generally
granted at exercise prices equal to the market value of the
Companys common stock on the date of the grant. The
options generally vest over three years and expire ten years
from date of grant.

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SCOLR, INC.


NOTES TO
FINANCIAL STATEMENTS  (Continued)

The Company has adopted the disclosure only
provisions of Statement of Financial Accounting Standards
No. 123, Accounting for Stock-Based Compensation
(SFAS 123). The Company applies Accounting Principles
Boards Opinion No. 25, Accounting for Stock Issued to
Employees, and related Interpretations in accounting for its
plans and generally does not recognize compensation expense for
its stock-based compensation plans. If the Company had elected
to recognize compensation expense based upon the fair value at
the grant date for awards under these plans consistent with the
methodology prescribed by SFAS 123, the Companys net loss
would change to the pro forma amounts indicated below:

|                   |             |      |   |            |   |  |   |          |  
|------------------ | ----------- | ---- | - | ---------- | - |  | - | -------- | -
|                   |             | 2002 |   | 2001      
|                   |             |      |   |           
|Net loss           |             |      |   |            |   |  |   |         
|                   | As reported |      | $ | (2,557,328 | ) |  | $ | (573,042 | )
|                   | Pro forma   |      | $ | (2,684,419 | ) |  | $ | (700,634 | )
|Net loss per share |             |      |   |            |   |  |   |         
|                   | As reported |      | $ | (0.13      | ) |  | $ | (0.03    | )
|                   | Pro forma   |      | $ | (0.13      | ) |  | $ | (0.04    | )

The fair value of option grants is estimated
using the Black-Scholes option-pricing model with the following
assumptions for the years ended December 31:

|                        |  |            |  |          
|----------------------- |  | ---------- |  | ---------
|                        |  | 2002       |  | 2001     
|                        |  |            |  |          
|Expected volatility     |  | 83%        |  | 88%      
|Expected dividend yield |  | 0%         |  | 0%       
|Risk-free interest rate |  | 3%         |  | 5.0%     
|Expected life           |  | 10.0 years |  | 7.0 years

A summary of the Companys stock option
plans activity is as follows:

|                                                                   |  |        |           |          |  |        |      |          |  |  |           |   |  |   |      | 
|------------------------------------------------------------------ |  | ------ | --------- | -------- |  | ------ | ---- | -------- |  |  | --------- | - |  | - | ---- | 
|                                                                   |  |        |           |         
|                                                                   |  | 2002   |           | 2001    
|                                                                   |  |        |           |         
|                                                                   |  |        |           | Weighted |  |        |      | Weighted
|                                                                   |  |        |           | average  |  |        |      | average 
|                                                                   |  |        |           | exercise |  |        |      | exercise
|                                                                   |  | Shares |           | price    |  | Shares |      | price   
|                                                                   |  |        |           |          |  |        |      |         
|Outstanding at beginning of year                                   |  |        | 3,490,583 |          |  | $      | .67  |          |  |  | 2,740,601 |   |  | $ | 0.71 | 
|Granted                                                            |  |        | 246,802   |          |  |        | 1.06 |          |  |  | 916,840   |   |  |   | 0.59 | 
|Exercised                                                          |  |        | (307,328  | )        |  |        | .43  |          |  |  |          |   |  |   |     | 
|Forfeited                                                          |  |        | (922,382  | )        |  |        | .85  |          |  |  | (166,858  | ) |  |   | 0.76 | 
|                                                                   |  |        |           |          |  |        |      |          |  |  |           |   |  |   |      | 
|Outstanding at end of year                                         |  |        | 2,507,675 |          |  | $      | .68  |          |  |  | 3,490,583 |   |  | $ | 0.67 | 
|                                                                   |  |        |           |          |  |        |      |          |  |  |           |   |  |   |      | 
|Options exercisable at end of year                                 |  |        | 1,552,050 |          |  | $      | .65  |          |  |  | 2,078,197 |   |  | $ | 0.72 | 
|                                                                   |  |        |           |          |  |        |      |          |  |  |           |   |  |   |      | 
|Weighted-average fair value of options granted
    during the year |  |        |           |          |  | $      | .88  |          |  |  |           |   |  | $ | 0.48 | 
|                                                                   |  |        |           |          |  |        |      |          |  |  |           |   |  |   |      | 

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##### Table of Contents



SCOLR, INC.


NOTES TO
FINANCIAL STATEMENTS  (Continued)

The following is a summary of stock options
outstanding at December 31, 2002:

|               |               |                     |  |                  |           |                   |  |  |      |  |  |  |           | 
|-------------- | ------------- | ------------------- |  | ---------------- | --------- | ----------------- |  |  | ---- |  |  |  | --------- | 
|               |               |                    
|               |               | Options Outstanding
|               |               |                    
|               |               |                     |  | Weighted-Average |           |                  
|               |               | Number              |  | Remaining        |           | Number of Options
|Exercise Price |               | Outstanding         |  | Contractual Life |           | Exercisable      
|               |               |                     |  |                  |           |                  
|               | $0.25 - $0.78 |                     |  |                  | 1,876,705 |                   |  |  | 7.32 |  |  |  | 1,083,065 | 
|               | $0.80 - $1.25 |                     |  |                  | 630,970   |                   |  |  | 5.45 |  |  |  | 468,985   | 
|               |               |                     |  |                  |           |                   |  |  |      |  |  |  |           | 
|               |               |                     |  |                  | 2,507,675 |                   |  |  |      |  |  |  | 1,552,050 | 
|               |               |                     |  |                  |           |                   |  |  |      |  |  |  |           | 

Note S  Warrants

The Company has the following warrants
outstanding to purchase common stock at December 31, 2002:

|                                                                                                                                                                                                      |  |  |         | 
|----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------- |  |  | ------- | 
|Warrants issued in conjunction with financing
    costs whereby one warrant entitles the holder to purchase one
    share of common stock at an exercise price of $0.50, expiring
    September 2012  |  |  | 750,000 | 
|Warrants issued in conjunction with services
    received whereby one warrant entitles the holder to purchase one
    share of common stock at an exercise price of $0.50, expiring
    December 2007 |  |  | 82,000  | 
|Warrants issued in conjunction with services
    received whereby one warrant entitles the holder to purchase one
    share of common stock at an exercise price of $0.81, expiring
    December 2007 |  |  | 85,000  | 
|                                                                                                                                                                                                      |  |  |         | 
|                                                                                                                                                                                                      |  |  | 917,000 | 
|                                                                                                                                                                                                      |  |  |         | 

Note T  Major Customers and
Concentration of Credit Risk

In 2002, the Company had sales to three
customers, which accounted for approximately 23%, 20%, and 10%
of net revenues. In 2001, the Company had sales to three
customers, which accounted for 16%, 15%, and 12% of net
revenues. The Company does not require its receivables to be
collateralized; as such the Companys receivables are
unsecured.

Note U 
Contingencies

In 2001, the Company was engaged in a lawsuit for
wrongful termination of a former employee. On September 20,
2001, the lawsuit was dismissed by the Equal Opportunity
Commission. The former employee may pursue his claim through
normal litigation channels; however, in the opinion of
management, based upon advice of legal counsel, no further
pursuit of this claim is expected to occur.

Note V  Private
Placement

In November 2001, the Board of Directors
authorized the sale of up to 2,000,000 shares of the
Companys common stock in a private placement. In April
2002, the board authorized the sale of an additional
833,333 shares of common stock in the private placement.

The Company sold 2,583,330 shares of common
stock for approximately $1,445,000 relating to the private
placement. The Company sold 205,000 shares to a related
party for $80,000 prior to December 31, 2001.

The Company entered into a one year consulting
agreement effective December 1, 2001 with an investor
relations company to increase investment community awareness of
the Company for a monthly fee of $7,500. As part of this
arrangement, the owner of the investor relations company agreed
to purchase 300,000 shares of

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SCOLR, INC.


NOTES TO
FINANCIAL STATEMENTS  (Continued)

unregistered common stock at $0.40 per share. The
shares were paid for with a note totaling $120,000, which
accrued interest at 5.0% and was due on the later of
December 1, 2002 or at the time the purchased shares are
publicly saleable. As of December 31, 2001, the Company had
not issued the 300,000 shares of common stock; accordingly, the
Company had recorded a stock subscription for the shares
totaling $120,000 at December 31, 2001.

In 2002, the Company cancelled the note
receivable totaling $120,000 and all accrued unpaid interest for
services and issued the 300,000 shares of common stock in
satisfaction of certain obligations to the Companys
investor relations firm. In addition, the Company issued 85,000
and 82,000 warrants to purchase common stock at an exercise
price of $0.81 and $0.50, respectively. The fair value of
warrants totaling $145,125 was recorded in the Statement of
Operations and was determined using the Black-Scholes
option-pricing model with the following assumptions: volatility
of 81%, risk-free interest rate of 3%, expected life of five
years and 0% dividend yield.

F-19