UNITED
STATES SECURITIES AND EXCHANGE COMMISSION
 Washington,
D.C. 20549
 Form
10-K
  
 x
                  ANNUAL
      REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF
      1934
  For
the fiscal year ended December 31, 2007
   ̈
                  TRANSITION
      REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF
      1934
  For
the transition period from 
to .
  Commission
file number 001-31982
  SCOLR
Pharma, Inc.
 (Exact
name of registrant as specified in its charter)
  Delaware
                    (State
      or other jurisdiction
                    of
      incorporation or organization)
                  91-1689591
                    (IRS
      Employer Identification No.)3625
      132nd Avenue S.E. Ste. 400
                    Bellevue,
      WA
                    (Address
      of principal executive offices)
                  98006
                    (Zip
      Code)
  Registrant’s
telephone number, including area code: (425) 373-0171
  Securities
      registered under Section 12(b) of the
                    Exchange
      Act:
                    Common
      Stock, $0.001 par value per share
                    (Title
      of each class)
                  Name
      of each exchange on which registered:
                    American
      Stock Exchange
  Securities
registered under Section 12(g) of the Exchange Act:
 None
  Indicate
by check mark if the registrant is a well-known seasoned issuer, as defined in
Rule 405 of the Securities Act.    Yes   ̈    No  x
  Indicate
by check mark if the registrant is not required to file reports pursuant to
Section 13 or Section 15(d) of the
Act.    Yes   ̈    No  x
  Indicate
by check mark whether the registrant (1) has filed all reports required to
be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934
during the preceding 12 months (or for such shorter period that the registrant
was required to file such reports), and (2) has been subject to such filing
requirements for the past 90
days.    Yes   x    No   ̈
  Indicate
by check mark if disclosure of delinquent filers pursuant to Item 405 of
Regulation S-K (§229.405 of this chapter) is not contained herein, and will
not 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-K
or any amendment to this Form 10-K.     ̈
  Indicate
by check mark whether the registrant is a large accelerated filer, an
accelerated filer, or a non-accelerated filer. (as defined in Rule 12b-2 of
the Exchange Act).    Large accelerated
filer   ̈    Accelerated
filer  x    Non-accelerated
filer   ̈
  Indicate
by check mark whether the registrant is a shell company (as defined in
Rule 12b-2 of the Exchange
Act.)    Yes   ̈    No  x
  The
aggregate market value of the registrant’s common stock held by non-affiliates
of the registrant as of June 30, 2007, was approximately $83 million, based
upon the closing sale price on the American Stock Exchange reported for such
date. The number of shares outstanding of the registrant’s common stock was
41,031,385 as of March 3, 2008.
 1
 Table of Contents
   DOCUMENTS
INCORPORATED BY REFERENCE
  Certain
information required by Item 5 of this report and the information required by
Part III of this annual report, to the extent not set forth herein, is
incorporated herein by reference from the registrant’s definitive proxy
statement relating to the registrant’s 2008 annual meeting of
stockholders.
 
 
  2
 Table of Contents
  SCOLR
Pharma, Inc.
 FORM
10-K
  TABLE OF CONTENTS
  PagePART
      IItem 1.
                  Business
                  4Item 1A.
                  Risk Factors
                  13Item 1B.
                  Unresolved Staff Comments
                  20Item 2.
                  Properties
                  20Item 3.
                  Legal Proceedings
                  20Item 4.
                  Submission of Matters to a Vote of Security
      Holders
                  20PART
      IIItem 5.
                  Market for the Registrant’s Common Equity, Related
      Stockholder Matters and Issuer Purchases of Equity
      Securities
                  21Item 6.
                  Selected Financial Data
                  23Item 7.
                  Management’s Discussion and Analysis of Financial Condition
      and Results of Operations
                  23Item 7A.
                  Quantitative and Qualitative Disclosures about Market
      Risk
                  29Item 8.
                  Financial Statements and Supplementary
    Data
                  30Item
      9.
                  Changes in and Disagreements With Accountants on Accounting
      and Financial Disclosure
                  54Item
      9A.
                  Controls and Procedures
                  54PART
      IIIItem
      10.
                  Directors and Executive Officers of the
      Registrant
                  55Item
      11.
                  Executive Compensation
                  55Item
      12.
                  Security Ownership of Certain Beneficial Owners and
      Management
                  55Item
      13.
                  Certain Relationships and Related
      Transactions
                  55Item
      14.
                  Principal Accountant Fees and Services
                  55PART
      IVItem
      15.
                  Exhibits and Financial Statement
    Schedules
                  56
 
   3
 Table of Contents
  PART
I
  In this
document, the words “we,” “our,” “ours,” and “us” refer only to SCOLR Pharma,
Inc. and not any other person or entity.
  Item 1.
                  Business
  This
report includes forward-looking statements within the meaning of the Private
Securities Litigation Reform Act of 1995. When used in this report, the words
“anticipate,” “believe,” “estimate,” “may,” “intend,” “expect,” and similar
expressions identify certain of such forward-looking statements. Although we
believe that our plans, intentions and expectations reflected in such
forward-looking statements are reasonable, we can give no assurance that such
plans, intentions or expectations will be achieved. Actual results, performance
or achievements could differ materially from historical results or those
contemplated, expressed or implied by the forward-looking statements contained
in this annual report. Important factors that could cause actual results to
differ materially from our forward-looking statements are set forth in this
annual report, including Item 1A, as well as those discussed elsewhere in
this annual report and others detailed from time-to-time in our periodic reports
filed with the SEC. Except as required by law, we undertake no obligation to
update any forward-looking statements, whether as a result of new information,
future events or otherwise.
  Overview
  We are a
specialty pharmaceutical company. Our corporate objective is to combine our
formulation experience and knowledge with our proprietary and patented
Controlled Delivery Technology (CDT®) platform to develop novel pharmaceutical,
over-the-counter (OTC), and nutritional products. Our CDT platform is based on
multiple issued and pending patents and other intellectual property for the
programmed release or enhanced performance of active pharmaceutical ingredients
and nutritional products.
  Our
innovative drug delivery technologies enable us to formulate tablets or capsules
that release their active agents predictably and programmably over a specified
timeframe of up to 24 hours. Our platform is designed to reduce the frequency of
drug administration, improve the effectiveness of the drug treatment, ensure
greater patient compliance with a treatment program, reduce side effects, or
increase drug safety. In addition, our technology can be incorporated into oral
formulations to increase the solubility characteristics of previously
non-soluble and sparingly-soluble drugs without employing costly or complex
nano-crystalization, micro-milling or coated particle technologies.
  We have
developed multiple private label extended-release nutritional products
incorporating our CDT platform that are sold by national retailers. In October
2005, we entered into a strategic alliance with a subsidiary of Perrigo Company
for the manufacture, marketing, distribution, sale and use of certain dietary
supplement products in the United States. We receive royalty payments based on a
percentage of Perrigo’s net profits derived from the sales of products covered
by our agreement.
  Our lead
product candidate is a CDT-based extended-release formulation of ibuprofen, an
analgesic typically used for the treatment of pain, fever and inflammation.
There are currently no extended-release formulations of ibuprofen approved for
use in North America. In addition, we have completed clinical trials for a 12
hour extended-release pseudoephedrine formulation and are preparing for
submission of our first Abbreviated New Drug Application, or ANDA, in 2008.
Pseudoephedrine is a decongestant that is widely used to relieve sinus pressure
related to allergies and the common cold. We are also engaged in development of
CDT-based extended-release formulations of ondansetron, rivastigmine, and
risperidone, as well as an immediate-release formulation of raloxifene.
Ondansetron is the active ingredient drug in Zofran®, GlaxoSmithKline’s product
for anti-nausea and vomiting associated with chemotherapy and radiation
treatments for cancer. Raloxifene is the active ingredient in Evista®, Eli
Lilly’s product for osteoporosis which uses a different solubilization
technology. Rivastigmine is the active ingredient in Exelon®, the Novartis drug
for management of Alzheimer’s disease. Risperidone is the active ingredient in
Risperdal®, Janssen, L.P.’s product for the management of schizophrenia and
bipolar mania.
  We have a
research collaboration with BioCryst Pharmaceuticals to develop an oral
formulation of peramivir, a promising antiviral compound, using our CDT
platform. Peramivir is a novel therapeutic being developed by BioCryst for
treatment of seasonal and life threatening influenza with a focus on intravenous
and intramuscular delivery. The goal of the collaboration is to develop a tablet
or capsule formulation for the oral administration of peramivir that improves
its oral bioavailability. We have also entered into a collaboration and license
agreement with Dr. Reddy’s Laboratories to pursue development and
commercialization of an undisclosed oral prescription drug with significant
potential for the cardiopulmonary market using our CDT technology. We are
developing other products that we have not disclosed for competitive reasons,
and we are evaluating additional drugs as potential development candidates for
expanding our growing portfolio of CDT applications.
   4
 Table of Contents
  We were
incorporated on October 12, 1994, in Delaware under the name Caddy Systems,
Inc. From April 1995 to July 2002, we operated under the name Nutraceutix, Inc.
In July 2002, we changed our name to SCOLR, Inc. and to SCOLR Pharma, Inc. in
July 2004. SCOLR is an acronym for “Self-Correcting Oral Linear Release,” an
important feature of our lead technology.
  Our
principal executive offices are located at 3625 132nd Ave SE, Suite 400,
Bellevue, Washington 98006. Our general telephone number is (425) 373-0171.
Our website is www.scolr.com.
Information contained on our website is not part of, and is not incorporated
into, this annual report. Our filings with the SEC are available without charge
on our website.
  Corporate
Strategy
  Our
strategy is to develop pharmaceutical, OTC, and nutraceutical products utilizing
our innovative oral drug delivery technologies. Our technologies enable us to
formulate tablets or capsules that release their active agents predictably and
programmably over a specified timeframe of up to 24 hours. We believe that our
technologies are capable of significantly improving the delivery of many
pharmaceutical, OTC, and nutraceutical products.
  We seek
collaborative arrangements and alliances with corporate partners, licensors, and
licensees to provide funding for the research, development, clinical testing,
manufacturing, marketing, and commercialization of our product candidates.
Controlled-release drug delivery technologies such as our CDT platform can be
applied to reformulate existing drugs and extend the patent protection, thereby
improving product release profiles and enhancing important revenue streams for
pharmaceutical companies. Many pharmaceutical and specialty pharmaceutical
companies have also successfully utilized controlled-release technologies to
develop product line extensions.
  We expect
to seek collaborations in order to advance the manufacturing, selling, and
marketing of our potential products. However, based on an evaluation of each
product opportunity, we may consider establishing limited manufacturing or sales
and marketing capabilities to better maintain control over product development
timelines and to capture more of their economic value of the opportunity. We do
not currently have commercialization or manufacturing capabilities.
  We spent
$7.8 million, $7.7, million and $5.9 million during 2007, 2006, and 2005,
respectively, on product research and development.
  Commercial
Relationships
  An
important part of our strategy is to seek collaborations and strategic
partnerships to develop or market some of our products. We have entered into
collaborations and currently plan to enter into additional collaborations with
established third parties to manufacture and commercialize our existing and
potential products. We are engaged in discussions with pharmaceutical companies
regarding development of products incorporating our CDT platform and other types
of marketing, manufacturing, or distribution opportunities. Following is a
summary of our recent collaborations.
  Dr. Reddy’s Laboratories.On
October 18, 2007, we entered into a collaboration and license agreement with Dr.
Reddy’s Laboratories, an emerging global pharmaceutical company, to pursue the
development and commercialization of an undisclosed oral prescription drug
product. We have completed initial formulation work and commenced product
scale-up activities. Under the terms of the agreement, Dr. Reddy’s is
responsible for the development, manufacturing and marketing of the drug
product. The agreement provides us with significant participation in net profits
of the potential product after recovery of development and commercialization
expenses.
  BioCryst. On
September 5, 2006, we entered into a research collaboration with BioCryst
Pharmaceuticals to develop an oral formulation of peramivir, a promising
antiviral compound using our CDT platform. Peramivir is a novel therapeutic
being developed by BioCryst for treatment of seasonal and life threatening
influenza with a focus on intravenous and intramuscular delivery. The goal of
the collaboration is to develop a tablet or capsule formulation for the oral
administration of peramivir that improves its oral bioavailability.
  Perrigo Company.On October
20, 2005, we entered into a strategic alliance with a subsidiary of Perrigo
Company. Perrigo is a leading global healthcare supplier and one of the world’s
largest manufacturers of OTC pharmaceutical and nutritional products for the
store brand and contract manufacturing markets. Under the agreement, we granted
a license to our CDT technology to Perrigo for the manufacture, marketing,
distribution, and sale of specific dietary supplements in the United States. In
addition, Perrigo may request that we develop additional dietary supplement
products that use our technology to be added to the agreement. Subject to
certain exceptions described in the agreement, the license we granted to Perrigo
is exclusive. We receive royalty payments based on Perrigo’s net profits derived
from the sales of products subject to the agreement. The first product shipments
by Perrigo began in the first quarter of 2006. Perrigo introduced three
additional once-daily CDT-based private label products during the fourth quarter
of 2006, and a fifth product was added late in 2007.
   5
 Table of Contents
  Wyeth Consumer Healthcare. In
December 2005, we entered a licensing agreement with Wyeth Consumer Healthcare,
a division of Wyeth, granting exclusive worldwide rights to use our CDT platform
for the development, manufacture and commercialization of products containing
ibuprofen. On March 14, 2007, we received a notice of termination from Wyeth
that our agreement would be terminated (without cause) effective April 16, 2007.
Since December 2005 through the termination of the contract, we received more
than $2.1 million in milestone and other payments from Wyeth.
  Nutraceutix. We completed the
sale of our probiotics development and manufacturing activities to Nutraceutix,
Inc. as of December 31, 2003. In connection with the sale, we granted
Nutraceutix the right to manufacture and sell certain products utilizing our CDT
technology. Subject to the rights of Nutraceutix to continue sales of certain
inventories for up to one year, the license terminated on December 31,
2007.
  Our
CDT Platform
  We
believe that our proprietary CDT platform has the potential to significantly
improve a large number of oral pharmaceutical, OTC, and nutritional
products.  Our proprietary CDT technologies can be used in solid oral
dosage formulations to yield tablets or capsules that release their active
agents in a controlled and programmable manner over a specified timeframe of up
to 24 hours.
  Oral
administration is the preferred route for drug delivery due to its convenience
and widely accepted use. However, many orally-administered, immediate-release
drug products are rapidly utilized by the body, thereby requiring repeat
administration throughout the day. Consequently, patient non-compliance can be a
significant problem for many of these products. Our oral controlled-release
technologies can eliminate the need for multiple daily dosing by extending the
release of the active drug component so that the product maintains its
therapeutic usefulness over a longer period of time. In addition, lowering the
peak levels of certain drugs in the blood by extending their release profile may
reduce the adverse effects associated with peak levels of these
drugs.
  Our CDT
platform represents a robust and simple approach to drug tablet and capsule
formulation that employs a low cost and simplified manufacturing process that
uses conventional granulation, blending, and compression equipment in a two or
three-step process. Our controlled-release tablet and capsule formulations
contain readily available and generally-regarded-as-safe (GRAS) excipients
(i.e., non-drug ingredients such as hydrophilic polymers, amino acids, or
electrolytes). These excipients are used to modulate the release rate of the
drug within the CDT tablet to provide programmable delivery profiles. These
profiles include attaining sustained-release with improved linearity or
zero-order kinetics.
  Our CDT
technology can accommodate comparatively high volumes of an active ingredient
while being programmable to deliver these active ingredients over a wide range
of release profiles and timeframes. We believe that our CDT-based tablet and
capsule formulations are capable of generating the sustained release profiles
required for reproducible, cost-effective, and optimized in-vivo delivery of drugs for
up to 24 hours.
  In
addition, our proprietary amino-acid technologies can be incorporated into solid
oral formulations to increase the solubility characteristics of previously
non-soluble or sparingly-soluble compounds. Our amino acid technologies are
designed to allow the successful manufacture of these drugs without employing
costly micro-milling, nano-particulate, coated-particle, or other complex
solubility enhancing technologies.
  Our CDT
platform is based on multiple issued and pending patents and other intellectual
property for the programmed release or enhanced performance of active
pharmaceutical ingredients and nutritional products. In aggregate, our amino
acid, salt-based, and dual polymer technologies offer a range of formulation
alternatives capable of addressing some of the most challenging hurdles in oral
drug delivery, including zero order kinetics, poorly soluble active ingredients,
and ingredients that are difficult to tablet. Our issued patents are summarized
below.
  •      
      Dual Polymer
      Patent—(U.S. Patent No. 6,337,091 issued 2002). This first
      generation of our technology is based on hydrophilic matrices which allow
      for the controlled diffusion of active ingredients from the matrix through
      progressive swelling and erosion of the tablets. The resulting CDT tablets
      or capsules employ combinations of conventional tableting materials
      selected specifically for the active ingredient(s) and the desired release
      profile. Various release patterns and rates can be achieved depending upon
      the matrix composition, the selection and ratio of polymers, ionic
      substrates, and excipients.
  •      
      Salt Patent—(U.S.
      Patent No. 6,090,411 issued July 18, 2000). This technology
      provides for the controlled and programmable release of the active
      pharmaceutical ingredient (API) with zero-order kinetics through dry
      blending and direct compression of a salt, a polymer, and the API. We
      believe that this salt-based technology provides several advantages over
      comparable sustained-release
technologies:
   6
 Table of Contents
  1)
      our technology employs a comparatively simple, two-step manufacturing
      process (involving no granulation), and the dry blending of a selected
      salt and polymer to create a dry
matrix;
  2)
      our salt patent platform is broadly applicable to dietary supplements, OTC
      products and prescription pharmaceuticals, and yields extremely rugged
      tablets;
  3)
      the in-vitro
      dissolution results of these tablets are not affected by drug solubility,
      pH, tablet size or configuration, tablet hardness, or friability;
      and,
  4)
      our technology uses GRAS excipients manufactured with standard
      pharmaceutical processing equipment thereby enabling cost-effective
      production.
  •      
      Amino Acid
      Patents—(U.S. Patent No. 6,517,868 issued February 11,
      2003, U.S. Patent No. 6,936,275 issued August 30, 2005, and U.S.
      Patent 7,229,642 issued June 12, 2007). These technologies employ a
      controlled-release matrix system based on the application of amino acids,
      gums and polymers via hydrophobic/polar interaction which may improve drug
      solubility. Our amino acid technologies are designed to offer simpler
      solutions to certain difficult formulation challenges. For example, our
      amino acid technologies are designed to successfully deliver poorly
      soluble drugs that are complex to formulate and difficult to manufacture
      using standard techniques and
processes.
  Datamonitor
has estimated the aggregate sales and license fees from drug delivery systems
for OTC and prescription drug products to be $79 billion in 2005 with a forecast
of approximately $117.3 billion in 2009. The leading revenue source for
drug delivery systems is the oral sector, with estimated total global revenues
by Datamonitor of over $20 billion in 2005 and forecast revenues of
approximately $29 billion in 2009. The United States continues to be the
largest market for drug delivery systems with estimated total revenues of over
$42 billion in 2005 with a forecast of approximately $57.6 billion in 2009. We
believe that the drug delivery industry will continue to show strong growth in
the future as many multi-national pharmaceutical companies seek new drug
delivery technologies to extend the life of existing pharmaceutical franchises
through new drug introductions involving older molecules incorporating new
patented drug delivery technology.
  Product
Development
  Our
proprietary drug delivery technologies are applicable to a wide range of drugs
with different physical and chemical properties, including water soluble and
insoluble drugs, as well as high dose and low dose drugs. Using our CDT
platform, we can formulate drugs with precise release profiles. In selecting
product candidates for development, we generally focus on the applicability of
our platform to a particular compound and benefits to patients, as well as
market size, patent protection, and other factors.
  Our CDT
technology has been used to develop several dietary supplement products that are
currently manufactured and distributed by third parties. We currently receive
royalties and other payments from the sale of products that incorporate our CDT
technology, including combinations of glucosamine and chondroitin, niacin,
calcium and other dietary products. These sales are being generated through our
alliance with Perrigo, including relationships with national retailers. Our CDT
glucosamine and chondroitin and calcium products are currently available
nationwide.
  We have
also applied our CDT platform to a portfolio of more than 20 pharmaceutical
targets on a preclinical demonstration basis. These target candidates include
existing analgesic, cardiovascular, diabetes, antiemetic, and pulmonary
products. We have an internal development program targeting a select group of
significant, existing drugs for reformulation in an effort to demonstrate the
applicability and viability of our CDT platform. We are engaged in development
of CDT-based extended-release formulation of a number of products, including
ibuprofen, pseudoephedrine, ondansetron, rivastigmine, and risperidone, as well
as an immediate release formulations of raloxifene. We are currently evaluating
additional drugs as potential CDT development candidates for expanding our
growing portfolio of CDT applications.
   7
 Table of Contents
 The
following table summarizes information regarding our current primary target
candidates. This table is qualified in its entirety by reference to the more
detailed descriptions contained elsewhere in this annual report.
  Current
      Development Targets
  Lead
      Products
                  Application
                  Potential
      Advantages
                  Status
                  Current
      Market Estimate(1)
                  CommentsCDT
      – 12 hrIbuprofen
                  OTC
      Analgesic
                  -
      1st extended-release OTC ibuprofen
                    - 1
      tablet vs. 3 every 12 hrs.
                    -
      Lower cost
                    -
      Patent protected
                  -
      Reacquired rights
                    -
      Multiple pilot trials completed
                    -
      Pivotal trials startedQ-4,
      2007
                    -
      NDA 505(B)2 planned 2008
                  $
      8.0 billion (Global OTC analgesic)
                  Pivotal
      – Phase III Trials started Q-4, 2007CDT
      – 12 hr Pseudoephedrine
                  OTC
      Decongestant
                  -
      1/3rd size of current OTC products
                    -
      Lower cost
                    -
      Patent protected
                  -
      ANDA trials completed, Q-2, 2005
                    -
      ANDA submission planned 2008
                  $
      1.0 billion (combined global market)
                  ANDA
      submission 2008CDT
      – IRRaloxifene
                  Rx
      Osteoporosis
                  -
      Less drug for similar results(2)
                    -
      Simplified manufacturing
                    -
      Lower cost
                    -
      Patent protected
                  - 2
      Human studies completed
                    -
      Results positive
                    -
      Reviewing clinical requirements for regulatory approval with
      FDA
                  $
      1.0 billion (Global)
                  Two
      pilot trials completed, Pivotal trial requirements being
      evaluatedCDT
      – EROndansetron
                  Rx
      Anti-Nausea
                  - 1
      tablet vs. 3 every 24 hrs.
                    -
      Simplified manufacturing
                    -
      Lower cost
                    -
      Patent protected
                  - 2
      Human studies completed
                    -
      Results Positive
                    -
      Reviewing clinical requirements for regulatory approval with
      FDA
                  $
      1.6 billion (Global)
                  Two
      pilot trials completed, Pivotal trial requirements being
      evaluatedBioCryst
      Collaboration:
                    CDT
      – Neuraminidase Inhibitor (Peramivir)
                  Rx
      Flu Treatment
                  -Develop
      oral tablet from injectable form
                    -
      Ease of administration
                    -
      Consumer compliance
                    -
      Broad application
                    -
      Patent protected
                  -Initial
      development announced winter 2006.
                    -
      Oral formulation work ongoing
                  >
      $1.0 billion (Global)
                  Initial
      animal studies completed; oral formulation work and clinical trials
      pendingDRL
      Collaboration: Undisclosed CDT-based Rx target
                  Cardiopulmonary
                  -
      Lower cost
                    -
      Patent protected
                    -
      Other non-disclosed
                  -
      Oral formulation work ongoing
                    -
      Product transfer initiated
                  Undisclosed
                  ConfidentialCDT
      – 24 hrRisperidone
                  Rx
      Schizophrenia and Bipolar Mania management
                  - 1
      tablet vs. 2 every 24 hrs.
                    -
      Simplified manufacturing
                    -
      Lower cost
                    -
      Patent protected
                  -
      Formulation work initiated Q-4, 2006
                    -
      Pilot clinical trials pending financing
                  $
      1.8 billion (Global)
                  Formulation
      work completed, Pilot trials to be scheduledCDT
      – 24 hrRivastigmine
                  Rx
      Alzheimer’s Disease
                  - 1
      tablet vs. 2 every 24 hrs.
                    -
      Improved convenience
                    -
      Patent protected
                  -
      Formulation work initiated Q-4, 2006
                    -
      Pilot clinical trials pending financing
                  $
      0.5 billion (Global)
                  Formulation
      work completed, Pilot trials to be
scheduled
 
 (1)     
      Market data sources – IMS, Datamonitor, industry analysts, company
      disclosures, SCOLR estimates.
 (2)     
      Based on animal and clinical
results.
 8
 Table of Contents
  Development
Status of Lead Products
  •
                  Ibuprofen—We developed an extended-release formulation of
      ibuprofen based on our CDT platform and continue preparations for
      submission of our first New Drug Application, or NDA, for a 12-hour
      CDT-based ibuprofen product. We have completed two of three product
      performance pivotal trials to evaluate the safety and efficacy of our
      product and expect to complete the third trial by the end of the second
      quarter of 2008. The Food and Drug Administration, or FDA, recently
      provided guidance on a label comprehension study and a consumer use study
      that will be required for product approval. Subject to successful
      completion of the final performance trial, and any additional guidance
      from the FDA, our goal is to submit an NDA under Section 505(b)(2) in the
      second half of 2008. There are currently no extended-release formulations
      of ibuprofen approved for use in North America. Based on industry sources,
      we estimate that sales of ibuprofen are more than $1 billion per year and
      sales of ibuprofen and non-ibuprofen OTC analgesic products are more than
      $8 billion globally.
  •
                  Pseudoephedrine—We
      completed human testing of our 12-hour CDT-based pseudoephedrine tablets
      and expect to file our first ANDA submission with the FDA during 2008. We
      believe our formulation will offer attractive tablet size when compared to
      similar tablets already on the market. Based on industry sources, we
      estimate that aggregate North American sales of products containing
      pseudoephedrine have been more than $1 billion per year. However, our
      ability to commercialize products containing pseudoephedrine may be
      adversely impacted by legislative and market changes relating to
      diversion.
  •
                  Raloxifene—We completed initial human clinical evaluations
      of CDT-based immediate-release raloxifene formulations during 2005 and
      2006. While the results of those trials supported the advancement of an
      additional formulation and human clinical work, we are seeking guidance
      from the FDA to assist us in evaluating the regulatory pathway and
      commercial viability of this product candidate. Raloxifene is used to
      prevent and treat osteoporosis. Additional studies would be required to
      provide further insight into the capabilities of the CDT-based technology
      and our ability to enhance bioavailability as well as to support
      development of a raloxifene product. Evista®
      is Eli Lilly’s immediate-release raloxifene product for osteoporosis
      utilizing a complex solubilization technology. In 2006, Eli Lilly reported
      more than $1 billion in global sales of
    Evista.
  •
                  Ondansetron—We
      successfully completed initial pilot bioavailability testing of our
      refined 24-hour CDT-based ondansetron formulation in Canada. The results
      indicate that our amino acid formulation technology is capable of
      producing a once daily sustained release ondansetron tablet. We are
      currently seeking guidance from the FDA on the applicable regulatory
      pathway to assist us in evaluating the commercial viability of this
      candidate. Ondansetron is the active ingredient in Zofran®,
      GlaxoSmithKline’s product for anti-nausea and vomiting associated with
      chemotherapy and radiation treatments for cancer. In 2006, GlaxoSmithKline
      reported approximately $1.6 billion in global sales of Zofran. In
      addition, several immediate release generic versions of ondansetron were
      approved by the FDA during late
2006.
  •
                  Peramivir—We initiated
      development of an oral formulation of peramivir as part of a research
      collaboration with BioCryst Pharmaceuticals. Animal studies have been
      completed and we are currently evaluating potential next steps to advance
      development. Peramivir is part of a new class of antiviral agents that
      inhibit influenza neuraminidase, an enzyme essential for the influenza
      virus to spread and infect its hosts. The compound was designed to treat
      and prevent various types of flu and may have utility against strains
      including influenza A and B, avian influenza, and other life-threatening
      sub-types that have shown resistance to currently available therapies. The
      goal of the collaboration is to develop a tablet or capsule formulation
      for the administration of peramivir that improves its oral
      bioavailability.
  •
                  Rivastigmine, and
      Risperidone—We completed internal development work on
      extended-release prototype formulations of rivastigmine and
      risperidone. Rivastigmine is used for the management of Alzheimer’s
      disease and is marketed by Novartis as Exelon®.
      Novartis reported global sales of Exelon of approximately $0.5 billion
      during 2006. Risperidone is an anti-psychotic for management of
      schizophrenia and bipolar mania and is marketed by Janssen, L.P. as
      Risperdal®.
      Industry analysts estimated global sales of Risperdal by Janssen were more
      than $2.3 billion for 2006, based on oral formulations alone. However, we
      do not plan to initiate clinical studies for these product candidates
      during 2008 unless we secure additional
  funding.
  •
                  Fenofibrate—We completed initial testing of our prototype
      CDT-fenofibrate formulation. As expected, the trial results clarified the
      additional formulation work required to prepare for commercialization. We
      have placed our development work on hold as a potential future licensing
      candidate, due to regulatory approval of a competing low-dose fenofibrate
      formulation. Fenofibrate is the active ingredient in Tricor®,
      an Abbot
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  product
      for hypercholesterolemia (elevated total cholesterol). Industry analysts
      estimated Abbot global sales of Tricor were more than $1 billion for
      2006.
  Intellectual
Property
  We
believe that patent and trade secret protection of our CDT platform are
important to our business and that our success will depend in part on our
ability to maintain existing patent protection, obtain additional patents,
maintain trade secret protection, and operate without infringing the proprietary
rights of others. We have rights to five U.S. patents and three federal
trademark registrations. Our policy is to pursue registrations for all of the
trademarks associated with our key products and technologies. Our registered
trademarks include: “CDT,” the CDT logo and design, and “SCOLR.”
  Our CDT
platform is based on multiple issued and pending patents and other intellectual
property for the programmed release or enhanced performance of active
pharmaceutical ingredients and nutritional products. Our intellectual property
includes two U.S. patents licensed exclusively to us by Temple University and
two patent rights assigned to us by Dr. Reza Fassihi, a Professor of
Biopharmaceutics and Industrial Pharmacy at the Temple University School of
Pharmacy. Dr. Fassihi currently serves on our board of directors and is a
consultant. Dr. Fassihi is also one of the inventors of the two patents
licensed to us by Temple University. We are obligated to pay annual license
maintenance fees, share in some up-front payments from customers, and pay
royalties based on product sales with respect to the CDT patents licensed from
Temple University or assigned to us by Dr. Fassihi. In the future, we plan
to file further U.S. and foreign patent applications directed to new or improved
products or processes.
  We
attempt to protect our proprietary position by filing U.S. and foreign patent
applications related to our proprietary technology inventions and improvements
that are important to the development of our business. Our success will depend
in part on our ability to obtain and maintain patent protection for our
technologies, preserve our trade secrets, and operate without infringing the
proprietary rights of others. However, the issuance of a patent is not
conclusive as to its validity or as to the enforceable scope of the claims of
the patent. Our competitors may challenge or circumvent any of our issued
patents and the patents may not provide us proprietary protection or a
commercial advantage. Furthermore, we cannot assure you that any of our future
processes or products will be patentable or will not infringe upon the patents
of third parties.
  Competition
  Our
business is highly competitive and is affected by new technologies, government
regulations, availability of financing, and other factors. In the drug delivery
field, examples of our major competitors include Alza Corporation, Biovail,
Inc., Pacira Pharmaceutical Inc., SkyePharma PLC, Elan Corporation, PLC, Flamel
Technologies, Inc., Impax Laboratories, Inc., Labopharm, Inc., and KV
Pharmaceutical Company. The successful development and commercialization of
major controlled-delivery prescription drugs can take five or more years and
millions of dollars of research and clinical trials. These major competitors
generally 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 research and development resources.
  Manufacturing
  We
currently have no internal commercial scale manufacturing capabilities.
Generally, either our collaborators manufacture the pharmaceutical products or
we use a contract manufacturer. Accordingly, we have to rely on third party
manufacturers of the pharmaceutical products we are evaluating in clinical
trials. We currently have agreements with Catalent Pharma Solutions, Inc. to
support our efforts. We also work with Perrigo regarding the manufacturing of
dietary supplements containing our CDT technology. Our dependence on third
parties for the manufacture of our potential products and clinical supplies may
adversely affect our ability to deliver such products in a timely or competitive
basis.
  Sources
and Availability of Raw Materials and Principal Suppliers
  Our
technology allows for the use of conventional, readily available, GRAS
excipients. A wide variety of materials can be used for our controlled delivery
formulation development and are available from a large number of manufacturers
and distributors. The active chemical raw materials essential to our business
are generally readily available from multiple sources in the United States and
throughout the world. Certain raw materials used in the manufacture of our
products are, however, available from limited sources and, in some cases a
single source. Any curtailment in the availability of such raw materials could
result in production or other delays and, in the case of products for which only
one raw material supplier exists or has been approved by the FDA, could result
in material loss of sales with consequent adverse effects on our business and
results of operations. During 2007 and 2006, regulatory restrictions impacted
our ability to obtain commercial quantities of pseudoephedrine and resulted in
delays to our development program. Also, because raw material sources for
pharmaceutical products must generally be identified and approved by regulatory
authorities, changes in raw material suppliers may result in production delays,
higher raw material costs, and loss of sales and customers. We obtain a portion
of our raw materials from
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  foreign
suppliers, and our arrangements with such suppliers are subject to, among other
risks, FDA approval, governmental clearances, export duties, political
instability, and restrictions on the transfers of funds.
  Government
Regulation
  Government
authorities in the United States and other countries extensively regulate the
research, development, manufacture, labeling, promotion, advertising,
distribution, and marketing of drug products. We must receive separate
regulatory approval for each of our product candidates before we or our
collaborators can sell them in the United States or internationally. In the
United States, the FDA regulates drug products under the Federal Food, Drug, and
Cosmetic Act, or FDCA, and implements regulations and other laws. Failure to
comply with applicable U.S. requirements, both before and after approval, may
subject us to administrative and judicial sanctions, such as a delay in
approving or refusal by the FDA to approve pending applications, warning
letters, product recalls, product seizures, total or partial suspension of
production or distribution, injunctions, and/or criminal
prosecutions.
  The
approval process requires substantial time, effort and financial resources, and
we cannot be sure that any approval will be granted on a timely basis, or at
all. There are several kinds of new drug applications, or NDAs, that may be
submitted to obtain FDA approval of our or our collaborators’ drugs, including
full NDAs; section 505(b)(2) NDAs; or, abbreviated new drug applications, or
ANDAs. A “full” NDA is an NDA in which the information required for approval,
including investigations of safety and effectiveness, comes from studies
conducted by or for the sponsor or for which the sponsor has obtained a right of
reference. A section “505(b)(2)” NDA is an NDA in which at least some of the
information required for approval comes from studies not conducted by or for the
sponsor and for which the sponsor has not obtained a right of reference. An
abbreviated new drug application, or ANDA, usually utilizes for proof of safety
and effectiveness data demonstrating that the drug is “bioequivalent” to a drug
which the FDA has previously approved.
  NDAs:Approval of a full NDA
by the FDA requires pre-clinical laboratory and animal tests and formulation
studies; submission to the FDA of an Investigational New Drug Application for
human clinical testing, which must become effective before human clinical trials
may begin; adequate and well-controlled clinical trials to establish the safety
and effectiveness of the product candidate for each indication for which
approval is sought; submission to the FDA of the NDA; satisfactory completion of
an FDA inspection of the manufacturing facility or facilities at which the drug
is produced to assess compliance with current good manufacturing processes
(cGMP); and, FDA review and approval of the NDA.
  505(b)(2) NDAs:Section 505(b)(2) NDAs may be submitted for drug products that
represent a modification of an already approved drug (such as, a new indication
or new dosage form) and for which investigations other than bioavailability or
bioequivalence studies are essential to the drug’s approval.
Section 505(b)(2) NDA applications may rely on the FDA’s previous findings
for the safety and effectiveness of the approved drug as well as information
obtained by the Section 505(b)(2) applicant needed to support the
modification of the listed drug. Preparing a 505(b)(2) NDA is generally less
costly and time-consuming than preparing a full NDA.
  ANDAs:The FDA may approve an
ANDA if the product is the same in important respects as an already approved
drug, or if the FDA has declared the drug suitable for an ANDA submission. ANDAs
must contain the same manufacturing and composition information as NDAs, but
applicants need not submit preclinical and clinical safety and effectiveness
data. Instead, they must submit studies showing that the product is
bioequivalent to the already approved drug. Drugs are bioequivalent if the rate
and extent of absorption of the drug does not show a significant difference from
the rate of extent of absorption of the already approved drug. Conducting
bioequivalence studies is less time-consuming and costly than conducting
pre-clinical and clinical studies necessary to support an NDA.
  The
testing and approval process requires substantial time, effort and financial
resources, and each may take several years to complete. The FDA may not grant
approval on a timely basis, or at all. We may encounter difficulties or
unanticipated costs in our efforts to secure necessary government approvals,
which could delay or preclude us from marketing our product candidates. The FDA
may limit the indications for use or place other conditions on any approvals
that could restrict the commercial application of our product
candidates.
  We use
third party manufacturers to produce our product candidates in clinical and
commercial quantities. Future inspections by the FDA may indentify compliance
issues at the facilities of our contract manufacturers or collaborators that may
disrupt production on distribution, or require substantial resources to connect.
Also, new government requirements may be established that could delay or prevent
regulatory approval of our product candidates under development.
  Other FDA
Requirements:
  We and
our collaborators are required to comply with a number of FDA requirements both
before and after approval, regardless of the type of application submitted. For
example, we are required to report certain adverse reactions and
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  production
problems, if any, to the FDA, and to comply with certain requirements concerning
advertising and promotion for our products. Also, quality control and
manufacturing procedures must continue to conform to cGMP after approval, and
the FDA periodically inspects manufacturing facilities to assess compliance with
cGMP. Accordingly, manufacturers must continue to expend time, money and effort
in all areas of regulatory compliance, including production and quality control
to comply with cGMP. In addition, discovery of issues such as safety problems
may result in changes in labeling or restrictions on a product manufacturer or
NDA holder, including removal of the product from the market. After approval,
certain changes to the approved product, such as adding new indications,
manufacturing changes, or additional labeling claims are subject to further FDA
review and approval. In addition, the FDA may require post-approval
studies.
  Employees
  As of
December 31, 2007, we employed 24 full time employees. None of our
employees is represented by labor unions. We believe our relationship with
employees is good.
  Executive
Officers
  Our
executive officers are generally elected annually at the meeting of our board of
directors held in conjunction with the annual meeting of stockholders. The
following are our current executive officers and their ages as of March 1,
2008:
  Name
                  Age
                  Office
                  Position
                    SinceDaniel
      O. Wilds
                  59
                  President
      and Chief Executive Officer
                  2003Richard
      M. Levy
                  49
                  Vice President of Finance and
      Chief Financial Officer
                  2005Alan
      M. Mitchel
                  51
                  Senior Vice President of Business and Legal Affairs
                  2005Stephen
      J. Turner
                  37
                  Vice
      President, Chief Technical Officer
                  2003
  The
following sets forth the business experience, principal occupations and
employment of each of our current executive officers.
  Daniel O.
Wilds was appointed our President and Chief Executive Officer and a Director in
August 2003. From 1998 to July 2003, Mr. Wilds served as Chairman,
President and CEO of Northwest Biotherapeutics, Inc., a biotechnology company
focused on discovering, developing, and commercializing immunotherapy products
that safely generate and enhance immune system responses to effectively treat
cancer. Prior to that position, he was President and CEO of Shiloov
Biotechnologies (USA), Inc. from 1997 to 1998. From 1992 to 1996, Mr. Wilds
was President and CEO of Adeza Biomedical Corporation, prior to which he served
as the President and CEO of Medisense, Inc. and President of Baxter’s
Chemotherapy Service. Mr. Wilds has also served as President and COO of
Travenol-Genentech, Inc., a joint venture between Baxter International and
Genentech, Inc., and has held other domestic and international senior management
positions in the biomedical and biopharmaceutical fields. Mr. Wilds
currently serves on the board of directors of Helix BioMedix, Inc.
Mr. Wilds holds a BA from California State University, Los Angeles and an
MBA from Northwestern University.
  Richard
M. Levy was appointed Chief Financial Officer and Vice President of Finance on
June 8, 2006, and served as interim Chief Financial Officer and Vice
President of Finance commencing December 15, 2005. Mr. Levy has
experience as chief financial officer, controller, consultant and auditor. He
served as the CFO for the specialty finance segment and corporate controller for
Washington Mutual Bank. Mr. Levy worked for Bank of America for seven
years. His experience there included serving as the senior vice president and
controller of Bank of America Texas operations and also included coordinating
all accounting activities and acting as chief financial officer for new
acquisitions, His work at Bank of America also included international financial
management experience in its international private banking and world banking
divisions. His corporate financial duties included serving as director and as
chief financial officer of various Bank of America subsidiaries. Mr. Levy
earned his BA in business economics and accounting from the University of
California, Santa Barbara and is licensed as a CPA.
  Alan M.
Mitchel has worked for SCOLR Pharma since January 2005 as Senior Vice President
of Business and Legal Affairs and Chief Legal Officer. For more than five years
prior to joining us, Mr. Mitchel practiced corporate law with private law
firms in Seattle and Miami. Mr. Mitchel received an LLB from Duke
University School of Law.
  Stephen
J. Turner has worked for SCOLR Pharma since the fall of 1999 and primarily has
been responsible for the commercialization and application of our CDT platform.
In 2003, Mr. Turner was promoted to our Vice President and Chief Technical
Officer. In addition to Mr. Turner’s involvement in our growth and
application of our technology platform, he is named on one patent issued to
SCOLR, has contributed to numerous additional patent filings, has published
articles in industry related publications, and has presented his research
findings at numerous academic seminars and symposia.
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  Mr. Turner
is an active member in scientific organizations including AAPS (American
Association of Pharmaceutical Scientists) and the Controlled Release Society.
Mr. Turner holds a BS in biology with a minor in geochemistry from Western
Washington University.
  Item 1A. Risk
Factors
  This
annual report on Form 10-K contains forward looking statements that involve
risks and uncertainties. Our business, operating results, financial performance,
and share price may be materially adversely affected by a number of factors,
including but not limited to the following risk factors, any one of which could
cause actual results to vary materially from anticipated results or from those
expressed in any forward-looking statements made by us in this annual report on
Form 10-K or in other reports, press releases or other statements issued from
time to time. Additional factors that may cause such a difference are set forth
elsewhere in this annual report on Form 10-K.
  We
have incurred substantial operating losses since we started doing business and
we expect to continue to incur substantial losses in the future, which may
negatively impact our ability to run our business.
  We have
incurred net losses since 2000, including net losses of $10.6 million in 2007,
$10.7 million in 2006, $8.9 million in 2005, and $5.7 million in 2004. We have
accumulated net losses of approximately $57.8 million from our inception through
December 31, 2007, and we expect to continue to incur significant operating
losses in the future.
  We plan
to continue the costly process of simultaneously conducting clinical trials and
preclinical research for multiple product candidates. Our product development
program may not lead to commercial products, either because our product
candidates fail to be effective, are not attractive to the market, or because we
lack the necessary financial or other resources or relationships to pursue our
programs through commercialization. Our net losses are likely to increase
significantly as we continue preclinical research and clinical trials, apply for
regulatory approvals, develop our product candidates, and develop the
infrastructure to support commercialization of our potential
products.
  We have
funded our operations primarily through the issuance of equity securities and we
may not be able to generate positive cash flow in the future. We expect that we
will need to seek additional funds through the issuance of equity securities or
other sources of financing during 2008. If we are unable to obtain necessary
additional financing, our ability to run our business will be adversely affected
and we may be required to reduce the scope of our research and business activity
or cease our operations.
  We
do not have sufficient cash to fund the development of our drug delivery
operations. If we are unable to obtain additional equity or debt financing in
the future, we will be required to delay, reduce or eliminate the pursuit of
licensing, strategic alliances and development of drug delivery
programs.
  We
believe that our cash on hand, including our cash equivalents, will be
sufficient to fund our drug delivery business at planned levels through early
2009. We will need to raise additional capital to fund operations, conduct
clinical trials, continue research and development projects, and commercialize
our product candidates. The timing and amount of our need for additional
financing will depend on a number of factors, including:
  •
                  the
      structure and timing of collaborations with strategic partners and
      licensees;
  •
                  our
      timetable and costs for the development of marketing operations and other
      activities related to the commercialization of our product
      candidates;
  •
                  the
      progress of our research and development programs and expansion of such
      programs;
  •
                  the
      emergence of competing technologies and other adverse market developments;
      and,
  •
                  the
      prosecution, defense and enforcement of potential patent claims and other
      intellectual property rights.
  Additional
equity or debt financing may not be available to us on acceptable terms, or at
all. If we raise additional capital by issuing equity securities, substantial
dilution to our existing stockholders may result which could decrease the market
price of our common stock due to the sale of a large number of shares of our
common stock in the market, or the perception that these sales could occur.
These sales, or the perception of possible sales, could also impair our ability
to raise capital in the future. In addition, the terms of any equity financing
may adversely affect the rights of our existing stockholders. If we raise
additional funds through strategic alliance or licensing arrangements, we may be
required to relinquish rights to certain of our technologies or product
candidates, or to grant licenses on terms that are unfavorable to us, which
could substantially reduce the value of our business.
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  If we are
unable to obtain sufficient additional financing, we would be unable to meet our
obligations and we would be required to delay, reduce or eliminate some or all
of our business operations, including the pursuit of licensing, strategic
alliances and development of drug delivery programs.
  Our
limited experience in preparing applications for regulatory approval of our
products, and our lack of experience in obtaining such approval, may increase
the cost of and extend the time required for preparation of necessary
applications.
  Each OTC
or pharmaceutical product we develop will require a separate costly and time
consuming regulatory approval before we or our collaborators can manufacture and
sell it in the United States or internationally. The regulatory process to
obtain market approval for a new drug takes many years and requires the
expenditure of substantial resources. We have had only limited experience in
preparing applications and do not have experience in obtaining regulatory
approvals. As a result, we believe we will rely primarily on third party
contractors to help us prepare applications for regulatory approval, which means
we will have less control over the timing and other aspects of the regulatory
process than if we had our own expertise in this area. Our limited experience in
preparing applications and obtaining regulatory approval could delay or prevent
us from obtaining regulatory approval and could substantially increase the cost
of applying for such approval.
 We
may not obtain regulatory approval for our products, which would materially
impair our ability to generate revenue.
 We may
encounter delays or rejections during any stage of the regulatory approval
process based upon the failure of clinical data to demonstrate compliance with,
or upon the failure of the product to meet the FDA’s requirements for safety,
efficacy, quality, and/or bioequivalence; and, those requirements may become
more stringent due to changes in regulatory agency policy or the adoption of new
regulations. For example, after submission of a marketing application, in the
form of an NDA or ANDA, the FDA may deny the application, may require additional
testing or data, and/or may require post marketing testing and surveillance to
monitor the safety or efficacy of a product. In addition, the terms of approval
of any marketing application, including the labeling content, may be more
restrictive than we desire and could affect the marketability of products
incorporating our controlled release technology.
  Certain
products incorporating our technology will require the filing of an NDA. A full
NDA must include complete reports of preclinical, clinical, and other studies to
prove adequately that the product is safe and effective, which involves among
other things, full clinical testing, and as a result requires the expenditure of
substantial resources. In certain cases involving controlled release versions of
FDA-approved immediate release products, we may be able to rely on existing
publicly available safety and efficacy data to support an NDA for controlled
release products under Section 505(b)(2) of the FDCA when such data exists
for an approved immediate release or controlled release version of the same
active chemical ingredient. We can provide no assurance, however, that the FDA
will accept a Section 505(b)(2) NDA, or that we will be able to obtain
publicly available data that is useful. The Section 505(b)(2) NDA process
is a highly uncertain avenue to approval because the FDA’s policies on
Section 505(b)(2) have not yet been fully developed. There can be no
assurance that the FDA will approve an application submitted under
Section 505(b)(2) in a timely manner or at all. Our inability to rely on
the 505(b)(2) process would increase the cost and extend the time frame for FDA
approvals.
  If
our clinical trials are not successful or take longer to complete than we
expect, we may not be able to develop and commercialize our
products.
  In order
to obtain regulatory approvals for the commercial sale of potential products
utilizing our CDT platform, we or our collaborators will be required to complete
clinical trials in humans to demonstrate the safety and efficacy, or in certain
cases, the bioequivalence, of the products. However, we or our collaborators may
not be able to commence or complete these clinical trials in any specified time
period, or at all, either because the appropriate regulatory agency objects or
for other reasons, including:
  •
                  unexpected
      delays in the initiation of clinical
sites;
  •
                  slower
      than projected enrollment of eligible
patients;
  •
                  competition
      with other ongoing clinical trials for clinical investigators or eligible
      patients;
  •
                  scheduling
      conflicts with participating
clinicians;
  •
                  limits
      on manufacturing capacity, including delays of clinical supplies;
      and,
  •
                  the
      failure of our products to meet required
  standards.
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  We also
rely on academic institutions and clinical research organizations to conduct,
supervise or monitor some or all aspects of clinical trials involving our
product candidates. We have less control over the timing and other aspects of
these clinical trials than if we conducted the monitoring and supervision on our
own. Third parties may not perform their responsibilities for our clinical
trials on our anticipated scheduled or consistent with a clinical trial
protocol.
  Even if
we complete a clinical trial of one of our potential products, the clinical
trial may not indicate that our product is safe or effective to the extent
required by the FDA or other regulatory agency to approve the product. If
clinical trials do not show any potential product to be safe, efficacious, or
bioequivalent, or if we are required to conduct additional clinical trials or
other testing of our products in development beyond those that we currently
contemplate, we may be delayed in obtaining, or may not obtain, marketing
approval for our products. Our product development costs may also increase if we
experience delays in testing or approvals, which could allow our competitors to
bring products to market before we do and would impair our ability to
commercialize our products.
  We
face intense competition in the drug delivery business, and our failure to
compete effectively would decrease our ability to generate meaningful revenues
from our products.
  The drug
delivery business is highly competitive and is affected by new technologies,
governmental regulations, health care legislation, availability of financing,
litigation and other factors. Many of our competitors have longer operating
histories and greater financial, research and development, marketing and other
resources than we do. We are subject to competition from numerous other entities
that currently operate or intend to operate in the industry. These include
companies that are engaged in the development of controlled-release drug
delivery technologies and products as well as other manufacturers that may
decide to undertake in-house development of these products. Some of our direct
competitors in the drug delivery industry include Alza Corporation, Biovail,
Inc., Penwest, Skyepharma PLC, Elan, Flamel, Impax Laboratories, Inc.,
Labopharm, and KV Pharmaceuticals, Inc.
  Many of
our competitors have more extensive experience than we have in conducting
preclinical studies and clinical trials, obtaining regulatory approvals, and
manufacturing and marketing pharmaceutical products. Many competitors also have
competing products that have already received regulatory approval or are in
late-stage development, and may have collaborative arrangements in our target
markets with leading companies and research institutions.
  Our
competitors may develop or commercialize more effective, safer or more
affordable products, or obtain more effective patent protection, than we are
able to develop, commercialize or obtain. As a result, our competitors may
commercialize products more rapidly or effectively than we do, which would
adversely affect our competitive position, the likelihood that our products will
achieve market acceptance, and our ability to generate meaningful revenues from
our products.
  If
we fail to comply with extensive government regulations covering the
manufacture, distribution and labeling of our products, we may have to withdraw
our products from the market, close our facilities or cease our
operations.
  Our
products, potential products, and manufacturing and research activities are
subject to varying degrees of regulation by a number of government authorities
in the United States (including the Drug Enforcement Agency, FDA, Federal Trade
Commission, and Environmental Protection Agency) and in other countries. For
example, our activities, including preclinical studies, clinical trials,
manufacturing, distribution, and labeling are subject to extensive regulation by
the FDA and comparable authorities outside the United States. Also, our
statements and our customers’ statements regarding dietary supplement products
are subject to regulation by the FTC. The FTC enforces laws prohibiting unfair
or deceptive trade practices, including false or misleading advertising. In
recent years, the FTC has brought a number of actions challenging claims by
nutraceutical companies.
  Each OTC
or pharmaceutical product developed by us will require a separate costly and
time consuming regulatory approval before we or our collaborators can
manufacture and sell it in the United States or internationally. Even if
regulatory approval is received, there may be limits imposed by regulators on a
product’s use or it may face subsequent regulatory difficulties. Approved
products are subject to continuous review and the facilities that manufacture
them are subject to periodic inspections. Furthermore, regulatory agencies may
require additional and expensive post-approval studies. If previously unknown
problems with a product candidate surface or the manufacturing or laboratory
facility is deemed non-compliant with applicable regulatory requirements, an
agency may impose restrictions on that product or on us, including requiring us
to withdraw the product from the market, close the facility, and/or pay
substantial fines.
  We also
may incur significant costs in complying with environmental laws and
regulations. We are subject to federal, state, local and other laws and
regulations governing the use, manufacture, storage, handling, and disposal of
materials and
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  certain
waste products. The risk of accidental contamination or injury from these
materials cannot be completely eliminated. If an accident occurs, we could be
held liable for any damages that result and these damages could exceed our
resources.
  Our
ability to commercialize products containing pseudoephedrine may be adversely
impacted by retail sales controls, legislation, and other measures designed to
counter diversion and misuse of pseudoephedrine in the production of
methamphetamine, an illegal drug.
  We are
engaged in the development of an extended-release formulation of
pseudoephedrine. On March 10, 2006, Congress enacted the Patriot Act, which
included the Combat Methamphetamine Epidemic Act of 2005. Among its various
provisions, this national legislation placed restrictions on the purchase and
sale of all products containing pseudoephedrine and imposed quotas on
manufacturers relating to the sale of products containing pseudoephedrine. Many
states have also imposed statutory and regulatory restrictions on the
manufacture, distribution and sale of pseudoephedrine products. We believe that
such quotas and restrictions resulted in delays in obtaining materials necessary
for the development of our pseudoephedrine product. While we have obtained
sufficient supplies to support the planned submission of our ANDA with the FDA
in 2008, our ability to commercialize products containing pseudoephedrine and
the market for such products may be adversely impacted by existing or new retail
sales controls, legislation and market changes relating to diversion and misuse
of pseudoephedrine in the production of methamphetamine.
  If
we cannot establish collaborative arrangements with leading individuals,
companies and research institutions, we may have to discontinue the development
and commercialization of our products.
  We have
limited experience in conducting full scale clinical trials, preparing and
submitting regulatory applications, or manufacturing and selling pharmaceutical
products. In addition, we do not have sufficient resources to fund the
development, regulatory approval, and commercialization of our products. We
expect to seek collaborative arrangements and alliances with corporate and
academic partners, licensors and licensees to assist with funding research and
development, to conduct clinical testing, and to provide manufacturing,
marketing, and commercialization of our product candidates. We may rely on
collaborative arrangements to obtain the regulatory approvals for our
products.
  For our
collaboration efforts to be successful, we must identify partners whose
competencies complement ours. We must also enter into collaboration agreements
with them on terms that are favorable to us and integrate and coordinate their
resources and capabilities with our own. We may be unsuccessful in entering into
collaboration agreements with acceptable partners or negotiating favorable terms
in these agreements.
  If we
cannot establish collaborative relationships, we will be required to find
alternative sources of funding and to develop our own capabilities to
manufacture, market, and sell our products. If we were not successful in finding
funding and developing these capabilities, we would have to terminate the
development and commercialization of our products.
  If
our existing or new collaborations are not successful, we will have to establish
our own commercialization capabilities, which  would be expensive and
time consuming and could delay the commercialization of the affected
product.
  Some of
our products are being developed and commercialized in collaboration with
corporate partners. Under these collaborations, we may be dependent on our
collaborators to fund some portion of development, to conduct clinical trials,
to obtain regulatory approvals for, and manufacture, market and sell products
using our CDT platform.
  We have
very limited experience in manufacturing, marketing and selling pharmaceutical
products. There can be no assurance that we will be successful in developing
these capabilities.
  Our
existing collaborations may be subject to termination on short notice. If any of
our collaborations are terminated, we may be required to devote additional
resources to the product covered by the collaboration, seek a new collaborator
on short notice or abandon the product. The terms of any additional
collaborations or other arrangements that we establish may not be favorable to
us.
  Our
collaborations or other arrangements may not be successful because of factors
such as:
  •
                  our
      collaborators may have insufficient economic motivation to continue their
      funding, research, development, and commercialization
      activities;
  •
                  our
      collaborators may discontinue funding any particular program, which could
      delay or halt the development or commercialization of any product
      candidates arising out of the
program;
   16
 Table of Contents
  •
                  our
      collaborators may choose to pursue alternative technologies or products,
      either on their own or in collaboration with others, including our
      competitors;
  •
                  our
      collaborators may lack sufficient financial, technical or other
      capabilities to develop these product
  candidates;
  •
                  we
      may underestimate the length of time that it takes for our collaborators
      to achieve various clinical development and regulatory approval
      milestones; or,
  •
                  our
      collaborators may be unable to successfully address any regulatory or
      technical challenges they may
encounter.
  We
have no manufacturing capabilities and will be dependent on third party
manufacturers.
  We do not
have commercial scale facilities to manufacture any products we may develop in
accordance with requirements prescribed by the FDA. Consequently, we have to
rely on third party manufacturers of the products we are evaluating in clinical
trials. If any of our product candidates receive FDA or other regulatory
authority approval, we will rely on third-party contractors to perform the
manufacturing steps for our products on a commercial scale. We may be unable to
identify manufacturers on acceptable terms or at all because the number of
potential manufacturers is limited and the FDA and other regulatory authorities,
as applicable, must approve any replacement manufacturer, including us, and we
or any such third party manufacturer may be unable to formulate and manufacture
our drug products in the volume and of the quality required to meet our clinical
and commercial needs. We will be dependent upon these third parties to supply us
in a timely manner with products manufactured in compliance with current good
manufacturing practices (cGMPs) or similar manufacturing standards imposed by
foreign regulatory authorities where our products will be tested and/or
marketed. While the FDA and other regulatory authorities maintain oversight for
cGMP compliance of drug manufacturers, contract manufacturers may at times
violate cGMPs. The FDA and other regulatory authorities may take action against
a contract manufacturer who violates cGMPs. We currently rely on Catalent Pharma
Solutions, LLC (formerly Cardinal Health PTS, LLC) for the production of a
number of our product candidates. Catalent is involved with an ownership
transition that could impact its ability to provide products and services for
us. If Catalent or other third party manufacturers are unable to provide
adequate products and services to us, we could suffer a delay in our clinical
trials and the development of or the submission of products for regulatory
approval. In addition, we would not have the ability to commercialize products
as planned and deliver products on a timely basis, and we may have higher
product costs or we may be required to cease distribution or recall some or all
batches of our products.
  If
we fail to protect and maintain the proprietary nature of our intellectual
property, our business, financial condition and ability to compete would
suffer.
  We
principally rely on patent, trademark, copyright, trade secret and contract law
to establish and protect our proprietary rights. We own or have exclusive rights
to several U.S. patents and patent applications and we expect to apply for
additional U.S. and foreign patents in the future. The patent positions of
pharmaceutical, nutraceutical, and bio-pharmaceutical firms, including ours, are
uncertain and involve complex legal and factual questions for which important
legal issues are largely unresolved. The coverage claimed in our patent
applications can be significantly reduced before a patent is issued, and the
claims allowed on any patents or trademarks we hold may not be broad enough to
protect our technology. In addition, our patents or trademarks may be
challenged, invalidated or circumvented, or the patents of others may impede our
collaborators’ ability to commercialize the technology covered by our owned or
licensed patents. Moreover, any current or future issued or licensed patents, or
trademarks, or existing or future trade secrets or know-how, may not afford
sufficient protection against competitors with similar technologies or
processes, and the possibility exists that certain of our already issued patents
or trademarks may infringe upon third party patents or trademarks or be designed
around by others. In addition, there is a risk that others may independently
develop proprietary technologies and processes that are the same as, or
substantially equivalent or superior to ours, or become available in the market
at a lower price. There is a risk that we have infringed or in the future will
infringe patents or trademarks owned by others, that we will need to acquire
licenses under patents or trademarks belonging to others for technology
potentially useful or necessary to us, and that licenses will not be available
to us on acceptable terms, if at all. We cannot assure you that:
  •
                  our
      patents or any future patents will prevent other companies from developing
      similar or functionally equivalent products or from successfully
      challenging the validity of our
patents;
  •
                  any
      of our future processes or products will be
  patentable;
  •
                  any
      pending or additional patents will be issued in any or all appropriate
      jurisdictions;
  •
                  our
      processes or products will not infringe upon the patents of third parties;
      or,
   17
 Table of Contents
  •
                  we
      will have the resources to defend against charges of patent infringement
      by third parties or to protect our own patent rights against infringement
      by third parties.
  We may
have to litigate to enforce our patents or trademarks or to determine the scope
and validity of other parties’ proprietary rights. Litigation could be very
costly and divert management’s attention. An adverse outcome in any litigation
could adversely affect our financial results and stock price.
  We also
rely on trade secrets and proprietary know-how, which we seek to protect by
confidentiality agreements with our employees, consultants, advisors, and
collaborators. There is a risk that these agreements may be breached, and that
the remedies available to us may not be adequate. In addition, our trade secrets
and proprietary know-how may otherwise become known to or be independently
discovered by others.
  Significant
expenses in applying for patent protection and prosecuting our patent
applications will increase our need for capital and could harm our business and
financial condition.
  We intend
to continue our substantial efforts in applying for patent protection and
prosecuting pending and future patent applications both in the United States and
internationally. These efforts have historically required the expenditure of
considerable time and money, and we expect that they will continue to require
significant expenditures. If future changes in United States or foreign patent
laws complicate or hinder our efforts to obtain patent protection, the costs
associated with patent prosecution may increase significantly.
  If
we fail to attract and retain key executive and technical personnel we could
experience a negative impact on our ability to develop and commercialize our
products and our business will suffer.
  The
success of our operations will depend to a great extent on the collective
experience, abilities and continued service of relatively few individuals. We
are dependent upon the continued availability of the services of our employees,
many of whom are individually key to our future success. For example, if we lose
the services of our President and CEO, Daniel O. Wilds, or our Vice President
and Chief Technical Officer, Stephen J. Turner, we could experience a negative
impact on our ability to develop and commercialize our CDT technology, our
financial results, and our stock price. We also rely on members of our
scientific staff for product research and development. The loss of the services
of key members of this staff could substantially impair our ongoing research and
development and our ability to obtain additional financing. We do not carry key
man life insurance on any of our personnel.
  In
addition, we are dependent upon the continued availability of Dr. Reza
Fassihi, a member of our board of directors with whom we have a consulting
agreement. The agreement may be terminated by either party on 30 days’ notice.
If our relationship with Dr. Fassihi is terminated, we could experience a
negative impact on our ability to develop and commercialize our CDT
technology.
  Our
success also significantly depends upon our ability to attract and retain highly
qualified personnel. We face intense competition for personnel in the drug
delivery industry. To compete for personnel, we may need to pay higher salaries
and provide other incentives than those paid and provided by more established
entities. Our limited financial resources may hinder our ability to provide such
salaries and incentives. Our personnel may voluntarily terminate their
relationship with us at any time, and the process of locating additional
personnel with the combination of skills and attributes required to carry out
our strategy could be lengthy, costly, and disruptive. If we lose the services
of key personnel, or fail to replace the services of key personnel who depart,
we could experience a severe negative impact on our financial results and stock
price.
  Future
laws or regulations may hinder or prohibit the production or sale of our
products.
  We may be
subject to additional laws or regulations in the future, such as those
administered by the FDA or other federal, state or foreign regulatory
authorities. Laws or regulations that we consider favorable, such as the Dietary
Supplement Health and Education Act, DSHEA, may be repealed. Current laws or
regulations may be interpreted more stringently. We are unable to predict the
nature of such future laws, regulations or interpretations, nor can we predict
what effect they may have on our business. Possible effects or requirements
could include the following:
  •
                  the
      reformulation of certain products to meet new
  standards;
  •
                  the
      recall or discontinuance of certain products unable to be
      reformulated;
  •
                  imposition
      of additional record keeping
requirements;
  •
                  expanded
      documentation of the properties of certain products;
  or,
   18
 Table of Contents
  •
                  expanded
      or different labeling, or scientific
  substantiation.
  Any such
requirement could have a material adverse effect on our results of operations
and financial condition.
  If
we fail to adequately manage the size of our business, it could have a severe
negative impact on our financial results or stock price.
  Our
management believes that, to be successful, we must appropriately manage the
size of our business. We have added numerous personnel and have added several
new research and development projects. We anticipate that we will experience
additional growth in connection with the development, manufacture, and
commercialization of our products. If we experience rapid growth of our
operations, we will be required to implement operational, financial and
information procedures and controls that are efficient and appropriate for the
size and scope of our operations. The management skills and systems currently in
place may not be adequate and we may not be able to manage any significant
growth effectively. Our failure to effectively manage our existing operations or
our growth could have a material adverse effect on our financial performance or
stock price.
  If
we fail to maintain an effective system of internal controls, we may not be able
to accurately report our financial results or prevent fraud.
  Effective
internal controls are necessary for us to provide reliable financial reports and
effectively prevent fraud. If we cannot provide reliable financial reports or
prevent fraud, our operating results could be harmed.
  A
significant number of shares of our common stock are or will be eligible for
sale in the open market, which could drive down the market price for our common
stock and make it difficult for us to raise capital.
  As of
March 3, 2008, 41,031,385 shares of our common stock were outstanding, and there
were 7,228,663 shares of our common stock issuable upon outstanding options and
warrants. In addition, approximately $21.1 million in shares of our common
stock will remain available for issuance under a shelf registration statement
declared effective by the SEC in November 2005. Our stockholders may experience
substantial dilution if we raise additional funds through the sale of equity
securities, and sales of a large number of shares by us or by existing
stockholders could materially decrease the market price of our common stock and
make it more difficult for us to raise additional capital through the sale of
equity securities. The risk of dilution and the resulting downward pressure on
our stock price could also encourage stockholders to engage in short sales of
our common stock. By increasing the number of shares offered for sale, material
amounts of short selling could further contribute to progressive price declines
in our common stock.
  Our
stock price is subject to significant volatility.
  The
market price of our common stock could fluctuate significantly. Those
fluctuations could be based on various factors in addition to those otherwise
described in this report, including:
  •
                  general
      conditions in the healthcare
industry;
  •
                  general
      conditions in the financial
markets;
  •
                  our
      failure or the failure of our collaborative partners, for any reason, to
      obtain FDA approval for any of our products or products we
      license;
  •
                  for
      those products that are ultimately approved by the FDA, the failure of the
      FDA to approve such products in a timely manner consistent with the FDA’s
      historical approval process;
  •
                  our
      failure, or the failure of our third-party partners, to successfully
      commercialize products approved by the
FDA;
  •
                  our
      failure to generate product revenues anticipated by
    investors;
  •
                  problems
      with our sole contract
manufacturer;
  •
                  the
      exercise of our right to redeem certain outstanding warrants to purchase
      our common stock;
  •
                  the
      sale of additional debt and/or equity securities by
  us;
  •
                  announcements
      by us or others of the results of preclinical testing and clinical trials
      and regulatory actions, technological innovations or new commercial
      therapeutic products; and,
   19
 Table of Contents
  •
                  developments
      or disputes concerning patent or any other proprietary
    rights.
  Certain
provisions in our charter documents and otherwise may discourage third parties
from attempting to acquire control of our company, which may have an adverse
effect on the price of our common stock.
  Our board
of directors has the authority, without obtaining stockholder approval, to issue
up to 5,000,000 shares of preferred stock and to fix the rights, preferences,
privileges and restrictions of such shares without any further vote or action by
our stockholders. Our certificate of incorporation and bylaws also provide for
special advance notice provisions for proposed business at annual meetings. In
addition, Delaware and Washington law contain certain provisions that may have
the effect of delaying, deferring or preventing a hostile takeover of our
company. Further, we have a stockholder rights plan that is designed to cause
substantial dilution to a person or group that attempts to acquire our company
without approval of our board of directors, and thereby make a hostile takeover
attempt prohibitively expensive for a potential acquiror. These provisions,
among others, may have the effect of making it more difficult for a third party
to acquire, or discouraging a third party from attempting to acquire, control of
our company, even if stockholders may consider such a change in control to be in
their best interests, which may cause the price of our common stock to
suffer.
  Item 1B.
                  Unresolved
      Staff Comments
  None.
  Item 2.
                  Properties
  Our
corporate headquarters, including administrative offices and research and
development facilities, are located approximately 15 miles east of Seattle,
Washington at 3625 132nd Avenue SE, Bellevue, Washington 98006. The property,
consisting of approximately 14,600 square feet, is leased until
September 30, 2008. In December 2007, we exercised our right to extend the
lease for an additional five years.  In May 2006, we entered into a
lease agreement for 8,544 rentable square feet of commercial space at 13221 SE
26th
Street, Bellevue, Washington. The lease has a term of five years.
  Item 3.
                  Legal
      Proceedings
  We are
not a party to any material litigation.
  Item 4.
                  Submission
      of Matters to a Vote of Securities
Holders
  No
matters were submitted to our stockholders during the quarter ended
December 31, 2007.
   20
 Table of Contents
  PART
II
  Item 5.
                  Market
      for the Registrant’s Common Equity, Related Stockholder Matters and Issuer
      Purchases of Equity Securities
  Our
common stock is traded on the American Stock Exchange under the symbol “DDD.”
The last sale price of our common stock as reported on the American Stock
Exchange on March 3, 2008, was $1.23 per share. The following table sets
forth the range of high and low close prices for our common stock as reported on
the American Stock Exchange for each full quarterly period from January 1,
2006, through December 31, 2007.
  COMMON
STOCK
  High
                  
                  
                  Low2006First
      Quarter
                  
                  $
                  8.00
                  
                  
                  $
                  5.49Second
      Quarter
                  
                  
                  5.85
                  
                  
                  
                  4.52Third
      Quarter
                  
                  
                  6.00
                  
                  
                  
                  4.69Fourth
      Quarter
                  
                  
                  5.89
                  
                  
                  
                  4.362007First
      Quarter
                  
                  $
                  4.80
                  
                  
                  $
                  2.07Second
      Quarter
                  
                  
                  2.82
                  
                  
                  
                  2.21Third
      Quarter
                  
                  
                  3.00
                  
                  
                  
                  1.62Fourth
      Quarter
                  
                  
                  3.89
                  
                  
                  
                  1.17
  As of
March 3, 2008, we had 1,206 stockholders of record. We have not paid or
declared any dividends upon our common stock since inception and do not
contemplate or anticipate paying any dividends upon the common stock in the
foreseeable future.
     21
 Table of Contents
  COMPARISON
OF STOCKHOLDER RETURN
  The
following graph compares the cumulative total returns on our common stock since
December 31, 2002, with the cumulative total return of companies included in the
AMEX Composite Index and the AMEX Pharmaceutical Index. The graph assumes that
$100 was invested on December 31, 2002, in our common stock and in each of the
indexes. All values assume reinvestment of the pretax value of dividends paid by
companies included in these indexes and calculated as of December 31 of each
year. We paid no dividend during the period. The data points used for the
performance graph are listed in the chart below.
  
 December
      31,
                    
                    2002
                    
                    
                    2003
                    
                    
                    2004
                    
                    
                    2005
                    
                    
                    2006
                    
                    
                    2007SCOLR
      Pharma, Inc.
                    
                    $
                    100.00
                    
                    
                    $
                    240.45
                    
                    
                    $
                    551.69
                    
                    
                    $
                    659.55
                    
                    
                    $
                    528.09
                    
                    
                    $
                    161.80AMEX
      Composite Index
                    
                    $
                    100.00
                    
                    
                    $
                    142.36
                    
                    
                    $
                    173.99
                    
                    
                    $
                    213.38
                    
                    
                    $
                    249.45
                    
                    
                    $
                    292.29AMEX
      Pharmaceutical Index
                    
                    $
                    100.00
                    
                    
                    $
                    112.41
                    
                    
                    $
                    106.06
                    
                    
                    $
                    107.19
                    
                    
                    $
                    115.59
                    
                    
                    $
                    113.40
  EQUITY
COMPENSATION PLAN INFORMATION
  Information
relating to our equity compensation plans is incorporated by reference to the
definitive proxy statement for our 2008 annual meeting of stockholders.
Additional information regarding our equity compensation plans is provided in
Note 14 to our financial statements in this annual report.
   22
 Table of Contents
  Item 6.                      Selected Financial
Data
  The
following selected financial data are derived from our financial statements. The
data should be read in connection with the financial statements, related notes
and other financial information included herein.
  Year Ended
      December 31,2007
                  
                  
                  2006
                  
                  
                  2005
                  
                  
                  2004
                  
                  
                  2003(1)STATEMENT
      OF OPERATIONS DATA:Net
      revenues
                  
                  $
                  1,971,783
                  
                  
                  $
                  2,278,449
                  
                  
                  $
                  635,407
                  
                  
                  $
                  441,993
                  
                  
                  $
                  6,594,073Cost
      of revenues
                  
                  
                  —
                  
                  
                  
                  —
                  
                  
                  
                  —
                  
                  
                  
                  —
                  
                  
                  
                  4,576,679Gross
      profit
                  
                  
                  1,971,783
                  
                  
                  
                  2,278,449
                  
                  
                  
                  635,407
                  
                  
                  
                  441,993
                  
                  
                  
                  2,017,394Selling,
      general and administrative
                  
                  
                  5,491,602
                  
                  
                  
                  7,050,961
                  
                  
                  
                  3,553,915
                  
                  
                  
                  2,908,905
                  
                  
                  
                  4,673,008Research
      and development
                  
                  
                  7,768,346
                  
                  
                  
                  7,692,903
                  
                  
                  
                  5,878,290
                  
                  
                  
                  2,603,361
                  
                  
                  
                  403,186Loss
      from operations
                  
                  
                  (11,288,165
                  )
                  
                  
                  (12,465,415
                  )
                  
                  
                  (8,796,798
                  )
                  
                  
                  (5,070,273
                  )
                  
                  
                  (3,058,800
                  )Other
      income and expense, net
                  
                  
                  669,227
                  
                  
                  
                  1,722,185
                  
                  
                  
                  (89,265
                  )
                  
                  
                  (677,408
                  )
                  
                  
                  (5,683,737
                  )Net
      loss
                  
                  $
                  (10,618,938
                  )
                  
                  $
                  (10,743,230
                  )
                  
                  $
                  (8,886,063
                  )
                  
                  $
                  (5,747,681
                  )
                  
                  $
                  (8,742,537
                  )BALANCE
      SHEET DATA:Cash
      and cash equivalents
                  
                  $
                  11,825,371
                  
                  
                  $
                  15,217,946
                  
                  
                  $
                  10,928,442
                  
                  
                  $
                  6,758,860
                  
                  
                  $
                  1,282,656Short-term
      investments
                  
                  
                  —
                  
                  
                  
                  993,542
                  
                  
                  
                  2,391,775
                  
                  
                  
                  —
                  
                  
                  
                  —Working
      capital
                  
                  
                  11,050,184
                  
                  
                  
                  16,239,020
                  
                  
                  
                  13,398,326
                  
                  
                  
                  6,318,119
                  
                  
                  
                  817,107Total
      assets
                  
                  
                  13,687,454
                  
                  
                  
                  18,494,480
                  
                  
                  
                  15,680,087
                  
                  
                  
                  9,960,478
                  
                  
                  
                  5,507,944Long-term
      obligations
                  
                  
                  111,119
                  
                  
                  
                  —
                  
                  
                  
                  —
                  
                  
                  
                  3,137
                  
                  
                  
                  50,979Fair
      value of warrants to purchase common stock
                  
                  
                  —
                  
                  
                  
                  1,171,045
                  
                  
                  
                  2,230,457
                  
                  
                  
                  2,133,160
                  
                  
                  
                  —Temporary
      equity
                  
                  
                  —
                  
                  
                  
                  —
                  
                  
                  
                  9,147,484
                  
                  
                  
                  1,415,974
                  
                  
                  
                  —Accumulated
      deficit
                  
                  
                  (57,834,638
                  )
                  
                  
                  (47,053,678
                  )
                  
                  
                  (36,310,448
                  )
                  
                  
                  (27,424,385
                  )
                  
                  
                  (21,676,704
                  )Stockholders’
      equity
                  
                  
                  12,152,019
                  
                  
                  
                  16,123,635
                  
                  
                  
                  3,370,805
                  
                  
                  
                  5,284,178
                  
                  
                  
                  3,085,523PER
      SHARE DATA:Net
      loss
                  
                  $
                  (0.28
                  )
                  
                  $
                  (0.29
                  )
                  
                  $
                  (0.26
                  )
                  
                  $
                  (0.19
                  )
                  
                  $
                  (0.41
                  )Weighted
      average shares of common stock outstanding
                  
                  
                  38,348,560
                  
                  
                  
                  37,155,613
                  
                  
                  
                  34,323,934
                  
                  
                  
                  29,781,604
                  
                  
                  
                  21,518,982
  No cash
dividends have been declared.
 ______________________________
 (1)
                  The
      sale of our probiotics assets was effective as of December 31, 2003.
      As a result of this sale, only our financial results for 2003 include
      operations of the probiotics unit.
  Item 7.                      Management’s
Discussion and Analysis of Financial Condition and Results of
Operations
  We are a
specialty pharmaceutical company that develops and formulates over-the-counter
products, prescription drugs, and dietary supplement products that use our
patented CDT technology. Our drug delivery business generates royalty revenue
from CDT-based sales in the dietary supplement markets. However, we will
continue to incur significant net losses as we advance preclinical research and
clinical trials, apply for regulatory approvals, develop our product candidates,
expand our operations and develop the infrastructure to support
commercialization of our potential products. Our results of operations going
forward will be dependent on our ability to commercialize our products and
technology and generate royalties, development fees, milestone, and similar
payments. While our strategy includes a significant commitment to research and
development activities in connection with the growth of our drug delivery
platform, we do not expect to initiate significant new programs unless we obtain
additional sources of funding.
  We have
generated substantially all of our working capital through the sale of equity
securities. On December 4, 2007, we raised approximately $4.2 million in gross
proceeds through a registered direct offering of 2,781,100 shares of our common
stock at a purchase price of $1.50 per share. Purchasers of our stock also
received warrants to purchase 1,390,550 shares of common stock at an exercise
price of $2.10 per share, exercisable for five years. Net proceeds of the
offering were approximately $3.6 million.
  On
April 21, 2006, we raised approximately $11.9 million in gross proceeds
through a registered direct offering of 2,370,100 shares of our common stock at
$5.00 per share. Net proceeds of the offering were approximately $10.9 million
after placement agent fees of approximately $711,000 and other direct and
incremental offering costs.
   23
 Table of Contents
  On
November 16, 2005, the Securities and Exchange
Commission  declared effective our registration statement that we
filed using a “shelf” registration process. Under this process, we may offer
from time-to-time in one or more offerings common stock and/or warrants to
purchase common stock at an aggregate public offering price of up to $40
million. As of December 31, 2007, approximately $21.1 million remained
available for issuance under this shelf registration statement which expires in
November 2008.
  Critical
Accounting Policies and Estimates
  Our
financial statements are presented in accordance with accounting principles that
are generally accepted in the United States. All professional accounting
standards effective as of December 31, 2007, have been taken into
consideration in preparing the financial statements. The preparation of the
financial statements requires estimates and assumptions that affect the reported
amounts of assets, liabilities, revenues, expenses and related disclosures. Some
of those estimates are subjective and complex, and, therefore, actual results
could differ from those estimates. An accounting policy is deemed to be critical
if it requires an accounting estimate to be made based on assumptions about
matters that are highly uncertain at the time the estimate is made and if
different estimates that reasonably could have been used, or changes in the
accounting estimates that are reasonably likely to occur periodically, could
materially impact the financial statements. We believe the following critical
accounting policies reflect our more significant estimates and assumptions used
in the preparation of our financial statements.
  Revenue
Recognition
  We
generate revenue from collaborative agreements, licensing fees, and from the
assignment of developed and patented technology. We must exercise judgment and
use estimates to determine the amount of revenue to recognize each period.
Revenue under collaborative arrangements may take the form of up-front payments,
payments for milestones, reimbursement of research and development costs, and
licensing payments. We recognize license revenue from intellectual technology
agreements. The payments received under these research collaboration agreements
are contractually not refundable even if the research effort is not successful.
Performance under our collaborative agreements is measured by scientific
progress, as mutually agreed upon by us and our collaborators.
  Up-front Payments. Up-front
payments from our research collaborations include payments for technology
transfer and access rights. Non-refundable, up-front payments received in
connection with collaborative research and development agreements are deferred
and recognized as licensing fees on a straight-line basis over the relevant
periods specified in the agreement, generally the research term. When the
research term is not specified in the agreement and instead the agreement
specifies the completion or attainment of a particular development goal, we make
an estimate of the time required to achieve that goal considering our experience
with similar projects, level of effort and the development stage of the project.
We review the basis of our revenue recognition and adjust it as necessary based
on the status of the project against the estimated timeline as additional
information becomes available.
  License Fees. Non-refundable
license fees where we have completed all future obligations are recognized as
revenue in the period when persuasive evidence of an agreement exists, delivery
has occurred, collectability is reasonably assured and the price is fixed and
determinable.
  Royalty Income. Royalties
from licensees are based on reported sales of licensed products and revenue is
calculated based on contract terms when reported sales are reliably measurable
and collectability is reasonably assured.
  Research and Development
Income. Revenues from milestone payments are recognized when the
milestone has been achieved, as long as the achievement of the milestone was not
reasonably assured at the inception of the arrangement, there was substantial
effort involved in achieving the milestone, the amount of the milestone payment
is reasonable in relation with the level of effort associated with the
achievement of the milestone, and the payment is non-refundable. Each milestone
event must have substance, and must represent the achievement of specific
defined goals. Reimbursements of research and development expenses we incur in
connection with collaborative agreements are recognized as revenue at the time
these amounts are determined to be measurable, reliable, and
collectable.
  Our
judgment in determining the collectability of amounts due impacts the timing of
revenue recognition. Credit worthiness and collectability are assessed, and when
a party is not deemed credit worthy, revenue is recognized when payment is
received. We also assess whether fees are fixed or determinable prior to
recognizing revenue. We must make interpretations of our customer contracts and
use estimates and judgments in determining if the fees associated with a license
arrangement are fixed or determinable. In applying these criteria to revenue
transactions, we must exercise judgment and use estimates to determine the
amount of up-front payments, license fees, research and development income, and
royalty income revenue to be recognized each period.
   24
 Table of Contents
  Derivative
Financial Instruments
  We
issued warrants in a private placement financing which contain registration
rights where significant liquidated damages could be required to be paid to the
holder of the instrument in the event a registration statement covering the
resale of shares issuable upon exercise of the warrants fails to remain
effective for a preset time period. We account for these warrants at fair value
in accordance with EITF 00-19, Accounting
for Derivative Financial Instruments Indexed to, and Potentially Settled in, a
Company’s Stock. The Black-Scholes option pricing valuation model is used
to determine the fair value of these warrants. Use of this model requires us to
make assumptions regarding stock volatility, dividend yields, expected term of
the warrants and risk-free interest rates.
  Deferred
Taxes—Valuation Allowance
  We
make estimates and use our judgment in determining the provision for income
taxes, deferred tax assets and liabilities, and any valuation allowance recorded
against net deferred tax assets. We record a valuation allowance to reduce our
deferred tax assets to the amount that is more likely than not to be realized.
While we may consider any potential future taxable income and ongoing prudent
and feasible tax planning strategies in assessing the need for the valuation
allowance, in the event we were to determine that we would be able to realize
our deferred tax assets in the future in excess of our net recorded amount, an
adjustment to the deferred tax asset would increase income in the period in
which we made such determination. At December 31, 2007, we had recorded
full valuation totaling approximately $16.5 million against our net deferred tax
assets.
 Change
in Accounting for Fair Value of Warrants to Purchase Common Stock
  We have
previously classified warrants we issued as a part of our February 24,
2004, private placement as a liability because we agreed to pay liquidated
damages to warrant holders in the event that the effective SEC registration
statement registering the resale of shares of common stock issuable upon
exercise of warrants does not remain effective. In December 2006, the FASB
issued FASB Staff Position EITF 00-19-2, “Accounting for Registration Payment
Arrangements” (FSP EITF 00-19-2), which provides guidance on the impact the
registration rights have on the classification of the warrants. Based on the
guidance of the FSP, we now evaluate separately the warrants and the
registration rights obligations and we reclassified the fair value of the
warrant liability to stockholders’ equity on January 1, 2007. The amount we
reclassified was $1,171,045, which was based on the fair value of the warrant
liability at December 31, 2006. The fair value of the entire arrangement at
inception was $1,527,245. The difference between the fair value of warrant
liability at inception and December 31, 2006, was $356,200, however, we
previously reclassified $194,178 as a cumulative effect adjustment to the
opening balance of accumulated deficit. The adoption of FSP EITF 00-19-02 had no
effect on our net loss.
  Results
of Operations
  Fiscal
2007 Compared to Fiscal 2006
  Revenues
  Total
revenues for the year ended December 31, 2007, were $2.0 million, a
decrease of 13%, compared to $2.3 million for the same period in 2006. Royalty
revenue from our CDT-based product sales to the dietary supplement markets
increased 38%, or $321,457, to $1.2 million for the year ended December 31,
2007, compared to $856,027 for the same period in 2006 largely as a result of
royalties generated through our alliance with Perrigo. The increase in royalty
income during 2007 from our alliance with Perrigo was offset by a decrease in
research and development income due to the termination of our agreement with
Wyeth Consumer Healthcare in March 2007.
  Royalty
payments from Perrigo are based solely on Perrigo’s net profits of CDT-based
products which involve uncertainties and are difficult to predict. Revenues from
Perrigo declined in the second half of 2007 primarily as a result of the
discontinuation of one of our products at a large customer. However, we expect
sales to increase in 2008 as the product will be reintroduced at the large
customer in 2008, and as a result of increasing sales of our calcium product was
introduced in late 2007. Revenues from Nutraceutix will decline in 2008, as a
result of the termination of the license agreement on December 31,
2007.
  Licensing
fees increased in 2007 due to the recognition of the outstanding balance of
deferred licensing revenue. In the first quarter of 2007, we received
approximately $600,000 in milestone payments from Wyeth as compared to $1.3
million in milestone payments in 2006. Revenues from Perrigo and Wyeth
represented 49% and 40%, respectively, of our total revenues during 2007.
Accounts receivable at year-end decreased as a result of a lower level of
revenue activity during the fourth quarter of 2007.
   25
 Table of Contents
  In 2007,
licensing fee income of $173,077 was recognized attributable to previously
deferred licensing fee revenue associated with our license agreement with Wyeth.
The December 2005 agreement with Wyeth provided for an upfront fee of $250,000
which was recorded as deferred revenue and was amortized over the development
period until the contract was terminated, at which time the remaining balance
was recorded to income.
  Marketing
and Selling Expenses
  Marketing
and selling expenses increased 15%, or $123,625, to $936,696 for the year ended
December 31, 2007, compared to $813,071 for the same period in 2006,
primarily due to an increase of $34,209 related to higher salaries. Commission
expense increased $20,419 related to higher royalty income offset by a decrease
of $27,393 in non-cash, share-based compensation expense. The remainder of the
increase in marketing and selling expenses was attributable to increases in
advertising and promotion costs associated with participation in additional
trade shows and conferences and consulting services for product
marketing.
  Research
and Development Expenses
  Research
and development expenses increased 1%, or $75,443, to $7.8 million for the year
ended December 31, 2007, compared to $7.7 million for the same period in
2006. This slight increase was primarily due to a $512,229 increase in our
outside manufacturing, supplies and clinical trial expenses, and a $229,181
increase in salaries, wages and employee benefits. These increases were offset
by a reduction of $800,000 in license expense associated with amendments to our
license agreements with Temple University and Archer-Daniels-Midland Company in
2006.
  In August
2006, we amended our license agreement with Temple University to reduce the
royalty rate for prescription drugs under the salt patent. This amendment
provided for payments by us of $400,000 to the inventors of the patent,
including $200,000 to Dr. Reza Fassihi, a member of our board of directors.
We agreed to pay ADM $450,000 in connection with the amendment of our license
agreement. We paid $200,000 in August 2006 and the remaining $250,000 in
2007.
  General
and Administrative Expenses
  General
and administrative expenses decreased 27%, or $1.7 million, to $4.6 million for
the year ended December 31, 2007, compared to $6.2 million for the same
period in 2006, primarily due to non-cash, share-based compensation decreases of
$910,121 due to the timing of stock option grants, and a lower fair value of
stock options granted in 2007. There were  decreases of $413,958 for
accounting expenses associated with initial costs of compliance with the
Sarbanes-Oxley Act of 2002 and SFAS 123(R) implementation. Additionally, payroll
related expenses including bonuses, decreased $39,071 and insurance expense
decreased approximately $60,000 due to lower premiums.
  Other
Income (Expense), Net
  Other
income decreased 61%, or $1.1 million, to $669,227 for the year ended
December 31, 2007, compared to $1.7 million for the same period in 2006,
primarily due to the reduction of an unrealized gain on the fair value of
warrants liability as we reclassified warrants issued from liabilities to
equity. In addition, interest income decreased due to lower balances and
interest rates.
  Net
Loss
  Net loss
decreased 1%, or $124,292, to $10.6 million for the year ended December 31,
2007, compared to $10.7 million for the same period in 2006, primarily due to
lower operating expenses, including costs associated with the amendments to our
license agreements with Temple University and ADM in 2006, and non-cash
share-based compensation expense resulting from the timing of stock option
grants and a lower fair value of stock options granted in 2007.
  Fiscal
2006 Compared to Fiscal 2005
  Revenues
  Total
revenues increased significantly, or $1.6 million to $2.3 million for the year
ended December 31, 2006, compared to $635,407 for 2005, primarily as a
result of the recognition of $1.3 million of research and development income
attributable to our agreement with Wyeth and increased royalty income of
$651,202 resulting from our alliance with Perrigo. Revenues from Wyeth and
Perrigo represented 62% and 29%, respectively, of our total revenues during
2006. Accounts receivable at year-end increased as a result of a higher level of
revenue activity during the fourth quarter of 2006.
   26
 Table of Contents
  In 2006,
we received a $500,000 milestone payment in accordance with our amended
agreement with Wyeth. We also recognized $832,998 of research and development
income for expense reimbursements from Wyeth. On March 14, 2007, the Company
received a notice of termination from Wyeth terminating the agreement effective
April 16, 2007.
  Royalty
income increased 35%, or $220,622, to $856,028 for the year ended
December 31, 2006, compared to $635,407 for the same period in 2005,
primarily due to a $651,202 increase in income attributable to our alliance with
Perrigo, offset by a decrease in income from ADM and Nutra. The first shipments
of products by Perrigo began in the first quarter of 2006. Income from ADM and
Nutra decreased due to our transition of sales and marketing activities to
Perrigo.
  In 2006,
licensing fee income of approximately $77,000 was attributable to the
recognition of previously deferred licensing fee revenue associated with our
license agreement with Wyeth. The December 2005 agreement with Wyeth provided
for an upfront fee of $250,000 which was recorded as deferred revenue and was
amortized over the development period.
  Marketing
and Selling Expenses
  Marketing
and selling expenses increased significantly, or $526,694 to $813,071 for the
year ended December 31, 2006, compared to $286,377 for the same period in
2005, primarily due to increases of approximately $234,210 in salaries and
related expenses attributable to additional personnel and higher salaries, and
an increase of approximately $100,000 associated with the recognition of
non-cash, share-based compensation expense due to the adoption of SFAS 123(R).
The remainder of the increase in marketing and selling expenses was attributable
to increases in advertising and promotion costs associated with participation in
additional trade shows and conferences, and non-cash, share-based compensation
costs for outside consulting services.
  Research
and Development Expenses
  Research
and development expenses increased 31%, or $1.8 million, to $7.7 million for the
year ended December 31, 2006, compared to $5.9 million for the same period
in 2005. This increase reflected the recognition of $800,000 in expense
associated with amendments to our license agreements with Temple University and
ADM, $600,000 for non-cash, share-based compensation expense due to the adoption
of SFAS 123(R), a $200,000 increase in salaries, wages and employee benefits,
and a $153,910 increase in rent. Increased rent reflected costs associated with
the lease of additional space.
  Of the
$800,000 expense for amendments to our license agreements, $400,000 was
associated with the amendment to the license agreement with Temple University
relating to the salt patent. The amendment to the agreement with Temple
University reduced the royalty rate for prescription drugs under the salt patent
and resulted in a payment of $400,000 to the inventors of the patent, including
$200,000 to Dr. Reza Fassihi, a member of our board of directors. The
remaining $400,000 of the expense for amendments was associated with the
amendment of the license agreement with ADM, representing (i) a $200,000
payment to ADM, (ii) the accrual of $250,000 associated with our obligation
to pay ADM an additional $250,000 at the earlier of August 10, 2007, or the
completion of a securities offering of not less than $10 million, and
(iii) the recognition of $50,000 of income from Perrigo based on its
reimbursement of $50,000 of the first cash payment to ADM, which offset research
and development expense. Perrigo also reimbursed us for $50,000 of the August
2007 payment to ADM.
  General
and Administrative Expenses
  General
and administrative expenses increased 91%, or $2.9 million, to $6.2 million for
the year ended December 31, 2006, compared to $3.3 million for the same
period in 2005, primarily due to non-cash, share-based compensation costs,
expenses associated with compliance with the Sarbanes-Oxley Act of 2002, higher
insurance costs, and higher salaries and wages. Employee and director non-cash,
share-based compensation costs increased $1.6 million due to the adoption of
SFAS 123(R) and increased approximately $200,000 due to consulting expenses
associated with the November 2005 advisory services agreement with Michael
Taglich, chairman of our board of directors. Consulting expenses, comprised of
compliance costs associated with development and implementation of internal
controls and compliance with Section 404 of the Sarbanes-Oxley Act,
external reporting and information technology services, contributed $243,935 to
the increase. Salaries and wages increased $409,720 due to increased personnel,
and severance costs incurred in the first quarter of 2006. Insurance expense
increased approximately $174,080 due to expanded coverage.
  Other
Income (Expense), Net
  Other
income increased $1.8 million, to $1.7 million income for the year ended
December 31, 2006, compared to $89,265 expense for the same period in 2005,
primarily due to the recognition of an unrealized gain on the fair value of
warrants liability and increased interest income.
   27
 Table of Contents
  Unrealized
gain on the fair value of warrants liability was approximately $1.0 million for
the year ended December 31, 2006, compared to a loss of $97,297 for the
same period in 2005. The unrealized gain represented the change in fair value of
the liability associated with warrants issued in connection with our February
2004 private placement. The fair value was estimated using the Black-Scholes
option pricing model and the gain and loss recorded in 2006 and 2005,
respectively, resulted from a decline and increase in the fair value of our
common stock during the respective years.
  The
increase in interest income was attributable to higher cash balances and
interest rates.
  Net
Loss
  Net loss
increased 21%, or $1.8 million, to $10.7 million for the year ended
December 31, 2006, compared to $8.9 million for the same period in 2005,
primarily due to our higher operating expenses, including costs associated with
the amendments to our license agreements with Temple University and ADM, and
non-cash share-based compensation expense resulting from the adoption of SFAS
123(R). The impact of these items on net loss was offset by increases in revenue
and other income.
  Liquidity and
Capital Resources
  As of
December 31, 2007, we had $11.1 million of working capital compared to
$16.2 million as of December 31, 2006. We have accumulated net losses of
approximately $57.8 million from our inception through December 31, 2007.
We have funded our operations primarily through the issuance of equity
securities, including $3.6 million and $10.9 million in net proceeds from our
registered direct offerings in December 2007 and April 2006, respectively, and
$14.1 million from our private placement in February 2005. Net cash provided by
financing activities decreased to $4.0 million in 2007 compared to $11.6 million
in 2006.
  We used
cash of $7.8 million for operating activities in 2007, which was $1.2 million
less than the amount used for operations during 2006. Expenditures during this
period decreased as a result of reduced general and administrative expenses,
which was offset by increased marketing activities. Cash provided by investing
activities was $407,088 in 2007, compared to $1.7 million in 2006, primarily due
to the decreased application of maturing short-term investments.
  We expect
our operating losses and negative cash flow to continue as we continue
preclinical research and clinical trials, apply for regulatory approvals, and
develop our product candidates. We believe our cash, cash equivalents and
short-term investments will be sufficient to fund our operations at planned
levels through early 2009. We plan to continue the costly process of
simultaneously conducting clinical trials and preclinical research for multiple
product candidates. We will need to raise additional capital to fund operations,
continue research and development projects, and commercialize our products. We
may not be able to secure additional financing on favorable terms, or at
all.
  We
anticipate that we will need to seek additional funds through the issuance of
equity securities or other sources of financing during 2008. The issuance of a
large number of additional equity securities could cause substantial dilution to
existing stockholders and could cause a decrease in the market price for shares
of our common stock, which could impair our ability to raise capital in the
future through the issuance of equity securities. If we are unable to obtain
necessary additional financing, our ability to run our business will be
adversely affected and we may be required to reduce the scope of our development
activities or discontinue operations.
  As of
December 31, 2007, our commitments to make future payments under long-term
contractual obligations were as follows:
  Payments Due
      by PeriodContractual
      Obligations
                  
                  Total
                  
                  
                  1
      Year
                  
                  
                  2
      to 3
                    Years
                  
                  
                  4
      to 5
                    Years
                  
                  
                  More than
                    5
      YearsOperating
      Leases
                  
                  $
                  2,418,410
                  
                  
                  $
                  368,909
                  
                  
                  $
                  937,804
                  
                  
                  $
                  838,510
                  
                  
                  $
                  273,187Term
      loan
                  
                  
                  212,692
                  
                  
                  
                  94,530
                  
                  
                  
                  118,162
                  
                  
                  
                  —
                  
                  
                  
                  —Total
                  
                  $
                  2,631,102
                  
                  
                  $
                  463,439
                  
                  
                  $
                  1,055,966
                  
                  
                  $
                  838,510
                  
                  
                  $
                  273,187
  We have
certain material agreements with our manufacturing and testing vendors related
to our ongoing clinical trial work associated with our development programs.
Contract amounts are paid based on materials-used and on a work-performed basis.
Generally, we have the right to terminate these agreements upon 30 days notice
and would be responsible for services and materials and related costs incurred
prior to termination.
   28
 Table of Contents
   New
Accounting Pronouncements
  On December 21, 2007, the
SEC issued Staff Accounting Bulletin No. 110, “Share-Based Payment”. SAB
No. 110 addresses the use of a “simplified” method in developing an
estimate of expected term of “plain vanilla” share options in accordance FAS
No. 123(R), “Share-Based Payment”. SAB No. 110 allows the use of the
“simplified” method of estimating expected term where a company may not have
sufficient historical exercise data. SAB No. 110 is effective
January 1, 2008, and we plan to continue to use the simplified method
to estimate the expected term of their plain vanilla employee options.
  On
December 12, 2007, the Financial Accounting Standards Board (FASB) ratified the
Emerging Issues Task Force (“EITF”) opinion related to EITF Issue 07-1,
“Accounting for Collaborative Arrangements.” The Task Force reached a consensus
that a collaborative arrangement is a contractual arrangement that involves two
or more parties, all of which are both (a) involved as active participants in a
joint operating activity that is not conducted primarily through a separate
legal entity and (b) exposed to significant risks and rewards that depend on the
commercial success of the joint operating activity. This Issue also addresses
(i) the income statement classification by participants in a collaborative
arrangement for transactions with third parties and transactions between the
participants and (ii) financial statement disclosures. The consensus on EITF
Issue 07-1 is effective for fiscal years beginning after December 15, 2008, and
for interim periods within those fiscal years. Entities should apply the
consensus retrospectively to all periods presented for only those collaborative
arrangements existing as of the effective date, unless it is impractical to do
so. We will adopt this new accounting pronouncement effective January 1, 2009,
and do not anticipate any material impact on our financial condition or results
of operations.
  In June
2007, the EITF reached a consensus on EITF Issue No. 07-3, “Accounting for
Advance Payments for Goods or Services to be Received for Use in Future Research
and Development Activities”. EITF 07-3 provides clarification surrounding the
accounting for nonrefundable research and development advance payments, whereby
such payments should be recorded as an asset when the advance payment is made
and recognized as an expense when the research and development activities are
performed. EITF 07-3 is effective for annual periods beginning after December
15, 2007. We will adopt this new accounting pronouncement effective January 1,
2008, and do not anticipate any material impact on our financial condition or
results of operations.
  Item 7A.
                  Qualitative
      and Quantitative Disclosure About Market
Risk
  The
primary objective of our investment activities is to preserve principal while
maximizing the income we receive from our investments without significantly
increasing our risk. We invest excess cash principally in U.S. marketable
securities from a diversified portfolio of institutions with strong credit
ratings and in U.S. government and agency bills and notes, and by policy, limit
the amount of credit exposure at any one institution. Some of the securities we
invest in may have market risk. This means that a change in prevailing interest
rates may cause the principal amount of the investment to fluctuate. To minimize
this risk, we schedule our investments to have maturities that coincide with our
expected cash flow needs, thus avoiding the need to redeem an investment prior
to its maturity date. Accordingly, we believe we have no material exposure to
interest rate risk arising from our investments.
   29
 Table of Contents
  Item 8.                      Financial
Statements and Supplementary Data
  CONTENTS
  PageReports of Independent Registered Public
      Accounting Firm
                  31Financial
      StatementsBalance Sheets
                  33Statements of
Operations
                  34Statement of Stockholders’
      Equity
                  35Statements of Cash Flows
                  37Notes to Financial Statements
                  38
 
  30
 Table
of Contents
  Report of Independent Registered Public
Accounting Firm
  Board of
Directors and Shareholders of SCOLR Pharma, Inc.
  We have
audited the accompanying balance sheets of SCOLR Pharma, Inc. (a Delaware
corporation) (the “Company”) as of December 31, 2007, and 2006, and the related
statements of operations, shareholders' equity, and cash flows for each of the
three years in the period ended December 31, 2007. 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 the standards of the Public Company
Accounting Oversight Board (United States). 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 Pharma, Inc. as of December
31, 2007, and 2006, and the results of its operations and its cash flows for
each of the three years in the period ended December 31, 2007, in conformity
with accounting principles generally accepted in the United States of
America.
  As
described in Note 1 to the consolidated financial statements, the Company
adopted the fair value recognition provisions of FASB Statement No. 123(R),
Share-Based Payment, using the modified-prospective-transition method effective
January 1, 2006.
  As
described in Note 19 to the consolidated financial statements, on January
1, 2007 the Company adopted Financial Accounting Standards Board Staff Position
EITF 00-19-2 “Accounting for  Registration Payment Arrangements” which
changed the method the Company was using to account for certain warrants and
registration payments.
  We also
have audited, in accordance with the standards of the Public Company Accounting
Oversight Board (United States), the effectiveness of SCOLR Pharma, Inc.’s
internal control over financial reporting as of December 31, 2007, based on
criteria established in Internal Control—Integrated Framework issued by the
Committee of Sponsoring Organizations of the Treadway Commission (COSO) and our
report dated March 6, 2008, expressed an unqualified opinion
thereon.
  
  /s/ GRANT
THORNTON LLP
  
  Seattle,
Washington
  March 6,
2008
   31
 Table of Contents
  Report of
Independent Registered Public Accounting Firm
  Board of
Directors and Shareholders of SCOLR Pharma, Inc.
  We have
audited SCOLR Pharma, Inc.’s (the “Company”) internal control over financial
reporting as of December 31, 2007, based on criteria established in Internal Control—Integrated
Framework issued by the Committee of Sponsoring Organizations of the
Treadway Commission (COSO). SCOLR Pharma, Inc.’s management is responsible for
maintaining effective internal control over financial reporting and for its
assessment of the effectiveness of internal control over financial reporting,
included in the accompanying Management’s Report on Internal Control Over
Financial Reporting. Our responsibility is to express an opinion on SCOLR
Pharma, Inc.’s internal control over financial reporting based on our
audit.
  We
conducted our audit in accordance with the standards of the Public Company
Accounting Oversight Board (United States). Those standards require that we plan
and perform the audit to obtain reasonable assurance about whether effective
internal control over financial reporting was maintained in all material
respects. Our audit included obtaining an understanding of internal control over
financial reporting, assessing the risk that a material weakness exists, testing
and evaluating the design and operating effectiveness of internal control based
on the assessed risk, and performing such other procedures as we considered
necessary in the circumstances. We believe that our audit provides a reasonable
basis for our opinion.
  A
company’s internal control over financial reporting is a process designed to
provide reasonable assurance regarding the reliability of financial reporting
and the preparation of financial statements for external purposes in accordance
with generally accepted accounting principles. A company’s internal control over
financial reporting includes those policies and procedures that (1) pertain to
the maintenance of records that, in reasonable detail, accurately and fairly
reflect the transactions and dispositions of the assets of the company; (2)
provide reasonable assurance that transactions are recorded as necessary to
permit preparation of financial statements in accordance with generally accepted
accounting principles, and that receipts and expenditures of the company are
being made only in accordance with authorizations of management and directors of
the company; and (3) provide reasonable assurance regarding prevention or timely
detection of unauthorized acquisition, use, or disposition of the company’s
assets that could have a material effect on the financial
statements.
  Because
of its inherent limitations, internal control over financial reporting may not
prevent or detect misstatements. Also, projections of any evaluation of
effectiveness to future periods are subject to the risk that controls may become
inadequate because of changes in conditions, or that the degree of compliance
with the policies or procedures may deteriorate.
  In our
opinion, SCOLR Pharma, Inc. maintained, in all material respects, effective
internal control over financial reporting as of  December 31, 2007,
based on criteria established in Internal Control—Integrated
Framework issued by COSO.
  We also
have audited, in accordance with the standards of the Public Company Accounting
Oversight Board (United States), the accompanying balance sheets of SCOLR
Pharma, Inc. as of December 31, 2007 and 2006, and the related statements of
operations, stockholders' equity, and cash flows for each of the three years in
the period ended December 31, 2007 and our report dated March 6, 2008 expressed
an unqualified opinion thereon.
  
  /s/ GRANT
THORNTON LLP
  
  Seattle,
Washington
  March 6,
2008
   32
 Table of Contents
  SCOLR
Pharma, Inc.
  BALANCE SHEETS
  December 31,2007
                  
                  
                  2006ASSETSCurrent
      AssetsCash
      and cash equivalents
                  
                  $
                  11,825,371
                  
                  
                  $
                  15,217,946Short-term
      investments
                  
                  
                  —
                  
                  
                  
                  993,542Accounts
      receivable
                  
                  
                  225,900
                  
                  
                  
                  864,620Interest
      and other receivables
                  
                  
                  16
                  
                  
                  
                  15,576Prepaid
      expenses
                  
                  
                  423,213
                  
                  
                  
                  347,136Total
      current assets
                  
                  
                  12,474,500
                  
                  
                  
                  17,438,820Property
      and equipment—net
                  
                  
                  748,931
                  
                  
                  
                  730,512Intangible
      assets—net
                  
                  
                  464,023
                  
                  
                  
                  325,148$
                  13,687,454
                  
                  
                  $
                  18,494,480LIABILITIES
      AND STOCKHOLDERS’ EQUITYCurrent
      LiabilitiesAccounts
      payable
                  
                  $
                  757,420
                  
                  
                  $
                  189,065Accrued
      liabilities
                  
                  
                  586,849
                  
                  
                  
                  825,158Current
      portion of term loan
                  
                  
                  80,047
                  
                  
                  
                  —Deferred
      revenue
                  
                  
                  —
                  
                  
                  
                  185,577Total
      current liabilities
                  
                  
                  1,424,316
                  
                  
                  
                  1,199,800Long-term
      portion of term loan
                  
                  
                  111,119
                  
                  
                  
                  —Fair
      value of warrants to purchase common stock
                  
                  
                  —
                  
                  
                  
                  1,171,045Total
      liabilities
                  
                  
                  1,535,435
                  
                  
                  
                  2,370,845Commitments
      and Contingencies (Notes 8, and 12)Stockholders’
      EquityPreferred
      stock, authorized 5,000,000 shares, $0.01 par value, none issued or
      outstanding
                  
                  
                  —
                  
                  
                  
                  —Common
      stock, authorized 100,000,000 shares, $0.001 par value, 40,991,385 and
      38,048,146 issued and outstanding as of December 31, 2007 and 2006,
      respectively
                  
                  
                  40,991
                  
                  
                  
                  38,048Additional
      contributed capital
                  
                  
                  69,945,666
                  
                  
                  
                  63,139,210Accumulated
      other comprehensive gain
                  
                  
                  —
                  
                  
                  
                  55Accumulated
      deficit
                  
                  
                  (57,834,638
                  )
                  
                  
                  (47,053,678
                  )Total
      stockholders’ equity
                  
                  
                  12,152,019
                  
                  
                  
                  16,123,635$
                  13,687,454
                  
                  
                  $
                  18,494,480
  The
accompanying notes are an integral part of these financial
statements.
    33
 Table of Contents
   SCOLR
Pharma, Inc.
  STATEMENTS OF OPERATIONS
  Years Ended
      December 31,2007
                  
                  
                  2006
                  
                  
                  2005RevenuesLicensing
      fees
                  
                  $
                  173,077
                  
                  
                  $
                  76,924
                  
                  
                  $
                  —Royalty
                  
                  
                  1,177,484
                  
                  
                  
                  856,027
                  
                  
                  
                  635,407Research
      and development
                  
                  
                  621,222
                  
                  
                  
                  1,345,498
                  
                  
                  
                  —Total
      revenues
                  
                  
                  1,971,783
                  
                  
                  
                  2,278,449
                  
                  
                  
                  635,407Operating
      expensesMarketing
      and selling
                  
                  
                  936,696
                  
                  
                  
                  813,071
                  
                  
                  
                  286,377Research
      and development
                  
                  
                  7,768,346
                  
                  
                  
                  7,692,903
                  
                  
                  
                  5,878,290General
      and administrative
                  
                  
                  4,554,906
                  
                  
                  
                  6,237,890
                  
                  
                  
                  3,267,538Total
      operating expenses
                  
                  
                  13,259,948
                  
                  
                  
                  14,743,864
                  
                  
                  
                  9,432,205Loss
      from operations
                  
                  
                  (11,288,165
                  )
                  
                  
                  (12,465,415
                  )
                  
                  
                  (8,796,798
                  )Other
      income (expense)Interest
      expense
                  
                  
                  (15,724
                  )
                  
                  
                  (170
                  )
                  
                  
                  (5,789
                  )Interest
      income
                  
                  
                  682,010
                  
                  
                  
                  843,427
                  
                  
                  
                  486,288Settlement
      in connection with asset sale and license agreement
                  
                  
                  —
                  
                  
                  
                  —
                  
                  
                  
                  (537,921
                  )Unrealized
      gain (loss) on fair value of warrants
                  
                  
                  —
                  
                  
                  
                  974,211
                  
                  
                  
                  (97,297
                  )Other
                  
                  
                  2,941
                  
                  
                  
                  (95,283
                  )
                  
                  
                  65,454669,227
                  
                  
                  
                  1,722,185
                  
                  
                  
                  (89,265
                  )Net
      loss
                  
                  $
                  (10,618,938
                  )
                  
                  $
                  (10,743,230
                  )
                  
                  $
                  (8,886,063
                  )Net
      loss per share, basic and diluted
                  
                  $
                  (0.28
                  )
                  
                  $
                  (0.29
                  )
                  
                  $
                  (0.26
                  )Shares
      used in calculation of basic and diluted net loss per
share
                  
                  
                  38,348,560
                  
                  
                  
                  37,155,613
                  
                  
                  
                  34,323,934
  The
accompanying notes are an integral part of these financial
statements.
   34
 Table of Contents
  SCOLR
Pharma, Inc.
 STATEMENT OF STOCKHOLDERS’ EQUITY
 Years
Ended December 31, 2007, 2006 and 2005
  Common
      StockNumber of Shares
                  
                  
                  Amount
                  
                  
                  Additional
                    Contributed
                    Capital
                  
                  
                  Accumulated
                    Deficit
                  
                  
                  Accumulated
                    Other
                    Comprehensive
                    Gain
      (Loss)
                  
                  
                  TotalBalance
      at December 31, 2004
                  
                  
                  30,690,886
                  
                  
                  $
                  30,120
                  
                  
                  $
                  32,678,443
                  
                  
                  $
                  (27,424,385
                  )
                  
                  $
                  —
                  
                  
                  $
                  5,284,178Issuance
      of common stock in private placement
                  
                  
                  3,750,000
                  
                  
                  
                  —
                  
                  
                  
                  —
                  
                  
                  
                  —
                  
                  
                  
                  —
                  
                  
                  
                  —Transfer
      of common stock from temporary to permanent equity
                  
                  
                  —
                  
                  
                  
                  1,884
                  
                  
                  
                  6,345,443
                  
                  
                  
                  —
                  
                  
                  
                  —
                  
                  
                  
                  6,347,327Proceeds
      from exercise of common stock options
                  
                  
                  528,916
                  
                  
                  
                  529
                  
                  
                  
                  508,056
                  
                  
                  
                  —
                  
                  
                  
                  —
                  
                  
                  
                  508,585Proceeds
      from exercise of warrants
                  
                  
                  55,000
                  
                  
                  
                  55
                  
                  
                  
                  27,445
                  
                  
                  
                  —
                  
                  
                  
                  —
                  
                  
                  
                  27,500Share-based
      compensation issued for employee services
                  
                  
                  —
                  
                  
                  
                  —
                  
                  
                  
                  63,500
                  
                  
                  
                  —
                  
                  
                  
                  —
                  
                  
                  
                  63,500Cancelled
      stock options
                  
                  
                  —
                  
                  
                  
                  —
                  
                  
                  
                  (63,500
                  )
                  
                  
                  —
                  
                  
                  
                  —
                  
                  
                  
                  (63,500
                  )Stock
      options issued for non-employee services
                  
                  
                  —
                  
                  
                  
                  —
                  
                  
                  
                  90,000
                  
                  
                  
                  —
                  
                  
                  
                  —
                  
                  
                  
                  90,000Unrealized
      loss on short-term investments
                  
                  
                  —
                  
                  
                  
                  —
                  
                  
                  
                  —
                  
                  
                  
                  —
                  
                  
                  
                  (722
                  )
                  
                  
                  (722
                  )Net
      loss
                  
                  
                  —
                  
                  
                  
                  —
                  
                  
                  
                  —
                  
                  
                  
                  (8,886,063
                  )
                  
                  
                  —
                  
                  
                  
                  (8,886,063
                  )Comprehensive
      loss
                  
                  
                  —
                  
                  
                  
                  —
                  
                  
                  
                  —
                  
                  
                  
                  —
                  
                  
                  
                  —
                  
                  
                  
                  (8,886,785
                  )Balance
      at December 31, 2005
                  
                  
                  35,024,802
                  
                  
                  $
                  32,588
                  
                  
                  $
                  39,649,387
                  
                  
                  $
                  (36,310,448
                  )
                  
                  $
                  (722
                  )
                  
                  $
                  3,370,805Issuance
      of common stock in registered direct offering
                  
                  
                  2,370,100
                  
                  
                  
                  2,370
                  
                  
                  
                  10,922,585
                  
                  
                  
                  —
                  
                  
                  
                  —
                  
                  
                  
                  10,924,955Transfer
      of common stock from temporary equity to permanent equity
                  
                  
                  —
                  
                  
                  
                  2,437
                  
                  
                  
                  9,145,047
                  
                  
                  
                  —
                  
                  
                  
                  —
                  
                  
                  
                  9,147,484Proceeds
      from exercise of common stock options
                  
                  
                  370,168
                  
                  
                  
                  370
                  
                  
                  
                  452,519
                  
                  
                  
                  —
                  
                  
                  
                  —
                  
                  
                  
                  452,889Proceeds
      from exercise of warrants
                  
                  
                  283,076
                  
                  
                  
                  283
                  
                  
                  
                  233,981
                  
                  
                  
                  —
                  
                  
                  
                  —
                  
                  
                  
                  234,264Transfer
      of fair value from exercise of warrants
                  
                  
                  —
                  
                  
                  
                  —
                  
                  
                  
                  85,201
                  
                  
                  
                  —
                  
                  
                  
                  —
                  
                  
                  
                  85,201Share-based
      compensation issued for employee services
                  
                  
                  —
                  
                  
                  
                  —
                  
                  
                  
                  2,366,785
                  
                  
                  
                  —
                  
                  
                  
                  —
                  
                  
                  
                  2,366,785Share-based
      compensation issued for non-employee services
                  
                  
                  —
                  
                  
                  
                  —
                  
                  
                  
                  42,600
                  
                  
                  
                  —
                  
                  
                  
                  —
                  
                  
                  
                  42,600Revaluation
      of stock options issued for non-employee services
                  
                  
                  —
                  
                  
                  
                  —
                  
                  
                  
                  241,105
                  
                  
                  
                  —
                  
                  
                  
                  —
                  
                  
                  
                  241,105Unrealized
      gain on short-term investments
                  
                  
                  —
                  
                  
                  
                  —
                  
                  
                  
                  —
                  
                  
                  
                  —
                  
                  
                  
                  777
                  
                  
                  
                  777Net
      loss
                  
                  
                  —
                  
                  
                  
                  —
                  
                  
                  
                  —
                  
                  
                  
                  (10,743,230
                  )
                  
                  
                  —
                  
                  
                  
                  (10,743,230
                  )Comprehensive
      loss
                  
                  
                  —
                  
                  
                  
                  —
                  
                  
                  
                  —
                  
                  
                  
                  —
                  
                  
                  
                  —
                  
                  
                  
                  (10,742,453
                  )Balance
      at December 31, 2006
                  
                  
                  38,048,146
                  
                  
                  $
                  38,048
                  
                  
                  $
                  63,139,210
                  
                  
                  $
                  (47,053,678
                  )
                  
                  $
                  55
                  
                  
                  $
                  16,123,635Transfer
      of fair value of warrants from liability to equity
                  
                  
                  —
                  
                  
                  
                  —
                  
                  
                  
                  1,333,067
                  
                  
                  
                  (162,022
                  )
                  
                  
                  —
                  
                  
                  
                  1,171,045Beginning
      Balance at January 1, 2007
                  
                  
                  38,048,146
                  
                  
                  $
                  38,048
                  
                  
                  $
                  64,472,277
                  
                  
                  $
                  (47,215,700
                  )
                  
                  $
                  55
                  
                  
                  $
                  17,294,680Issuance
      of common stock in private placement
                  
                  
                  2,781,100
                  
                  
                  
                  2,781
                  
                  
                  
                  3,626,425
                  
                  
                  
                  —
                  
                  
                  
                  —
                  
                  
                  
                  3,629,206Proceeds
      from exercise of common stock options
                  
                  
                  120,333
                  
                  
                  
                  120
                  
                  
                  
                  137,866
                  
                  
                  
                  —
                  
                  
                  
                  —
                  
                  
                  
                  137,986Proceeds
      from exercise of warrants
                  
                  
                  41,806
                  
                  
                  
                  42
                  
                  
                  
                  (42
                  )
                  
                  
                  —
                  
                  
                  
                  —
                  
                  
                  
                  —
   35
 Table of Contents
  Common
      StockNumber
      of Shares
                    
                    
                    Amount
                    
                    
                    Additional Contributed Capital
                    
                    
                    Accumulated Deficit
                    
                    
                    Accumulated
      Other Comprehensive Gain (Loss)
                    
                    
                    TotalShare-based
      compensation issued for employee services
                    
                    
                    —
                    
                    
                    
                    —
                    
                    
                    
                    1,674,453
                    
                    
                    
                    —
                    
                    
                    
                    —
                    
                    
                    
                    1,674,453Share-based
      compensation issued for non-employee services
                    
                    
                    —
                    
                    
                    
                    —
                    
                    
                    
                    34,687
                    
                    
                    
                    —
                    
                    
                    
                    —
                    
                    
                    
                    34,687Unrealized
      gain on short-term investments
                    
                    
                    —
                    
                    
                    
                    —
                    
                    
                    
                    —
                    
                    
                    
                    —
                    
                    
                    
                    (55
                    )
                    
                    
                    (55
                    )Net
      loss
                    
                    
                    —
                    
                    
                    
                    —
                    
                    
                    
                    —
                    
                    
                    
                    (10,618,938
                    )
                    
                    
                    —
                    
                    
                    
                    (10,618,938
                    )Comprehensive
      loss
                    
                    
                    —
                    
                    
                    
                    —
                    
                    
                    
                    —
                    
                    
                    
                    —
                    
                    
                    
                    —
                    
                    
                    
                    (10,618,993
                    )Balance
      at December 31, 2007
                    
                    
                    40,991,385
                    
                    
                    $
                    40,991
                    
                    
                    $
                    69,945,666
                    
                    
                    $
                    (57,834,638
                    )
                    
                    $
                    —
                    
                    
                    $
                    12,152,019
  The
accompanying notes are an integral part of this financial
statement.
 36
 Table of Contents
  SCOLR
Pharma, Inc.
 STATEMENTS OF CASH FLOWS
  December 31,2007
                  
                  
                  2006
                  
                  
                  2005Cash
      flows from operating activities:Net
      loss
                  
                  $
                  (10,618,938
                  )
                  
                  $
                  (10,743,230
                  )
                  
                  $
                  (8,886,063
                  )Adjustments
      to reconcile net loss to net cash used in operating
      activities:Depreciation
      and amortization
                  
                  
                  401,643
                  
                  
                  
                  352,986
                  
                  
                  
                  334,973Loss
      on settlement in connection with asset sale and license
      agreement
                  
                  
                  —
                  
                  
                  
                  —
                  
                  
                  
                  537,921Loss
      on disposal of equipment
                  
                  
                  5,700
                  
                  
                  
                  1,758
                  
                  
                  
                  2,159Share-based
      compensation for non-employee services
                  
                  
                  34,687
                  
                  
                  
                  283,705
                  
                  
                  
                  —Share-based
      compensation for employee services
                  
                  
                  1,674,453
                  
                  
                  
                  2,366,785
                  
                  
                  
                  90,000Unrealized
      (gain) loss on fair value of warrants
                  
                  
                  —
                  
                  
                  
                  (974,211
                  )
                  
                  
                  97,297Write-off
      of long-term assets
                  
                  
                  21,762
                  
                  
                  
                  162,902
                  
                  
                  
                  —Changes
      in assets and liabilitiesAccounts
      receivable
                  
                  
                  654,280
                  
                  
                  
                  (661,903
                  )
                  
                  
                  (125,521
                  )Prepaid
      expenses
                  
                  
                  (76,077
                  )
                  
                  
                  (33,350
                  )
                  
                  
                  (93,098
                  )Accounts
      payable and accrued liabilities
                  
                  
                  330,046
                  
                  
                  
                  336,019
                  
                  
                  
                  (397,984
                  )Deferred
      revenue
                  
                  
                  (185,577
                  )
                  
                  
                  (64,423
                  )
                  
                  
                  250,000Net
      cash used in operating activities
                  
                  
                  (7,758,021
                  )
                  
                  
                  (8,972,962
                  )
                  
                  
                  (8,190,316
                  )Cash
      flows from investing activities:Payments
      received on note receivable
                  
                  
                  —
                  
                  
                  
                  505,927
                  
                  
                  
                  664,801Purchase
      of equipment and furniture
                  
                  
                  (353,829
                  )
                  
                  
                  (162,948
                  )
                  
                  
                  (347,412
                  )Proceeds
      from sale of equipment
                  
                  
                  —
                  
                  
                  
                  —
                  
                  
                  
                  4,157Patent
      and technology rights payments
                  
                  
                  (232,571
                  )
                  
                  
                  (59,937
                  )
                  
                  
                  (103,665
                  )Purchase
      of short-term investments
                  
                  
                  (1,323,761
                  )
                  
                  
                  (3,923,924
                  )
                  
                  
                  (3,462,474
                  )Maturities
      and sales of short-term investments
                  
                  
                  2,317,249
                  
                  
                  
                  5,322,934
                  
                  
                  
                  1,069,977Net
      cash provided by (used in) investing activities
                  
                  
                  407,088
                  
                  
                  
                  1,682,052
                  
                  
                  
                  (2,174,616
                  )Cash
      flows from financing activities:Proceeds
      from term loan
                  
                  
                  246,500
                  
                  
                  
                  —
                  
                  
                  
                  —Payments
      on long-term obligations and capital lease obligations
                  
                  
                  (55,334
                  )
                  
                  
                  (3,137
                  )
                  
                  
                  (47,841
                  )Prepaid
      financing cost
                  
                  
                  —
                  
                  
                  
                  (28,557
                  )
                  
                  
                  (32,567
                  )Proceeds
      from issuance of common stock, net of issuance costs
                  
                  
                  3,629,206
                  
                  
                  
                  10,924,955
                  
                  
                  
                  14,078,837Proceeds
      from exercise of common stock options and warrants
                  
                  
                  137,986
                  
                  
                  
                  687,153
                  
                  
                  
                  536,085Net
      cash provided by financing activities
                  
                  
                  3,958,358
                  
                  
                  
                  11,580,414
                  
                  
                  
                  14,534,514Net
      (decrease) increase in cash
                  
                  
                  (3,392,575
                  )
                  
                  
                  4,289,504
                  
                  
                  
                  4,169,582Cash
      at beginning of period
                  
                  
                  15,217,946
                  
                  
                  
                  10,928,442
                  
                  
                  
                  6,758,860Cash
      at end of period
                  
                  $
                  11,825,371
                  
                  
                  $
                  15,217,946
                  
                  
                  $
                  10,928,442Cash
      paid during the year for:Interest
                  
                  $
                  14,128
                  
                  
                  $
                  170
                  
                  
                  $
                  5,789Non-cash
      investing and financing activities:Issuances
      of warrants in connection with common stock offering
                  
                  $
                  918,457
                  
                  
                  $
                  29,483
                  
                  
                  $
                  194,899Transfer
      of fair value from warrant liability to equity for exercise of
      warrants
                  
                  $
                  —
                  
                  
                  $
                  85,201
                  
                  
                  $
                  —
  The
accompanying notes are an integral part of these financial
statements.
  37
 Table of Contents
  SCOLR
Pharma, Inc.
  NOTES TO FINANCIAL STATEMENTS
  December 31,
2007, 2006 and 2005
  Note
1—Description of Business and Summary of Significant Accounting
Policies
  SCOLR
Pharma, Inc. (the “Company”) is a specialty pharmaceutical company that develops
and formulates pharmaceutical, over-the-counter, and nutritional products. The
Company uses its patented Controlled Delivery Technologies (CDT®) to
develop products and license technologies to pharmaceutical and nutritional
product companies. Prior to 2004, the Company manufactured nutraceutical-based
health and dietary supplements for the animal and human nutrition markets. The
Company’s transition to a focused specialty pharmaceutical business was
completed with the sale of its probiotics business in 2003.
  The
Company has incurred net losses since 2000. As of December 31, 2007, the
Company’s accumulated deficit was $57,834,638. The Company expects its operating
losses and negative cash flow to increase as it advances preclinical research
and clinical trials, applies for regulatory approvals, develops its product
candidates, expands its operations, and develops the infrastructure to support
commercialization of its products.
  The
Company’s business is subject to the risks and uncertainties associated with
development of drug delivery systems and products. These risks include, but are
not limited to, a history of net losses, technological changes, dependence on
collaborations and key personnel, the successful commercialization of the
Company’s product candidates, compliance with government regulations, patent
infringement litigation and competition from current and potential competitors,
(many of which have greater resources) dependence on third party manufacturers,
and a requirement for additional funding.
  A summary
of the Company’s significant accounting policies consistently applied in the
preparation of the accompanying financial statements follows.
  Cash
and Cash Equivalents
  The
Company considers all highly liquid investments with an original maturity of
three months or less when purchased to be cash equivalents. Cash and cash
equivalents are carried at cost, which approximates market value. The Company
holds cash and cash equivalents and marketable securities at several major
financial institutions, which often exceed FDIC insured limits. Historically,
the Company has not experienced any losses as a result of such concentration of
credit risk.
  Short-term
Investments
  Short-term
investments are generally held to maturity, but are considered
available-for-sale and are therefore carried at fair value, with unrealized
gains and losses reported as a separate component of stockholder’s equity.
Interest on securities classified as available-for-sale is included in interest
income. The amortized cost of debt securities is adjusted for amortization of
premiums and accretion of discounts to maturity. This amortization and accretion
is included in interest income. Realized gains and losses are included in
interest income.
  Accounts
Receivable
  In 2007,
the majority of the Company’s accounts receivable were due from companies that
provide royalty income from the use of the Company’s CDT
technology.
  In 2006,
the Company’s accounts receivable reflect amounts due from companies that
provide reimbursement of research and development costs, and that provide
royalty income from the use of the Company’s CDT technology. Payments for
reimbursement of research and development costs are received on a monthly basis.
Payments are received on a quarterly basis, usually within 45 days after the end
of each quarter, for royalty income receivables.
  The
Company determines the allowance for doubtful accounts by considering a number
of factors, including the length of time trade accounts receivable are past due,
the customer’s previous loss history, the customer’s current ability to pay its
obligation, and the condition of the general economy and the industry as a
whole. The Company’s policy is to  write off accounts receivable when
they become uncollectible, and payments subsequently received on such accounts
are credited to the provision for doubtful accounts.
   38
 Table of Contents
  Financial
Instruments
  The
carrying values of financial instruments including cash and cash equivalents,
short-term investments, accounts and notes receivable, accounts payable, and
debt obligations approximate fair value based on the short-term nature of these
instruments.
  The
Company issued warrants in a private placement financing which contain
registration rights where significant liquidated damages could be required to be
paid to the holder of the instrument in the event a registration statement
covering the resale of shares issuable upon exercise of warrants fails to remain
effective for a preset time period. The Company accounts for these warrants at
fair value in accordance with EITF 00-19, Accounting for Derivative Financial
Instruments Indexed to, and Potentially Settled in, a Company’s Own
Stock. The Black-Scholes option pricing valuation model is used to
determine fair value of these warrants. Use of this model requires that the
Company make assumptions regarding stock volatility, dividend yields, expected
term of the warrants, and risk-free interest rates. When warrants are exercised,
the Company determines the fair value of the exercised warrants and reclassifies
the balance from liability to equity (see Note 19).
  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
                  3-5
      yearsSoftware
                  3
      yearsMachinery
      and equipment
                  3-10 yearsMachinery
      and equipment under capital leases
                  3-10
      years
  Intangible
Assets
  Intangible
assets include capitalized costs, technical and product rights, patents, and
trademarks. Capitalized costs principally include legal fees incurred with the
application for patents and trademarks. Technical and product rights, 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 long lived assets for impairments whenever events or changes in
circumstances indicate that the carrying amount may not be recoverable using a
fair value approach.
  Revenue
Recognition
  The
Company generates revenue from collaborative agreements, licensing fees and from
the assignment of developed and patented technology. Revenue under collaborative
arrangements may take the form of royalty income, up-front payments, payments
for milestones, reimbursement of research and development costs, and licensing
payments. Payments received under collaborative research agreements are
generally not refundable even if the research effort is not
successful.
  Revenues
recognized during 2007, 2006, and 2005, include amounts earned under royalty
arrangements with related and third parties under which such parties are
licensed to sell products that include technology developed or licensed by the
Company. Such royalty revenues are recognized when earned, as reported to the
Company by its licensees, and when collectability is reasonably
assured.
  Revenues
recognized in 2007 and 2006, also include non-refundable, up-front payments
received in connection with collaborative research and development agreements,
which were initially deferred and then recognized as licensing fees on a
straight-line basis over the relevant periods specified in the agreement,
generally the research term. Non-refundable license fees are recognized as
revenue once no future performance obligation exists, the price is fixed and
determinable, delivery has occurred, and collectability is reasonably
assured.
  For
revenue arrangements with multiple elements, the delivered element is considered
a separate unit of accounting only when the delivered element has stand-alone
value to the customer, there is objective and reliable evidence of the fair
value of the undelivered items, and delivery of the undelivered items is in the
control of the Company. If these conditions are met, consideration received is
allocated among the separate units based on their respective fair values, and
the applicable revenue recognition criteria are applied to each of the separate
units. Revenues from milestone payments are recognized
   39
 Table of Contents
  when the
milestone has been achieved, as long as the achievement of the milestone was not
reasonably assured at the inception of the arrangement, there was substantial
effort involved in achieving the milestone, the amount of the milestone payment
is reasonable in relation with the level of effort associated with the
achievement of the milestone, and the payment is non-refundable. Each milestone
event must have substance and must represent the achievement of specific defined
goals.
  Reimbursements
of research and development expenses incurred by the Company in connection with
collaborative agreements are recognized as revenue at the time these amounts are
determined to be measurable and reliable.
  Income
Taxes
  The
Company accounts for income taxes under SFAS No. 109, Accounting for Income Taxes.
Deferred tax assets and liabilities are provided for the temporary differences
between the financial reporting basis and the tax basis of the Company’s assets
and liabilities, for net operating loss carryforwards, and tax credit
carryforwards. Deferred tax assets and liabilities, net operating loss
carryforwards, and tax credit carryforwards are measured using enacted tax rates
and laws that will apply when the assets and liabilities are expected to
reverse. The Company provides a valuation allowance when necessary to reduce
deferred tax assets to amounts expected to be realized.
  Research
and Development Costs
  Research
and development expenses consist of costs associated with products being
developed internally as well as those products being developed under
collaborative agreements with others. These expenses include related salaries
and benefits, clinical trial and related clinical trial manufacturing costs,
contract and other outside service fees, and facility related costs. Research
and development costs are expensed as incurred. In instances where the Company
enters into agreements with third parties for research, clinical trial, and
related clinical trial manufacturing costs, such costs are expensed upon the
earlier of when non-refundable amounts are due or as services are performed.
Amounts due to the Company under such arrangements may be either fixed fee or
fee for service, and may include upfront payments, monthly payments, and
payments upon the completion of milestones or receipt of deliverables or
termination costs incurred in the orderly termination of services.
  Earnings
(Loss) Per Share
  Basic
earnings (loss) per share is calculated based on the weighted average number of
shares outstanding during the year and income available to common shareholders.
Diluted earnings (loss) per share include the effect of potential common stock,
except when their effect is anti-dilutive. The weighted average shares for
computing basic earnings (loss) per share were 38,348,560 for the year ended
December 31, 2007, 37,155,613 for the year ended December 31, 2006, and
34,323,934 for the year ended December 31, 2005.  At
December 31, 2007, 2006 and 2005 options and warrants to purchase
7,301,745, 5,609,457, and 5,693,996 shares of common stock, respectively, prior
to the application of the treasury stock method, were not included in the
calculation of diluted net loss per share as they were
anti-dilutive.
  Share-Based
Compensation
  Effective
January 1, 2006, the Company adopted the fair value recognition provisions
of FASB Statement No. 123(R), Share-Based Payment, (“SFAS
123(R)”) using the modified-prospective-transition method. Under that transition
method, compensation cost recognized for the periods ended December 31,
2007 and 2006, includes: (a) compensation cost for all share-based payments
granted prior to, but not yet vested as of January 1, 2006, based on the
grant date fair value estimated in accordance with the original provisions of
FASB Statement No. 123, Accounting for Stock-Based
Compensation (“SFAS 123”), and (b) compensation cost for all
share-based payments granted or modified subsequent to January 1, 2006,
based on the grant date fair value estimated in accordance with the provisions
of SFAS 123(R). Results for prior periods have not been restated as a result of
adopting SFAS 123(R). See Note 14 to the Company’s financial statements for
further detail, including the impact of the adoption on its results of
operations.
  Share-based
compensation expense for performance-based options granted to non-employees is
determined in accordance with SFAS 123(R) and Emerging Issues Task Force Issue
No. 96-18, Accounting for
Equity Instruments that are Issued to Other than Employees for Acquiring, or in
Conjunction with Selling, Goods or Services (“EITF 96-18”), at the fair
value of the consideration received or the fair value of the equity instruments
issued, whichever is more reliably measured. The fair value of options granted
to non-employees is measured as of the earlier of the performance commitment
date or the date at which performance is complete (“measurement date”). When it
is necessary under generally accepted accounting principles to recognize cost
for the transaction prior to the measurement date, the fair value of unvested
options granted to non-employees is remeasured at the balance sheet
date.
   40
 Table of Contents
  Prior to
January 1, 2006, the Company accounted for the plan under the recognition
and measurement provisions of APB Opinion No. 25, Accounting for Stock Issued to
Employees, (“APB 25”) and related interpretations, as permitted by
SFAS 123. Under APB 25, compensation expense for employee and director
stock options was based on the intrinsic value of the award which is equivalent
to the excess, if any, of the fair value of the Company’s common stock at the
date of grant over the exercise price of the options. Any deferred compensation
was amortized over the vesting period of the individual options, using the
straight-line method.
  Reclassifications
  Certain
prior year amounts have been reclassified on the Statements of Cash Flows to
conform to the current period presentation. These reclassifications did not
change the prior year’s net cash flows from operating, investing and financing
activities.
  Use
of Estimates
  The
preparation of financial statements in accordance with accounting principles
generally accepted in the United States of America requires management to make
estimates and assumptions that affect the reported amounts of assets and
liabilities and the disclosure of contingent assets and liabilities at the date
of the financial statements, and the reported amounts of revenues and expenses
during the reporting period. Estimates are used for, but not limited to those
used in revenue recognition; the determination of the allowance for doubtful
accounts, depreciable lives of assets, estimates and assumptions used in the
determination of fair value of stock options and warrants, and deferred tax
valuation allowances. Future events and their effects cannot be determined with
certainty. Accordingly, the accounting estimates require the exercise of
judgment. The accounting estimates used in the preparation of the financial
statements may change as new events occur, as more experience is acquired, as
additional information is obtained and as the Company’s operating environment
changes. Actual results could differ from those estimates.
  New
Accounting Pronouncements
  On December 21, 2007, the
SEC issued Staff Accounting Bulletin No. 110, “Share-Based Payment”. SAB
No. 110 addresses the use of a “simplified” method in developing an
estimate of expected term of “plain vanilla” share options in accordance SFAS
No. 123(R), “Share-Based Payment”. SAB No. 110 allows the use of the
“simplified” method of estimating expected term where a company may not have
sufficient historical exercise data. SAB No. 110 is effective
January 1, 2008 and the Company plans to continue to use the
simplified method to estimate the expected term of its plain vanilla employee
options.
  On
December 12, 2007, the Financial Accounting Standards Board (FASB) ratified the
Emerging Issues Task Force (“EITF”) opinion related to EITF Issue 07-1,
“Accounting for Collaborative Arrangements.” The Task Force reached a consensus
that a collaborative arrangement is a contractual arrangement that involves two
or more parties, all of which are both (a) involved as active participants in a
joint operating activity that is not conducted primarily through a separate
legal entity and (b) exposed to significant risks and rewards that depend on the
commercial success of the joint operating activity. This Issue also addresses
(i) the income statement classification by participants in a collaborative
arrangement for transactions with third parties and transactions between the
participants and (ii) financial statement disclosures. The consensus on EITF
Issue 07-1 is effective for fiscal years beginning after December 15, 2008, and
for interim periods within those fiscal years. Entities should apply the
consensus retrospectively to all periods presented for only those collaborative
arrangements existing as of the effective date, unless it is impractical to do
so. The Company will adopt this new accounting pronouncement effective January
1, 2009, and does not anticipate any material impact on its financial condition
or results of operations.
  In June
2007, the EITF reached a consensus on EITF Issue No. 07-3, “Accounting for
Advance Payments for Goods or Services to be Received for Use in Future Research
and Development Activities”. EITF 07-3 provides clarification surrounding the
accounting for nonrefundable research and development advance payments, whereby
such payments should be recorded as an asset when the advance payment is made
and recognized as an expense when the research and development activities are
performed. EITF 07-3 is effective for annual periods beginning after December
15, 2007. The Company will adopt this new accounting pronouncement effective
January 1, 2008, and does not anticipate any material impact on its financial
condition or results of operations.
  Note
2—Liquidity
  The
Company incurred a net loss of approximately $10.6 million for year ended
December 31, 2007, and used cash of approximately $7.8 million in
operations. Cash flows provided by investing activities of $407,088 primarily
represent the net proceeds from maturing short-term investments. Cash flows from
financing activities of $4.0 million for the year ended
   41
 Table of Contents
  December 31,
2007, primarily reflected $3.6 million net proceeds from the December 2007
registered direct offering of 2,781,100 shares of the Company’s common stock at
a purchase price of $1.50 per share. Purchasers of the Company’s common stock
also received warrants to purchase 1,390,550 shares of common stock at an
exercise price of $2.10 per share (see Note 15 “Financing Event”). In addition,
the Company received proceeds of approximately $250,000 from a term
loan.
  The
Company had approximately $11.8 million in cash, and cash equivalents at
December 31, 2007. The Company expects its operating losses and negative
cash flow to continue as it continues preclinical research and clinical trials,
apply for regulatory approvals, and develops its product candidates. The Company
believes its cash, cash equivalents, and short-term investments will be
sufficient to fund its operations at planned levels through early 2009. The
Company plans to continue the costly process of simultaneously conducting
clinical trials and preclinical research for multiple product candidates. The
Company will need to raise additional capital to fund operations, continue
research and development projects, and commercialize its products. The Company
may not be able to secure additional financing on favorable terms, or at
all.
  The
Company anticipates that it will need to seek additional funds through the
issuance of equity securities or other sources of financing during 2008. In
November 2005, the SEC declared effective the Company’s registration statement
that it filed using a “shelf” registration process. Under this process, the
Company may offer from time-to-time in one or more offerings common stock and/or
warrants to purchase common stock at an aggregate public offering price of up to
$40 million. As of December 31, 2007, approximately $21.1 million remained
available under this shelf registration which expires November
2008.
  The
Company may raise additional capital through public or private equity financing,
partnerships, debt financing, or other sources. Additional funds may not be
available on favorable terms or at all. If adequate funds are not available, the
Company may curtail operations and may delay, modify or cancel research and
development projects.
  Note
3—Short-term Investments
  At
December 31, 2007, the Company did not have any short-term
investments.
  At
December 31, 2006, short-term investments consisted of commercial paper with an
original holding period greater than 90 days and less than one year. The
position was as follows at December 31, 2006:
  Type
      of Security (Under 1 year)
                  
                  Cost
                  
                  
                  Gross
                    Unrealized
                    Gain
                  
                  
                  Estimated Fair
                    ValueCommercial
      Paper
                  
                  $
                  993,487
                  
                  
                  $
                  55
                  
                  
                  $
                  993,542Total
      short-term investments
                  
                  $
                  993,487
                  
                  
                  $
                  55
                  
                  
                  $
                  993,542
 Realized
gains on the sales of available-for-sale securities were $60,996 and $12,098 in
2006 and 2005 respectively. The realized losses on sales of available-for-sale
securities were $8,930 and $0 in 2006 and 2005 respectively.
  Note
4—Accounts Receivable
  Accounts
receivable consists of the following at December 31:
 2007
                  
                  
                  2006Research
      and development receivables
                  
                  $
                  —
                  
                  
                  $
                  453,512Royalty
      receivables
                  
                  
                  225,900
                  
                  
                  
                  411,108Net
      receivables
                  
                  $
                  225,900
                  
                  
                  $
                  864,620
  The
Company did not have any write-offs or bad debt expense in 2007 and 2006. In
2005, the Company had a $42,644 write-off. In addition, the Company did not have
an allowance for doubtful accounts in 2007 or 2006 as all accounts receivable
were considered collectible.
  Note
5—Notes Receivable
  In
January 2006, the Company received payment in full of the $505,927 note
receivable from Nutraceutix, Inc., the buyer of the Company’s probiotic
development and manufacturing business sold in 2003.
   42
 Table of Contents
  Note
6—Property and Equipment
  Property
and equipment consist of the following at December 31:
  2007
                  
                  
                  2006Furniture
      and fixtures
                  
                  $
                  70,813
                  
                  
                  $
                  75,665Software
                  
                  
                  38,237
                  
                  
                  
                  33,851Machinery
      and equipment
                  
                  
                  1,555,854
                  
                  
                  
                  1,426,650Leasehold
      improvements
                  
                  
                  48,765
                  
                  
                  
                  48,7661,713,669
                  
                  
                  
                  1,584,932Less
      accumulated depreciation and amortization
                  
                  
                  (964,738
                  )
                  
                  
                  (854,420
                  )$
                  748,931
                  
                  
                  $
                  730,512
  For the
years ended December 31, 2007, 2006, and 2005 depreciation expense totaled
$329,710, $277,252, and $247,217, respectively.
  Note
7—Intangible Assets
  Intangible
assets consist of the following at December 31:
  2007
                  
                  
                  2006Patents
      and trademarks
                  
                  $
                  849,475
                  
                  
                  $
                  645,051Less
      accumulated amortization
                  
                  
                  (385,452
                  )
                  
                  
                  (319,903
                  )$
                  464,023
                  
                  
                  $
                  325,148
  For the
years ended December 31, 2007, 2006, and 2005 amortization expense totaled
$71,307, $75,733, and $87,756, respectively.
  The
following is a schedule by years of future amortization expense for each of the
next five years based on existing intangible assets as of December 31,
2007.
  Year
      Ending December 31,2008
                  
                  $
                  78,4412009
                  
                  
                  67,7862010
                  
                  
                  58,3362011
                  
                  
                  53,5662012
                  
                  
                  52,0482013
      and thereafter
                  
                  
                  153,846Total
                  
                  $
                  464,023
  The
Company reviews its strategy related to patent initiatives and may decide not to
pursue further research and development in certain areas, quarterly or when
circumstances change as it relates to the programs. As a result, capitalized
costs associated with certain patent filings with net book values of
approximately $22,000, $69,000, and $0, were written-off in 2007, 2006, and
2005, respectively. The write-offs were recorded to research and development
expense.
  Note
8—Lease Obligations
  The
Company conducts a portion of its operations utilizing leased office facilities
and equipment with terms expiring through 2013. The Company’s corporate
headquarters, including administrative offices and research and development
facilities consist of approximately 14,600 square feet. In December 2007, the
Company extended the lease on this space for an additional five years. Some of
the operating leases require the Company to pay taxes, maintenance, insurance,
and other occupancy expenses applicable to leased premises or equipment. The
Company did not have any capital leases as of December 31, 2007. The
following is a schedule of future minimum lease payments for facilities and
equipment under operating leases as of December 31, 2007:
 43
 Table of Contents
  Year
      Ending December 31,
                  
                  Operating
                    Leases2008
                  
                  $
                  368,9092009
                  
                  
                  459,1672010
                  
                  
                  478,6372011
                  
                  
                  432,5342012
      and thereafter
                  
                  
                  679,163Future
      minimum lease payments
                  
                  $
                  2,418,410
  Rent
expense for leased facilities and equipment was $433,514, $415,734, and $240,905
for the years ended December 31, 2007, 2006, and 2005,
respectively.
  Note
9 — Bank Term Loan
  On
March 26, 2007, the Company executed a $250,000 bank term loan agreement
for the purchase of equipment to be used in its research and development
activities. The stated interest rate and effective interest rate of the loan are
8.25% and 9.34%, respectively. The loan matures in March 2010. Principal and
interest payments are to be made in 36 equal monthly payments of $7,877 each,
with a final payment due on the date of maturity. The obligations under the loan
are secured by the acquired equipment.
  Note
10—Income Taxes
  The
Company has incurred net operating losses. The Company continues to maintain a
valuation allowance for the full amount of the net deferred tax asset balance,
including its net operating losses as sufficient uncertainty exists regarding
its ability to realize such tax assets in the future. The Company expects the
amount of the net deferred tax asset balance and associated valuation allowance
to increase in future periods as the Company incurs future net operating
losses.
  The
Company’s recorded provision for income taxes (zero in all years presented)
differs from the amount computed by applying the statutory federal income tax
rate of 34% to its net loss. The sources of the differences are as follows at
December 31:
  2007
                  
                  
                  2006
                  
                  
                  2005Tax
      benefit at statutory rate
                  
                  $
                  (3,610,439
                  )
                  
                  $
                  (3,652,698
                  )
                  
                  $
                  (3,021,261
                  )Permanent
      differences
                  
                  
                  364,977
                  
                  
                  
                  22,681
                  
                  
                  
                  38,560Increase
      in valuation allowance
                  
                  
                  3,245,462
                  
                  
                  
                  3,630,017
                  
                  
                  
                  2,982,701Total
      provision
                  
                  $
                  —
                  
                  
                  $
                  —
                  
                  
                  $
                  —
  Deferred
income tax assets and liabilities reflect the net effect of temporary
differences between the carrying amounts of assets and liabilities for financial
reporting purposes and the amounts used for income tax purposes. Deferred tax
assets are also recorded for the future tax benefit of net operating losses and
tax credit carryforwards. The Company had no deferred tax liabilities in 2007
and 2006. Significant components of the Company’s deferred tax assets are as
follows at December 31:
  2007
                  
                  
                  2006Deferred
      Tax AssetsNet
      operating loss carry forwards
                  
                  $
                  15,081,261
                  
                  
                  $
                  11,920,599Depreciation
      and amortization
                  
                  
                  274,204
                  
                  
                  
                  271,589Stock
      options
                  
                  
                  1,073,786
                  
                  
                  
                  757,020Other
      assets
                  
                  
                  83,710
                  
                  
                  
                  248,497Deferred
      tax assets
                  
                  $
                  16,512,961
                  
                  
                  $
                  13,197,705Valuation
      allowance
                  
                  
                  (16,512,961
                  )
                  
                  
                  (13,197,705
                  )Net
      deferred tax asset
                  
                  $
                  —
                  
                  
                  $
                  —
  The
Company has established a valuation allowance for the full amount of the net
deferred tax asset balance as sufficient uncertainty exists regarding its
ability to realize such tax assets in the future. The net increase in the
valuation allowance for the years ending December 31, 2007, 2006, and 2005,
was $3,315,256, $4,146,716, and $3,422,419, respectively.
  At
December 31, 2007, the Company had available net operating loss
carryforwards of approximately $44.4 million of which $4.1 million related to
stock option deductions. Net operating loss carryforwards of $271,740, $237,111,
and $0
   44
 Table of Contents
  expired
during 2007, 2006, and 2005, respectively. The remaining net operating loss
carryforwards will begin expiring in 2008 and may be used to offset future
federal taxable income through the year ending December 31, 2027. The use
of net operating losses may be limited in any given year under Internal Revenue
Code Section 382 upon the occurrence of certain events, including
significant changes in ownership interests which may have occurred, or which may
occur in future years.
  In June
2006, the FASB issued Interpretation No. 48, Accounting for Uncertainty in Income
Taxes (“FIN 48”). FIN 48 clarifies the accounting and disclosure for
uncertainty in income taxes by prescribing the minimum recognition threshold a
tax position is required to meet before being recognized in the financial
statements. It also provides guidance on derecognition, measurement,
classification, interest and penalties, accounting for interim periods,
disclosure and transition, and clearly scopes income taxes out of Statements of
Financial Accounting Standards Statement No. 5, Accounting for Contingencies.The Company adopted FIN 48 on January 1, 2007. The adoption of FIN 48 had
no impact on the Company’s financial statements. There were no significant
unrecognized tax benefits as of January 1, or December 31, 2007. The Company
does not anticipate any significant changes to its unrecognized tax benefits
within the next twelve months.
  Historically,
the Company has not incurred any interest or penalties associated with tax
matters and no interest or penalties were recognized during the year ended
December 31, 2007. However, the Company has adopted a policy whereby amounts
related to interest and penalties associated with tax matters are classified as
a general and administrative expense when incurred.
  Tax years
that remain open for examination include 2005, 2006, and 2007. In addition, tax
years from 1992 to 2003 may be subject to examination in the event that the
Company utilizes the net operating losses from those years in its current or
future tax returns.
  Note
11—Technical Rights, Patent License and Royalty Agreements
  The
Company has agreements with Temple University (“Temple”) providing the Company
with exclusive worldwide rights for certain patents related to its Controlled
Delivery Technology (CDT®), with
the right to sublicense. On July 11, 2006, the Company completed an
amendment to the license agreement with Temple, dated September 6, 2000,
relating to the Company’s rights to U.S. Patent No. 6,090,411 (“salt
patent”). The amendment provides for a reduction in the amount of the royalty
for sales of prescription drugs covered by the license as well as a reduction in
the annual license maintenance fee payable to Temple University. Under the terms
of Temple University’s development policy, the inventors of the patent receive
50% of the royalty payments received by the University. In connection with the
amendment to the license agreement, the Company paid $400,000 in cash to the
inventors of the patent, including $200,000 to Dr. Reza Fassihi, a member
of the Company’s board of directors, and the inventors agreed to waive their
rights to payment of future royalties received by Temple University based on
sales of prescription drugs as well as the portion of the annual license
maintenance fee attributable to prescription drugs. These transactions were
recorded as research and development expense. Under the terms of the amended
agreements with Temple, the Company is required to make minimum annual royalty
payments of $48,750.
  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 granted ADM a license to manufacture, use, and sell
certain nutraceutical products covered by certain patents owned or licensed by
the Company. The Company amended its license agreement with ADM in August 2006
which resulted in the Company’s payment to ADM of $200,000, and accrual of
$250,000 associated with its obligation to pay ADM an additional $250,000. The
second $250,000 payment was paid and expensed in the third quarter of 2006 and
paid in the third quarter of 2007. These transactions were recorded as research
and development expense.
  In August
2005, the Company entered into an amendment to the license agreement it
originally granted to Nutraceutix. The amendment limited the rights previously
granted to Nutraceutix to manufacture and sell certain extended release dietary
supplement products to certain designated customers of Nutraceutix, eliminated
the right to use the Company’s trademarks, resolved certain disputes, and
eliminated the remaining minimum payments due under the original agreement.
Commencing July 1, 2005, the Company began receiving royalty payments on
such sales at a reduced rate and such payments are recognized as royalty revenue
as they become due. During the years ended December 31, 2007, 2006, and
2005, the Company recorded revenue in the amount of $163,668, $165,873, and
$94,630, respectively under this agreement. Subject to the rights of Nutraceutix
to continue sales of certain inventories for up to one year, the license
terminated on December 31, 2007.
  On
October 20, 2005, the Company entered into a Manufacture, License and
Distribution Agreement with Perrigo Company of South Carolina, Inc. (“Perrigo”).
Under the agreement, the Company granted a license to its CDT technology to
Perrigo for the manufacture, marketing, distribution, sale, and use of specific
dietary supplement products in the United States. In addition, Perrigo may
request that the Company develop additional dietary supplement products that use
this technology to be added to the agreement. The Company receives royalties
based on a percentage of Perrigo’s net profits
   45
 Table of Contents
  derived
from the sales of licensed products under the agreement. During the years ended
December 31, 2007, 2006, and 2005, the Company recorded royalty revenues
earned under this agreement of $975,344, $651,202, and $0,
respectively.
  In
December 2005, the Company entered a licensing agreement with Wyeth Consumer
Healthcare, a division of Wyeth (“Wyeth”), granting exclusive worldwide rights
to use the Company’s CDT platform for the development, manufacture and
commercialization of products containing ibuprofen. Wyeth paid the Company an
initial upfront fee of $250,000 and agreed to pay additional amounts contingent
upon the achievement of specified milestones during the product development
period.  On March 14, 2007, the Company received a notice of
termination from Wyeth that effective April 16, 2007. Since December 2005
through the termination of the agreement, the Company received more than $2.1
million in milestone and other payments from Wyeth.
  During
the three months ended March 31, 2007, the Company recognized research and
development income of $500,000 related to a milestone payment from Wyeth and
approximately $109,000 for reimbursement of research and development costs
related to the agreement. The $250,000 upfront fee was previously recorded as
deferred revenue and was being amortized as licensing fee income over the
development period. As a result of the termination of the agreement, the Company
recognized the approximately $173,000 remaining balance of previously deferred
licensing fee income during the three months ended March 31,
2007.
  As a
result of the termination, the Company reacquired all rights to use its
technology for products containing ibuprofen.
  On
September 5, 2006, the Company entered into a research collaboration with
BioCryst Pharmaceuticals (“BioCryst”), to develop an oral formulation of
peramivir, a promising antiviral compound using the Company’s CDT platform.
Peramivir is a novel therapeutic being developed by BioCryst for treatment of
seasonal and life threatening influenza with a focus on intravenous and
intramuscular delivery. The goal of the collaboration is to develop a tablet or
capsule formulation for the oral administration of peramivir that improves oral
bioavailability.
  On
October 18, 2007, the Company entered into a collaboration and license agreement
with Dr. Reddy’s Laboratories (“Dr. Reddy’s”) to pursue the development and
commercialization of an undisclosed oral prescription drug
product.  Under the terms of the agreement, Dr. Reddy’s will be
responsible for the development, manufacturing, and marketing of the drug
product. The Company will be responsible for the formulation and assist with the
scale-up activities of the product.
  Note
12—Future Commitments
  The
Company has certain material agreements with its manufacturing and testing
vendors related to its ongoing clinical trial work associated with its drug
delivery technology. Contract amounts are paid based on materials used and on a
work performed basis. Generally, the Company has the right to terminate these
agreements upon 30 days notice and would be responsible for services and
materials and related costs incurred prior to termination. Certain leases as
discussed in Note 8 related to leased office facilities have terms expiring
through 2013.
  Note
13—Retirement Plan
  The
Company has a defined contribution 401(k) retirement plan which covers all
employees. The Company matches 25% of employee contributions, up to 8% of
employee eligible compensation. The Company contributed $35,689, $17,977, and
$12,987 to the Plan for the years ended December 31, 2007, 2006, and 2005,
respectively.
  Note
14—Share-Based Compensation
  The
Company has granted equity incentive awards to its employees, consultants,
officers, and directors under its 2004 Equity Incentive Plan (the “2004 Plan”)
and its 1995 Stock Option Plan (the “1995 Plan”). The 2004 Plan was approved by
stockholders in June 2004, and replaced the 1995 Plan. Under the 2004 Plan,
equity-based incentive awards may be granted in the form of stock options, stock
appreciation rights, stock awards, performance awards, and outside director
options.
  The
options granted to employees are generally granted at exercise prices equal to
the market value of the Company’s common stock on the date of grant, vest over
three years, and expire ten years from the date of grant.
  Under the
terms of the 2004 Plan, non-employee directors receive automatic annual grants
of stock options at exercise prices equal to the market value of the Company’s
common stock on the date of grant, which generally vest in equal monthly
installments over one year and expire ten years from the date of
grant.
  Generally,
when the Company issued options to employees the exercise price of the option
equaled the market price of the underlying stock on the date of the grant;
therefore, under APB 25 no corresponding compensation expense was
   46
 Table of Contents
  recognized.
With the adoption of the Company’s 2004 Equity Incentive Plan, non-employee
directors were allowed to elect to receive the value of their quarterly retainer
fee for services either in the form of cash or a share-based director fee award,
which consisted of either fully vested stock options with an exercise price
equal to 50% of the fair value of the underlying common stock on the date of the
grant, or stock units. A stock unit is an unfunded bookkeeping entry
representing a right to receive one share of the Company’s common stock.
Non-employee directors are not required to pay any additional cash consideration
in connection with the settlement of a stock unit award. To the extent that
directors elected to receive a share-based award, stock compensation expense was
recognized based on the grant date intrinsic value of the stock option or the
fair value of the stock unit. In December 2005, the non-employee director
compensation program was revised such that non-employee directors may no longer
elect to receive stock options or stock units rather than cash in satisfaction
of their quarterly fees for services. In conjunction with that change, the
Company settled the options issued to directors for their quarterly retainer
fees by exchanging them for cash equal to the difference between the quoted
market price of the underlying common stock on the date of cancellation and the
exercise price of the stock options.
  The 2004
Plan initially authorized the issuance of up to 2,000,000 shares of common
stock, plus 388,441 shares which were previously reserved for issuance under the
1995 Plan not subject to outstanding options. On June 8, 2006, the
Company’s stockholders approved a 2,000,000 share increase in the maximum
aggregate number of shares that may be issued under the 2004 Equity Incentive
Plan. If any award under the 2004 Plan, or any award previously issued and
outstanding under the 1995 Plan, expires, lapses or otherwise terminates for any
reason without having been exercised or settled in full, or if shares subject to
forfeiture or repurchase are forfeited or repurchased by the Company, the shares
underlying the award will again become available for issuance under the 2004
Plan. As of December 31, 2007, the Company had 1,573,335 shares available
for future grants under both Plans.
  On
January 1, 2006, the Company adopted the provisions of SFAS 123(R),
requiring it to recognize expense related to the fair value of its share-based
compensation awards. The Company elected to use the
modified-prospective-transition method as permitted by SFAS 123(R) and therefore
has not restated its financial results for prior periods. Under this transition
method, share-based compensation expense for the year ended December 31,
2006, includes compensation expense for all share-based compensation awards
granted prior to, but not yet vested as of January 1, 2006, based upon the
grant date fair value estimated in accordance with the original provisions of
SFAS 123. Share-based compensation expense for all share-based compensation
awards granted subsequent to December 31, 2005, is based on the grant date
fair value estimated in accordance with the provisions of SFAS 123(R) using the
Black-Scholes option pricing model. The Company recognizes compensation expense
for stock option awards on a straight-line basis over the requisite service
period of the award, which is the vesting period.
  As a
result of adopting SFAS 123(R) on January 1, 2006, the Company’s net loss
for the year ended December 31, 2006, was $2,366,785 greater than under the
Company’s previous accounting method for share-based compensation while basic
and diluted net loss per share for the year ended December 31, 2006, is
($0.06) greater than under the Company’s previous accounting method for
share-based compensation. The adoption of SFAS 123(R) had no impact on the
Company’s cash flow from operations and financing activities.
  The
following table sets forth the aggregate share-based compensation expense
resulting from stock options issued to the Company’s employees and to
non-employees for services rendered that is recorded in the Company’s results of
operations for the year ended December 31:
  December 31,
                    2007
                  
                  
                  December 31,
                    2006Share-based
      compensation:Marketing
      and selling
                  
                  $
                  130,972
                  
                  
                  $
                  115,766Research
      and development
                  
                  
                  610,895
                  
                  
                  
                  614,731General
      and administrative
                  
                  
                  932,586
                  
                  
                  
                  1,636,288Share-based
      compensation for employees
                  
                  
                  1,674,453
                  
                  
                  
                  2,366,785General
      and administrative, non-employee services
                  
                  
                  34,687
                  
                  
                  
                  241,105Marketing,
      non-employee services
                  
                  
                  —
                  
                  
                  
                  42,600Total
      share-based compensation expense
                  
                  $
                  1,709,140
                  
                  
                  $
                  2,650,490
  The
share-based compensation expense for non-employee services reflects option
grants to outside consultants. There are no future performance conditions
associated with these grants and no consideration was received for the
options.
  SFAS 123,
as amended by SFAS 148, Accounting for Stock-Based
Compensation—Transition and Disclosure, required companies that chose to
continue to follow APB 25 to provide pro forma disclosure of the impact of
accounting for share-
   47
 Table of Contents
  based
compensation using the fair value method of SFAS 123. For purposes of these pro
forma disclosures, the estimated fair value of the options was amortized on a
straight-line basis over the related vesting periods.
  The
following table illustrates the effect on net loss and net loss per common share
as if the Company had applied the fair value recognition provisions of SFAS 123
to share-based compensation during the year ended December 31,
2005:
  2005Net
      loss, as reported
                  
                  $
                  (8,886,063
                  )Employee
      share-based compensation expense determined under fair-value based
      method
                  
                  
                  (2,510,471
                  )Employee
      share-based compensation expense included in reported net
    loss
                  
                  
                  75,500Pro
      forma net loss
                  
                  $
                  (11,321,034
                  )As
      reported
                  
                  $
                  (0.26
                  )Pro
      forma
                  
                  $
                  (0.33
                  )
  The fair
value of share-based awards is estimated using the Black-Scholes option pricing
model with the following assumptions for the years ended December 31, 2007,
2006, and 2005. When estimating forfeitures, the Company considers the potential
for voluntary and involuntary terminations.
  Black-Scholes Model Assumptions
                    December 31,2007
                  
                  
                  2006
                  
                  
                  2005Expected
      volatility
                  
                  
                  56% – 64
                  %
                  
                  
                  57% – 63
                  %
                  
                  
                  63% – 73
                  %Expected
      dividend yield
                  
                  
                  0
                  %
                  
                  
                  0
                  %
                  
                  
                  0
                  %Risk-free
      interest rate
                  
                  
                  3.23% – 5.26
                  %
                  
                  
                  4.3% – 5.0
                  %
                  
                  
                  4.0% – 4.6
                  %Expected
      life
                  
                  6 – 10 years
                  
                  
                  6 – 10 years
                  
                  
                  10 years
  The
Company’s computation of expected volatility is based on historical realized
volatility. Prior to the implementation of SFAS 123(R), the Company estimated
that the expected lives of all options were equal to their contractual term. The
options granted to employees meet the definition of “plain vanilla” options
defined in the Securities and Exchange Commission’s Staff Accounting Bulletin
No. 107 (“SAB 107”). Therefore, management utilizes the shortcut method
described in SAB 107 in determining the expected life of employee options. The
shortcut method estimates the expected term based on the midpoint between the
vesting date and the end of the contractual term. The Company’s computation of
expected life for non-employee director’s awards and for outside consultant
awards under SFAS 123(R) continues to be based on the contractual term of the
award. The risk-free interest rate is based on the U.S. Treasury yield curve in
effect at the time of the grant for issues with a term that approximates the
expected life used as the assumption in the model.
  A summary
of the Company’s stock option plan activity for the year ended December 31,
2007 is as follows:
  Shares
                  
                  
                  Weighted-
                    Average
                    Exercise
                    Price
                  
                  
                  Weighted-
                    Average
                    Remaining
                    Contractual
                    Term (years)
                  
                  
                  Aggregate
                    Intrinsic
                    ValueOutstanding
      at December 31, 2006
                  
                  
                  3,240,665
                  
                  
                  $
                  3.64Granted
                  
                  
                  734,167
                  
                  
                  $
                  2.10Exercised
                  
                  
                  (120,333
                  )
                  
                  $
                  1.15Forfeited
                  
                  
                  (227,096
                  )
                  
                  $
                  4.50Outstanding
      at December 31, 2007
                  
                  
                  3,627,403
                  
                  
                  $
                  3.36
                  
                  
                  
                  6.97
                  
                  
                  $
                  310,296Outstanding
      vested or expected to vest options at December 31,
    2007
                  
                  
                  3,557,649
                  
                  
                  $
                  3.35
                  
                  
                  
                  7.26
                  
                  
                  $
                  328,577Options
      exercisable at December 31, 2007
                  
                  
                  2,743,862
                  
                  
                  $
                  3.49
                  
                  
                  
                  6.22
                  
                  
                  $
                  258,046
  Cash
received from options exercised was $137,986, $452,889, and $508,585 for the
years ended December 31, 2007, 2006, and 2005, respectively. No actual tax
benefit was realized for tax deductions from option exercise of the share-based
payment arrangements because the Company has recorded a full valuation allowance
against all deferred tax assets due to the uncertainty of realization of such
assets. The Company has a policy of issuing new shares to satisfy share option
exercises.
   48
 Table of Contents
   The
weighted-average grant date fair value of equity options granted during the
years ended December 31, 2007, 2006, and 2005, was $1.35, $3.73, and $3.45,
respectively. The total intrinsic value of options exercised for the years ended
December 31, 2007, 2006, and 2005, was $223,103, $1,685,739, and
$2,288,482, respectively. The total fair value of shares vested during the years
ended December 31, 2007, and 2006, was $2,160,764, and $2,369,348,
respectively.
  As of
December 31, 2007, there was $1,552,156 total unrecognized non-cash
compensation cost related to non-vested options granted under the 1995 Plan and
2004 Plan. That cost is expected to be recognized over a weighted-average period
of 1.77 years.
  In
January 2007, the Company issued non-transferable and immediately vested stock
options to purchase 25,000 shares of the Company’s stock to Dr. Jeffrey Reich in
connection with services to facilitate the Company’s alliance with BioCryst. Dr.
Reich joined the Company’s board of directors in October 2007. The compensation
was for services rendered prior to the date of the award and no further services
were required to be rendered and no performance condition was required to be met
before the options became fully exercisable. The options, which have a ten-year
term, were issued under the 2004 Equity Plan and can only be settled through
exercise and issuance of the Company’s common shares. They have been classified
as equity and accounted for in accordance with EITF 96-18, Accounting for Equity Instruments
that are Issued to Other Than Employees for Acquiring, or in Conjunction with
Selling, Goods or Services, and EITF 00-18, Accounting for Certain Transactions
Involving Equity Instruments Granted to Other Than Employees. The fair
value of the options at the date of grant, of $2.55 per share, was determined
using the Black-Scholes model with the following assumptions: stock
volatility—57%; expected dividend yield—0%; expected term—10.0 years; risk-free
interest rate—5.0%. Expected stock volatility was based on historical realized
volatility. The expected term was the contractual term of the award. The
risk-free interest rate was based on the U.S. Treasury yield curve in effect at
the date of grant for issues with a term that approximates the expected life
used as the assumption in the model. The total related consulting expense of
$63,000 was recognized in the first quarter 2007 as marketing
expense.
  In
November 2005, the Company entered into an advisory services agreement with
Michael N. Taglich, a member of its board of directors, relating to services
provided by Mr. Taglich as a consultant. The agreement terminated on
November 5, 2007. Under the terms of the agreement, the Company granted to
Mr. Taglich a non-transferable option to purchase 100,000 shares of the
Company’s common stock at an exercise price of $4.61. The option, which vested
in equal monthly increments over the two-year period of the service agreement
beginning in 2005, had a ten-year term and was subject to EITF 96-18, Accounting for Equity Instruments
that are Issued to Other Than Employees for Acquiring, or in Conjunction with
Selling, Goods or Services. As of December 31, 2006, 50,000 shares
were fully vested. Expected stock volatility was based on historical realized
volatility. The expected term was the remaining contractual term of the award.
The risk-free interest rate was based on the U.S. Treasury yield curve in effect
at the measurement date for issues with a term that approximates the remaining
expected life used as the assumption in the model. The fair value of the option
was re-measured at each financial reporting period date until November 5, 2007,
based on the agreement’s vesting schedule. The related consulting expense was
recognized over the two year vesting period using the graded vesting method. The
Company recognized a reduction in the expense of $29,156 in 2007 due to a
decrease in the Company’s stock price, and expense of $241,104 and $90,000 for
the years ended December 31, 2006, and 2005, respectively, for these
options. At the time the agreement concluded, a total of 50,000 options had
vested under the agreement.
  November
      5,
                  
                  
                  December
      31,2007
                  
                  
                  2006
                  
                  
                  2005Weighted-Average
      Fair Value Warrants
                  
                  $
                  1.16
                  
                  
                  $
                  3.22
                  
                  
                  $
                  3.87Black-Scholes
      Assumption:Dividend
      Rate
                  
                  
                  —
                  
                  
                  
                  —
                  
                  
                  
                  —Average
      Risk-Free Interest Rate
                  
                  
                  4.12
                  %
                  
                  
                  4.71
                  %
                  
                  
                  3.90
                  %Average
      Volatility
                  
                  
                  63
                  %
                  
                  
                  59
                  %
                  
                  
                  63
                  %Remaining
      Contractual Life in Years
                  
                  
                  8.0
                  
                  
                  
                  8.8
                  
                  
                  
                  9.8
  Note
15—Financing Events
  Registered
Direct Offering
  On
December 4, 2007, we raised approximately $4.2 million in gross proceeds through
a registered direct offering of 2,781,100 shares of our common stock at a
purchase price of $1.50 per share. Purchasers of the Company’s stock also
received warrants to purchase 1,390,550 shares of common stock at an exercise
price of $2.10 per share, exercisable for five years. Net proceeds of the
offering were approximately $3.6 million after placement agent fees of $250,300
and other direct and incremental offering costs of approximately $283,000.
ThinkEquity Partners LLC acted as placement agent for the offering. Taglich
Brothers, Inc. provided financial advisory services and was paid a fee of
$112,509, which was deducted
   49
 Table of Contents
  from the
fee paid to the placement agent. Michael N. Taglich, a member of the Company’s
board of directors, is the president and a principal shareholder of Taglich
Brothers.  In connection with the offering, the Company also issued
warrants to purchase 1,390,550 shares of its common stock at $2.10 per share,
exercisable for five years, and valued at $918,457 using the Black-Scholes
option-pricing model. Under the terms of the warrant agreement, in the event
that another offering is completed within a period of twelve months, the
exercise price of the warrant will be adjusted to be equal to the price at which
the common stock is sold in the new offering. The Black-Scholes valuation was
based on the following assumptions: volatility of 64%; term of five years;
risk-free interest rate of 3.28%; and 0% dividend yield.
  On
April 21, 2006, the Company completed an offering of 2,370,100 shares of
its common stock at $5.00 per share for gross proceeds of $11.9 million. Net
proceeds of the offering were approximately $10.9 million after placement agent
fees of approximately $711,000 and other direct and incremental offering costs.
Taglich Brothers, Inc. and Roth Capital Partners, LLC acted as placement agents
for the offering. In connection with the offering, the Company also issued
warrants to purchase 11,000 shares of its common stock at $7.50 per share to the
placement agents, exercisable for five years, and valued at $29,483 using the
Black-Scholes option-pricing model. The Black-Scholes valuation was based on the
following assumptions: volatility of 62%; term of five years; risk-free interest
rate of 4.92%; and, 0% dividend yield. Taglich Brothers, Inc. acted as one of
the placement agents in the offering and received placement agent fees of
$511,030 and warrants to purchase 5,500 shares of common stock.
  Private
Placements
  On
February 8, 2005, the Company raised $15.0 million in gross proceeds
through a private placement of 3,750,000 shares of its common stock for $4.00
per share to accredited investors. The sale of these shares resulted in net
proceeds to the Company of approximately $14.1 million. The Company filed a
registration statement with the Securities and Exchange Commission as required
under a registration rights agreement registering the resale of shares issued in
the private placement (including shares of common stock issuable upon exercise
of warrants issued to the placement agent), which was declared effective on
April 15, 2005. If the registration statement does not remain effective for
a specified period of time as defined in the registration rights agreement,
until all shares tradable under the registration statement are sold, or until
the shares are freely tradable without volume restriction absent the
registration statement, the Company is subject to cash liquidated damages equal
to the aggregate purchase price of such purchaser’s remaining shares multiplied
by 2.0% for every thirty days that the registration statement is unavailable for
sales. As of December 31, 2006, and 2005, a total of 2,381,900 and
2,436,500 common shares, respectively, which remained subject to potential
liquidated damages were classified as temporary equity. Therefore, the Company
reclassified these shares to permanent equity. As of February 2007, these shares
were no longer subject to liquidated damages because they were eligible for
resale under applicable securities law.
  Taglich
Brothers, Inc. acted as the placement agent for the financing transaction
completed in February 2005 and received a cash fee of $750,000 and warrants,
valued at $194,899 using the Black-Scholes option-pricing model, to purchase up
to 75,000 shares of the Company’s common stock at an exercise price of $5.00 per
share exercisable for five years. The Black-Scholes valuation was based on the
following assumptions: volatility of 67%; term of 5 years; risk-free interest
rate of 3.72%; and, 0% dividend yield. The warrants issued to the placement
agent were not subject to liquidated damages and were therefore accounted for as
equity instruments.
  On
February 24, 2004, the Company raised $10.4 million in gross proceeds
through a private placement of 3,206,538 shares of its common stock for $3.25
per share to accredited investors. The sale of these shares resulted in net
proceeds to the Company of approximately $9.5 million. The purchasers also
received five year warrants to purchase 801,636 shares of common stock at an
exercise price of $4.75 per share. The Company filed a registration statement
with the Securities and Exchange Commission registering the resale of shares
issued in the private placement and the shares of common stock issuable upon
exercise of the warrants issued in the financing (including shares of common
stock issuable upon exercise of warrants issued to the placement agent), which
was declared effective as of April 14, 2004. At December 31, 2005, a
total of $9,147,484 associated with 2,436,500 common shares continued to be
subject to potential liquidated damages and have been classified as temporary
equity. As of December 31, 2006, the $8,942,511 relating to such shares was
transferred to permanent equity as the maximum amount of potential liquidated
damages was less than 10% of the aggregate purchase price and reflected a
reasonable estimate of the difference in fair value between registered and
unregistered shares. As of February 2007, these shares were no longer subject to
liquidated damages because they were eligible for resale under applicable
security law.
  The
warrants issued to investors in this transaction were also issued pursuant to
the registration rights agreement and were subject to liquidated damage
provisions. The Company considers the warrants to be derivative financial
instruments and has classified the warrants as a liability at fair value in the
balance sheet. On January 13, 2006, and December 28, 2004, 25,000 and
76,923, respectively, of the 801,636 warrants were exercised. As a result, the
exercised warrants were marked-to-market as of the exercise dates in 2006 and
2004 and the estimated fair value of $85,201 and $228,951, respectively,
was
   50
 Table of Contents
  reclassified
from liability to additional paid in capital. There were 699,713 warrants
classified as a liability at December 31, 2006 prior to the
reclassification. Information regarding the valuation of the warrants is as
follows:
  2006
                  
                  
                  2005December 31
                  
                  
                  December 31Weighted-Average
      Fair Value Warrants
                  
                  $
                  1.67
                  
                  
                  $
                  3.08Black-Scholes
      Assumption:Dividend
      Rate
                  
                  
                  —
                  
                  
                  
                  —Average
      Risk-Free Interest Rate
                  
                  
                  4.82
                  %
                  
                  
                  4.35
                  %Average
      Volatility
                  
                  
                  57
                  %
                  
                  
                  63
                  %Remaining
      Contractual Life in Years
                  
                  
                  2.2
                  
                  
                  
                  3.2
  The
change in the fair value of the warrants in each period is reflected as an
unrealized gain/(loss) on fair value in the accompanying statement of
operations.
  Rodman
and Renshaw acted as the lead placement agent for this transaction and Taglich
Brothers, Inc. assisted in the financing. The placement agents received a cash
fee of $729,487 and warrants to purchase 224,458 shares, of which Taglich
Brothers, Inc. received $174,965 and warrants to purchase 53,846 shares. Michael
N. Taglich and Robert Schroeder, directors of the Company at the time of the
financing, are affiliates of Taglich Brothers, Inc. In addition,
Mr. Taglich purchased 49,631 shares of common stock and warrants to
purchase 12,408 shares of common stock as part of the private placement. The
total fair value of the 1,046,773 warrants issued in the financing was
$1,994,271 using the Black-Scholes option-pricing model. The Black-Scholes
valuation was based on the following assumptions: volatility of 68%; term of 5
years; risk-free interest rate of 3.01%; and, 0% dividend yield. The warrants
issued to the placement agent are not subject to liquidated damages and are
therefore accounted for as equity instruments.
  The
Company also issued (i) 32,000 shares of its common stock and a warrant to
purchase 15,000 shares to an unaffiliated third party as a finder’s fee, and
(ii) 23,077 shares of its common stock and warrants to purchase 5,679
shares in partial payment of an advisory fee in connection with the sale of the
probiotics division.
  Shelf
Registration
  On
October 27, 2005, the Company filed a shelf registration statement on Form
S-3 with the U.S. Securities and Exchange Commission (SEC), pursuant to which it
may sell, from time to time, up to $40 million in common stock and/or common
stock purchase warrants. The registration statement was declared effective by
the SEC in November 2005 and expires in November 2008. The specific terms of any
future offering would be established at the time of the offering. As of
December 31, 2007, approximately $21.1 million remains
available.
  Note
16—Warrants
  During
the year ended December 31, 2007, a total of 85,000 warrants were
exercised, including 43,194 warrants that were surrendered to satisfy the
exercise price. As a result, 41,806 shares of common stock were issued during
the year ended December 31, 2007. The weighted average exercise price for
the year ended December 31, 2007, was $0.81. The Company had the following
warrants to purchase common stock outstanding at December 31,
2007:
  Issue
      Date
                  
                  Issued
                    Warrants
                  
                  
                  Exercise
                    Price
                  
                  Term
                  
                  Outstanding
                    Warrants
                  
                  Expiration
      DateSeptember 30, 2002
                  
                  
                  750,000
                  
                  
                  $
                  0.50
                  
                  10 years
                  
                  
                  750,000
                  
                  September 30, 2012April 7,
      2003
                  
                  
                  50,000
                  
                  
                  
                  1.00
                  
                  5
      years
                  
                  
                  50,000
                  
                  April
      7, 2008June 25,
      2003
                  
                  
                  476,191
                  
                  
                  
                  1.16
                  
                  5
      years
                  
                  
                  452,943
                  
                  June
      25, 2008February 24, 2004
                  
                  
                  1,046,773
                  
                  
                  
                  4.75
                  
                  5
      years
                  
                  
                  944,849
                  
                  February
      23, 2009February 8, 2005
                  
                  
                  75,000
                  
                  
                  
                  5.00
                  
                  5
      years
                  
                  
                  75,000
                  
                  February
      7, 2010April
      21, 2006
                  
                  
                  11,000
                  
                  
                  
                  7.50
                  
                  5
      years
                  
                  
                  11,000
                  
                  April
      20, 2011December
      4, 2007
                  
                  
                  1,390,550
                  
                  
                  
                  2.10
                  
                  5
      years
                  
                  
                  1,390,550
                  
                  December
      3, 2012Grand
      Total
                  
                  
                  3,799,514
                  
                  
                  
                  
                  
                  
                  
                  
                  3,674,342
  Each
warrant entitles the holder to purchase one share of common stock at the
exercise price.
   Note
17—Major Customers and Concentration of Credit Risk
  In 2007,
two customers accounted for 49% and 40% of total revenue. In 2006, the Company
received royalty income for sales of products related to the CDT technology from
two customers, which accounted for 62% and 29% of net revenues.
   51
 Table of Contents
  The
Company maintains its cash balances in one financial institution, which at
times, may exceed federally insured limits. The Company has not experienced any
losses in such accounts and believes it is not exposed to any significant credit
risk on cash.
  Note
18—Related Party Transactions
  The
Company’s CDT platform is currently based on five patented drug delivery
technologies and includes intellectual property from two U.S. patents licensed
exclusively to the Company by Temple University and two U.S. patents assigned to
the Company by Dr. Reza Fassihi, a Professor of Biopharmaceutics and
Industrial Pharmacy at the Temple University School of Pharmacy.
Dr. Fassihi currently serves on the Company’s board of directors.
Dr. Fassihi is also one of the inventors of the two patents licensed to the
Company by Temple University.
  The
Company entered into two license agreements with Temple University pursuant to
which the Company obtained exclusive worldwide rights to two patents issued to
Temple University which listed Dr. Fassihi as one of the inventors. Under the
terms of Temple University’s development policy, the inventors receive 50% of
the royalty payments received by the University. On July 11, 2006, the
Company amended the license agreement with Temple University relating to the
salt patent. The amendment provides for a reduction in the amount of the royalty
for sales of prescription drugs covered by the license as well as a reduction in
the annual license maintenance fee payable to Temple University.  In
connection with the amendment to the license agreement, the Company paid
$400,000 in cash to the inventors of the patent, including $200,000 to Dr.
Fassihi, and the inventors agreed to waive their rights to payment of royalties
received by Temple University based on sales of prescription drugs as well as
the portion of the annual license maintenance fee attributable to prescription
drugs.  As a result of these arrangements, the Company estimates that Dr.
Fassihi received approximately $15,000 of the fees paid to Temple for the dual
polymer patent during 2007.
  Dr.
Fassihi also assigned the Company all of his right, title and interest in and to
the technology known as “oral extended release dosage form based on the
principle of controlled hydration” on May 24, 2001. Dr. Fassihi assigned all of
his right, title and interest in the technology known as “multiple compressed
asymmetric composite delivery system for release-rate modulation of bioactives”
to us on August 1, 2002. Dr. Fassihi received $50,000 in connection with
execution of this assignment agreement and filing of the patent and the Company
agreed to pay an additional fee upon issuance of the first patent.  The
Company is obligated to pay Dr. Fassihi a share of upfront payments from
customers and royalties based on product sales with respect to the intellectual
property assigned to us under each agreement.
  In
addition, the Company has a consulting agreement with Dr. Fassihi. This
agreement was amended effective December 31, 2006, to provide for the
continuance of Dr. Fassihi’s consulting services. The agreement may be
terminated by either party on 30 days’ notice. In the years ended
December 31, 2007, 2006, and 2005, Dr. Fassihi was paid $48,000 each
year for consulting services. In addition, in 2006 Dr. Fassihi received a
$200,000 payment associated with the amendment to the Temple University
agreement (see Note 11).
  Note
19 — Change in Accounting for Fair Value of Warrants to Purchase Common
Stock
  In
December 2006, the Financial Accounting Standards Board, (“FASB”) issued FASB
Staff Position EITF 00-19-2, “Accounting for Registration Payment
Arrangements”(“FSP EITF 00-19-2”). FSP EITF 00-19-2 requires an issuer
of financial instruments, such as debt, convertible debt, equity shares or
warrants, to account for a contingent obligation to transfer consideration under
a registration payment arrangement in accordance with FASB Statement 5, “Accounting for
Contingencies,” and FASB Interpretation 14, “Reasonable Estimation of the Amount
of a Loss.” FSP EITF 00-19-2 applies to registration payment arrangements
regardless of whether they are issued as a separate agreement (such as a
registration rights agreement or shareholders’ rights agreement) or are included
as a provision of either the financial instruments or some other agreement. FSP
EITF 00-19-2 also applies to an arrangement in which the issuer endeavors to
obtain or maintain listing on a stock exchange. The Company adopted FSP EITF
00-19-2 effective January 1, 2007.
  The
Company has previously classified warrants issued as a part of its
February 24, 2004, private placement as a liability because the Company
granted registration rights which included the payment of liquidated damages
under certain circumstances including in the event that the SEC registration
statement registering the resale of shares of common stock issuable upon
exercise of the warrants does not remain effective. The Company generally uses
its best efforts and all commercially reasonable efforts to maintain “effective”
registration statements. Accordingly, Company management believes that as of
both the date of inception and the date of adopting this FSP, its obligation to
transfer consideration under its registration payments arrangements is not
probable. Further, the Company had determined that without regard to the
registration payment arrangement, all warrants issued would have been classified
as equity instruments in accordance with other applicable generally accepted
accounting principles for all periods.
   52
 Table of Contents
  Prior to
the adoption of this FSP, the Company accounted for the warrants and the
registration payment arrangement as one instrument and classified the entire
arrangement as a liability. Based on the guidance of the FSP, the Company
reclassified the fair value of the warrant liability to stockholders’ equity on
January 1, 2007. The reclassified amount of $1,171,045 was based on the
fair value of the warrant liability at December 31, 2006. The fair value of
the entire arrangement at inception was $1,527,245. The difference between the
December 31, 2006, fair value of warrant liability and the fair value of
the warrant liability at its inception was $356,200; however, $194,180 was
previously reclassified to accumulated deficit when the warrants were exercised.
The remaining $162,022 was presented as a cumulative effect adjustment to the
opening balance of accumulated deficit.
  The
adoption of FSP EITF 00-19-02 had no effect on the Company’s net loss. The
following table presents the effect of the adoption of FSP EITF 00-19-02 on
accumulated deficit:
  Accumulated
      deficit at December 31, 2006 – as previously reported
                  
                  $
                  (47,053,678
                  )Change
      in accounting principle
                  
                  
                  (162,022
                  )Beginning
      accumulated deficit – adjusted January 1, 2007
                  
                  
                  (47,215,700
                  )Add:
      Net loss for the twelve months ended December 31, 2007
                  
                  
                  (10,618,938
                  )Ending
      accumulated deficit at December 31, 2007
                  
                  $
                  (57,834,638
                  )
  53
 Table of Contents
  Note
20—Quarterly Results (Unaudited)
  The table
below shows the quarterly results of operations for 2007 and 2006:
  Quarterly
      Results of Operations (Unaudited)For
      Year 2007
                  
                  March 31
                  
                  
                  June 30
                  
                  
                  September 30
                  
                  
                  December 31Net
      revenues
                  
                  $
                  1,119,919
                  
                  
                  $
                  422,056
                  
                  
                  $
                  207,474
                  
                  
                  $
                  222,334Gross
      profit
                  
                  
                  1,119,919
                  
                  
                  
                  422,056
                  
                  
                  
                  207,474
                  
                  
                  
                  222,334Operating
      expenses
                  
                  
                  3,222,254
                  
                  
                  
                  2,715,117
                  
                  
                  
                  3,452,549
                  
                  
                  
                  3,870,027Operating
      loss
                  
                  
                  (2,102,335
                  )
                  
                  
                  (2,293,061
                  )
                  
                  
                  (3,245,075
                  )
                  
                  
                  (3,647,693
                  )Other
      income (expense)Interest
      expense
                  
                  
                  (161
                  )
                  
                  
                  (5,615
                  )
                  
                  
                  (5,191
                  )
                  
                  
                  (4,757
                  )Interest
      income
                  
                  
                  204,976
                  
                  
                  
                  185,345
                  
                  
                  
                  160,080
                  
                  
                  
                  131,609Other
                  
                  
                  2,941
                  
                  
                  
                  —
                  
                  
                  
                  —
                  
                  
                  
                  —207,756
                  
                  
                  
                  179,730
                  
                  
                  
                  154,889
                  
                  
                  
                  126,852Net
      loss
                  
                  $
                  (1,894,579
                  )
                  
                  $
                  (2,113,331
                  )
                  
                  $
                  (3,090,186
                  )
                  
                  $
                  (3,520,841
                  )Net
      loss per share, basic and diluted
                  
                  $
                  (0.05
                  )
                  
                  $
                  (0.06
                  )
                  
                  $
                  (0.08
                  )
                  
                  $
                  (0.09
                  )Quarterly
      Results of Operations (Unaudited)For
      Year 2006
                  
                  March 31
                  
                  
                  June 30
                  
                  
                  September 30
                  
                  
                  December 31Net
      revenues
                  
                  $
                  92,846
                  
                  
                  $
                  279,179
                  
                  
                  $
                  1,069,897
                  
                  
                  $
                  836,527Gross
      profit
                  
                  
                  92,846
                  
                  
                  
                  279,179
                  
                  
                  
                  1,069,897
                  
                  
                  
                  836,527Operating
      expenses
                  
                  
                  3,307,468
                  
                  
                  
                  3,327,523
                  
                  
                  
                  4,419,629
                  
                  
                  
                  3,689,244Operating
      loss
                  
                  
                  (3,214,622
                  )
                  
                  
                  (3,048,344
                  )
                  
                  
                  (3,349,732
                  )
                  
                  
                  (2,852,717
                  )Other
      income (expense)Interest
      expense
                  
                  
                  (159
                  )
                  
                  
                  —
                  
                  
                  
                  (11
                  )
                  
                  
                  —Interest
      income
                  
                  
                  131,245
                  
                  
                  
                  233,510
                  
                  
                  
                  249,082
                  
                  
                  
                  229,590Unrealized
      gain/(loss) on fair value of warrants
                  
                  
                  (4,166
                  )
                  
                  
                  639,409
                  
                  
                  
                  (429,303
                  )
                  
                  
                  768,271Other
                  
                  
                  —
                  
                  
                  
                  (93,519
                  )
                  
                  
                  —
                  
                  
                  
                  (1,764
                  )126,920
                  
                  
                  
                  779,400
                  
                  
                  
                  (180,232
                  )
                  
                  
                  996,097Net
      loss
                  
                  $
                  (3,087,702
                  )
                  
                  $
                  (2,268,944
                  )
                  
                  $
                  (3,529,964
                  )
                  
                  $
                  (1,856,620
                  )Net
      loss per share, basic and diluted
                  
                  $
                  (0.09
                  )
                  
                  $
                  (0.06
                  )
                  
                  $
                  (0.09
                  )
                  
                  $
                  (0.05
                  )
  Item 9.
                  Changes
      in and Disagreements with Accountants on Accounting and Financial
      Disclosures
  None.
  Item 9A.
                  Controls
      and Procedures
  Evaluation
of Disclosure Controls and Procedures
  Our
management, with the participation of our principal executive officer and
principal financial officer, evaluated the effectiveness of our disclosure
controls and procedures (as defined in Rule 13a-15(e) under the Securities
Exchange Act of 1934 Exchange Act, as of December 31, 2007. Based on this
evaluation, our principal executive officer and our principal financial officer
concluded that our disclosure controls and procedures were effective as of
December 31, 2007.
  Management’s
Report on Internal Control Over Financial Reporting
  No change
in our internal control over financial reporting (as defined in Rules 13a-15(f)
and 15d-15(f) under the Exchange Act) occurred during the fourth quarter of our
fiscal year ended December 31, 2007, that has materially affected, or is
reasonably likely to materially affect, our internal control over financial
reporting.
  Our
management is responsible for establishing and maintaining adequate internal
control over financial reporting, as such term is defined in Rule 13a-15(f)
under the Exchange Act. Our internal control over financial reporting is a
process designed under the supervision of our principal executive and principal
financial officers to provide reasonable assurance regarding the reliability of
financial reporting and the preparation of our financial statements for external
reporting purposes in accordance with U.S. generally accepted accounting
principles.
 54
 Table of Contents
  As of
December 31, 2007, management assessed the effectiveness of our internal
control over financial reporting based on the framework established in “Internal
Control – Integrated Framework” issued by the Committee of Sponsoring
Organizations of the Treadway Commission (“COSO”). Based on this evaluation,
management has determined that our internal control over financial reporting was
effective as of December 31, 2007.
  Because
of its inherent limitations, internal control over financial reporting may not
prevent or detect misstatements. Also, projections of any evaluation of
effectiveness to future periods are subject to the risk that controls may become
inadequate because of changes in conditions, or that the degree of compliance
with the policies or procedures may deteriorate.
  Grant
Thornton LLP, the independent registered public accounting firm that audited the
financial statements included in this annual report on Form 10-K, has also
audited the effectiveness of our internal control over financial reporting as of
December 31, 2007, as stated in its report which appears in Item 8
herein.
  PART
III
  Item 10.
                  Directors
      and Executive Officers of the
Registrant
  The
information required by this item regarding our directors, executive officers
and corporate governance is incorporated by reference to the definitive proxy
statement for our 2008 annual meeting of stockholders. The information required
by this item regarding executive officers is set forth in Item 1 of this
annual report under the caption “Executive Officers.”
  Item 11.
                  Executive
      Compensation
  The
information required by this item is incorporated by reference to the definitive
proxy statement for our 2008 annual meeting of stockholders.
  Item 12.
                  Security
      Ownership of Certain Beneficial Owners and Management and Related
      Stockholder Matters
  The
information required by this item is incorporated by reference to the definitive
proxy statement for our 2008 annual meeting of stockholders.
  Item 13.
                  Certain
      Relationships and Related
Transactions
  The
information required by this item is incorporated by reference to the definitive
proxy statement for our 2008 annual meeting of stockholders.
  Item 14.
                  Principal
      Accountant Fees and Services
  The
information required by this item is incorporated by reference to the definitive
proxy statement for our 2008 annual meeting of stockholders.
     55
 Table of Contents
  PART
IV
  Item 15.
                  Exhibits
      and Financial Statement Schedules
  The
following exhibits are filed herewith:
  Incorporated
      by ReferenceExhibit
                    No.
                  Description
                  Filed
                    Herewith
                  Form
                  Exhibit
                    No.
                  File
      No.
                  Filing
      Date4.1
                  Certificate
      of Incorporation as amended on July 31, 2004
                  
                  10-QSB
                  3
                  001-31982
                  8/13/20044.2
                  Certificate
      of designation of Series A Junior Participating Preferred
      Stock
                  X4.3
                  Bylaws,
      as amended
                  
                  10-QSB
                  3
                  001-31982
                  5/17/20044.4
                  Rights
      Agreement, dated as of November 1, 2002, by and between SCOLR, Inc. and
      OTR, Inc.
                  X4.5
                  Form
      of Common Stock Purchase Warrant dated as of February 8,
    2005
                  
                  8-K
                  4.1
                  001-31982
                  2/11/20054.6
                  Form
      of Warrant dated as of December 4, 2007
                  
                  8-K
                  4.1
                  001-31982
                  11/30/200710.1
                  Form
      of Common Stock Purchase Warrant dated June 25, 2003
                  
                  S-2
                  10.3
                  333-107906
                  8/13/200310.2
                  Form
      of Common Stock Purchase Warrant dated February 24, 2004
                  
                  8-K
                  10.3
                  001-31982
                  2/26/200410.3
                  Warrant
      Agreement dated September 30, 2002
                  X10.4
                  1995
      Stock Option Plan, together with amendment No. 1 thereto*
                  
                  10-K
                  10.6
                  001-319822
                  3/13/200710.5
                  Amendment
      No. 2 to Company 1995 Stock Option Plan*
                  
                  S-8
                  4.2
                  333-40290
                  6/28/200010.6
                  Form
      of Incentive Stock Agreement*
                  
                  S-2
                  10.8
                  333-107906
                  8/13/200310.7
                  Form
      of Nonqualified Stock Option Agreement*
                  
                  S-2
                  10.9
                  333-107906
                  8/13/200310.8
                  Research
      and Transfer Agreement dated September 11, 1998, among Temple University,
      Dr. Reza Fassihi, and the Company
                  
                  S-2
                  10.11
                  333-107906
                  8/13/200310.9†
                  License
      agreement dated December 22, 1998, as amended, between Temple University
      and the Company
                  
                  S-2
                  10.12
                  333-107906
                  8/13/200310.10†
                  License
      Agreement dated September 6, 2000, between Temple University and the
      Company
                  
                  S-2
                  10.13
                  333-107906
                  8/13/200310.11†
                  Master
      Research and Development Agreement dated May 1, 2001, between Temple
      University and the Company
                  
                  S-2
                  10.14
                  333-107906
                  8/13/2003
  56
 Table of Contents
   Incorporated
      by ReferenceExhibit
                    No.
                  Description
                  Filed
                    Herewith
                  Form
                  Exhibit
                    No.
                  File
      No.
                  Filing
      Date10.12
                  Consulting
      Agreement dated December 22, 2000, between Dr. Reza Fassihi and the
      Company*
                  
                  S-2
                  10.15
                  333-107906
                  8/13/200310.13†
                  Intellectual
      Property Assignment and Assumption Agreement dated May 24, 2001, between
      Dr. Reza Fassihi and the Company
                  
                  S-2
                  10.16
                  333-107906
                  8/13/200310.14†
                  License
      Agreement dated September 1, 2001, between Temple University and the
      Company
                  
                  S-2
                  10.17
                  333-107906
                  8/13/200310.15†
                  Intellectual
      Property Assignment and Assumption Agreement dated August 1, 2002, between
      Dr. Reza Fassihi and the Company
                  
                  S-2
                  10.18
                  333-107906
                  8/13/200310.16
                  Additional
      Services Agreement dated August 7, 2002, between Dr. Reza Fassihi and the
      Company*
                  
                  S-2
                  10.19
                  333-107906
                  8/13/200310.17
                  License,
      Manufacture, and Distribution Agreement by and between the Company and
      Nutraceutix, Inc., dated December 31, 2003
                  
                  8-K
                  2.2
                  000-24693
                  1/23/200310.18
                  Building
      Lease—3625 132nd Avenue SE, Bellevue, WA, dated April 15,
    2003
                  
                  S-2
                  10.25
                  333-107906
                  8/13/200310.19
                  Employment
      Agreement dated July 2, 2003, between Stephen Turner and the
      Company*
                  
                  S-2
                  10.27
                  333-107906
                  8/13/200310.20
                  2004
      Equity Incentive Plan*
                  
                  10-QSB
                  10
                  001-31982
                  8/13/200410.21
                  Form
      of Option Agreement under the 2004 Equity Incentive Plan*
                  
                  10-QSB
                  10.2
                  001-31982
                  11/12/200410.22
                  Form
      of Outside Director Option Agreement for Annual grants to directors under
      the 2004 Equity Incentive Plan*
                  
                  10-QSB
                  10.3
                  001-31982
                  11/12/200410.23
                  Form
      of Non Employee Director Option Agreement for stock based fee awards under
      the 2004 Equity Incentive Plan*
                  
                  10-QSB
                  10.4
                  001-31982
                  11/12/200410.24†
                  Amendment
      No. 1 to Intellectual Property Assignment and Assumption Agreement dated
      July 16, 2004, between Dr. Reza Fassihi and the Company.
                  
                  10-QSB
                  10.1
                  001-31982
                  11/12/200410.25
                  Employment
      Agreement dated November 12, 2004, between Daniel O. Wilds and the
      Company*
                  
                  8-K
                  10.1
                  001-31982
                  11/18/200410.26
                  Employment
      Agreement dated January 10, 2005, between Alan M. Mitchel and the
      Company*
                  
                  8-K
                  10.1
                  001-31982
                  1/11/200510.27†
                  Manufacture,
      License and Distribution Agreement dated October 20, 2005, between the
      Company and Perrigo Company of South Carolina
                  
                  10-K
                  10.33
                  001-31982
                  3/23/2006
  57
 Table of Contents
   Incorporated
      by ReferenceExhibit
                    No.
                  Description
                  Filed
                    Herewith
                  Form
                  Exhibit
                    No.
                  File
      No.
                  Filing
      Date10.28
                  Settlement
      Agreement and First Amendment to the License Manufacture and Distribution
      Agreement, dated as of August 3, 2005, between the Company and
      Nutraceutix, Inc.
                  
                  8-K
                  10.1
                  001-31982
                  8/5/200510.29
                  First
      Amendment to Lease, effective as of October 12, 2005
                  
                  10-K
                  10.35
                  001-31982
                  3/23/200610.30
                  Employment
      Agreement dated as of December 15, 2005 between the Company and Richard M.
      Levy*
                  
                  8-K
                  99.1
                  001-31982
                  12/20/200510.31††
                  Amendment
      to License Agreement dated as of June 1, 2006, (executed July 11, 2006)
      between SCOLR Pharma, Inc. and Temple University
                  
                  10-Q
                  10.1
                  001-31982
                  11/7/200610.32
                  Amended
      and Restated Exclusive License Agreement made as of August 10, 2006, by
      and between Archer-Daniels-Midland Company and the Company
                  
                  10-Q
                  10.2
                  001-31982
                  11/7/200610.33††
                  Amendment
      to License Agreement dated as of August 10, 2006, between Temple
      University and the Company
                  
                  10-Q
                  10.4
                  001-31982
                  11/7/200610.34
                  Amendment
      to Consulting Agreement effective as of December 31, 2006, between Dr.
      Reza Fassihi and the Company*
                  
                  10-K
                  10.42
                  001-319822
                  3/13/200723.1
                  Consent
      of Grant Thornton LLP
                  X31.1
                  Certification
      of Chief Executive Officer pursuant to Section 302 of the Sarbanes-Oxley
      Act of 2002
                  X31.2
                  Certification
      of Chief Financial Officer pursuant to Section 302 of the Sarbanes-Oxley
      Act of 2002
                  X32.1
                  Certification
      of Chief Executive Officer pursuant to 18 U.S.C. Section 1350 as adopted
      pursuant to Section 906 of the Sarbanes-Oxley Act of 2002
                  X32.2
                  Certification
      of Chief Financial Officer pursuant to 18 U.S.C. Section 1350 as adopted
      pursuant to Section 906 of the Sarbanes-Oxley Act of 2002
                  X
 
 †
                  Confidential
      treatment granted as to certain portions, which portions are omitted and
      filed separately with the SEC.
 ††
                  Portions
      of such exhibit have been omitted pursuant to a request for confidential
      treatment filed with the SEC.
 *
                  Management
      contract or compensatory plan or
arrangement.
   58
 Table of Contents
  SIGNATURES
  Pursuant
to the requirements of Section 13 or 15(d) of the Securities Exchange Act
of 1934, the registrant has duly caused this report to be signed on its behalf
by the undersigned, thereunto duly authorized.
  SCOLR
      PHARMA, INC.By:
                  /s/    DANIEL O. WILDSDaniel
      O. Wilds
                    Chief
      Executive Officer and President
                    (Principal
      Executive Officer)
  Date:
March 10, 2008
  Signature
                  Title
                  Date/s/    DANIEL O. WILDS
                  President,
      Chief Executive Officer and Director (Principal Executive
      Officer)
                  March
      10, 2008Daniel
      O. Wilds/s/    RICHARD M. LEVY
                  Chief
      Financial Officer and Vice President—Finance (Principal Financial and
      Accounting Officer)
                  March
      10 , 2008Richard
      M. Levy/s/    RANDALL L-W. CAUDILL
                  Director
                  March
      10, 2008Randall
      L-W. Caudill/s/    REZA FASSIHI
                  Director
                  March
      10, 2008Reza
      Fassihi/s/    HERBERT L. LUCAS, JR.
                  Director
                  March
      10, 2008Herbert
      L. Lucas, Jr./s/    BRUCE S. MORRA
                  Director
                  March
      10, 2008Bruce
      S. Morra/s/    JEFFREY B. REICH
                  Director
                  March
      10, 2008Jeffrey
      B. Reich/s/    MICHAEL N. TAGLICH
                  Chairman
      of the Board
                  March
      10, 2008Michael
      N. Taglich/s/    WAYNE L. PINES
                  Director
                  March
      10, 2008Wayne
      L. Pines/s/    GREGORY L. WEAVER
                  Director
                  March
      10, 2008Gregory
      L. Weaver
   59
 Table of Contents
  EXHIBIT
INDEX
   Incorporated
      by ReferenceExhibit
                    No.
                  Description
                  Filed
                    Herewith
                  Form
                  Exhibit
                    No.
                  File
      No.
                  Filing
      Date4.1
                  Certificate
      of Incorporation as amended on July 31, 2004
                  
                  10-QSB
                  3
                  001-31982
                  8/13/20044.2
                  Certificate
      of designation of Series A Junior Participating Preferred
      Stock
                  X4.3
                  Bylaws,
      as amended
                  
                  10-QSB
                  3
                  001-31982
                  5/17/20044.4
                  Rights
      Agreement, dated as of November 1, 2002, by and between SCOLR, Inc. and
      OTR, Inc.
                  X4.5
                  Form
      of Common Stock Purchase Warrant dated as of February 8,
    2005
                  
                  8-K
                  4.1
                  001-31982
                  2/11/20054.6
                  Form
      of Warrant dated as of December 4, 2007
                  
                  8-K
                  4.1
                  001-31982
                  11/30/200710.1
                  Form
      of Common Stock Purchase Warrant dated June 25, 2003
                  
                  S-2
                  10.3
                  333-107906
                  8/13/200310.2
                  Form
      of Common Stock Purchase Warrant dated February 24, 2004
                  
                  8-K
                  10.3
                  001-31982
                  2/26/200410.3
                  Warrant
      Agreement dated September 30, 2002
                  X10.4
                  1995
      Stock Option Plan, together with amendment No. 1 thereto*
                  
                  10-K
                  10.6
                  001-319822
                  3/13/200710.5
                  Amendment
      No. 2 to Company 1995 Stock Option Plan*
                  
                  S-8
                  4.2
                  333-40290
                  6/28/200010.6
                  Form
      of Incentive Stock Agreement*
                  
                  S-2
                  10.8
                  333-107906
                  8/13/200310.7
                  Form
      of Nonqualified Stock Option Agreement*
                  
                  S-2
                  10.9
                  333-107906
                  8/13/200310.8
                  Research
      and Transfer Agreement dated September 11, 1998, among Temple University,
      Dr. Reza Fassihi, and the Company
                  
                  S-2
                  10.11
                  333-107906
                  8/13/200310.9†
                  License
      agreement dated December 22, 1998, as amended, between Temple University
      and the Company
                  
                  S-2
                  10.12
                  333-107906
                  8/13/200310.10†
                  License
      Agreement dated September 6, 2000, between Temple University and the
      Company
                  
                  S-2
                  10.13
                  333-107906
                  8/13/200310.11†
                  Master
      Research and Development Agreement dated May 1, 2001, between Temple
      University and the Company
                  
                  S-2
                  10.14
                  333-107906
                  8/13/2003
  60
 Table of Contents
   Incorporated
      by ReferenceExhibit
                    No.
                  Description
                  Filed
                    Herewith
                  Form
                  Exhibit
                    No.
                  File
      No.
                  Filing
      Date10.12
                  Consulting
      Agreement dated December 22, 2000, between Dr. Reza Fassihi and the
      Company*
                  
                  S-2
                  10.15
                  333-107906
                  8/13/200310.13†
                  Intellectual
      Property Assignment and Assumption Agreement dated May 24, 2001, between
      Dr. Reza Fassihi and the Company
                  
                  S-2
                  10.16
                  333-107906
                  8/13/200310.14†
                  License
      Agreement dated September 1, 2001, between Temple University and the
      Company
                  
                  S-2
                  10.17
                  333-107906
                  8/13/200310.15†
                  Intellectual
      Property Assignment and Assumption Agreement dated August 1, 2002, between
      Dr. Reza Fassihi and the Company
                  
                  S-2
                  10.18
                  333-107906
                  8/13/200310.16
                  Additional
      Services Agreement dated August 7, 2002, between Dr. Reza Fassihi and the
      Company*
                  
                  S-2
                  10.19
                  333-107906
                  8/13/200310.17
                  License,
      Manufacture, and Distribution Agreement by and between the Company and
      Nutraceutix, Inc., dated December 31, 2003
                  
                  8-K
                  2.2
                  000-24693
                  1/23/200310.18
                  Building
      Lease—3625 132nd Avenue SE, Bellevue, WA, dated April 15,
    2003
                  
                  S-2
                  10.25
                  333-107906
                  8/13/200310.19
                  Employment
      Agreement dated July 2, 2003, between Stephen Turner and the
      Company*
                  
                  S-2
                  10.27
                  333-107906
                  8/13/200310.20
                  2004
      Equity Incentive Plan*
                  
                  10-QSB
                  10
                  001-31982
                  8/13/200410.21
                  Form
      of Option Agreement under the 2004 Equity Incentive Plan*
                  
                  10-QSB
                  10.2
                  001-31982
                  11/12/200410.22
                  Form
      of Outside Director Option Agreement for Annual grants to directors under
      the 2004 Equity Incentive Plan*
                  
                  10-QSB
                  10.3
                  001-31982
                  11/12/200410.23
                  Form
      of Non Employee Director Option Agreement for stock based fee awards under
      the 2004 Equity Incentive Plan*
                  
                  10-QSB
                  10.4
                  001-31982
                  11/12/200410.24†
                  Amendment
      No. 1 to Intellectual Property Assignment and Assumption Agreement dated
      July 16, 2004, between Dr. Reza Fassihi and the Company.
                  
                  10-QSB
                  10.1
                  001-31982
                  11/12/200410.25
                  Employment
      Agreement dated November 12, 2004, between Daniel O. Wilds and the
      Company*
                  
                  8-K
                  10.1
                  001-31982
                  11/18/200410.26
                  Employment
      Agreement dated January 10, 2005, between Alan M. Mitchel and the
      Company*
                  
                  8-K
                  10.1
                  001-31982
                  1/11/200510.27†
                  Manufacture,
      License and Distribution Agreement dated October 20, 2005, between the
      Company and Perrigo Company of South Carolina
                  
                  10-K
                  10.33
                  001-31982
                  3/23/2006
  61
 Table of Contents
   Incorporated
      by ReferenceExhibit
                    No.
                  Description
                  Filed
                    Herewith
                  Form
                  Exhibit
                    No.
                  File
      No.
                  Filing
      Date10.28
                  Settlement
      Agreement and First Amendment to the License Manufacture and Distribution
      Agreement, dated as of August 3, 2005, between the Company and
      Nutraceutix, Inc.
                  
                  8-K
                  10.1
                  001-31982
                  8/5/200510.29
                  First
      Amendment to Lease, effective as of October 12, 2005
                  
                  10-K
                  10.35
                  001-31982
                  3/23/200610.30
                  Employment
      Agreement dated as of December 15, 2005 between the Company and Richard M.
      Levy*
                  
                  8-K
                  99.1
                  001-31982
                  12/20/200510.31††
                  Amendment
      to License Agreement dated as of June 1, 2006, (executed July 11, 2006)
      between SCOLR Pharma, Inc. and Temple University
                  
                  10-Q
                  10.1
                  001-31982
                  11/7/200610.32
                  Amended
      and Restated Exclusive License Agreement made as of August 10, 2006, by
      and between Archer-Daniels-Midland Company and the Company
                  
                  10-Q
                  10.2
                  001-31982
                  11/7/200610.33††
                  Amendment
      to License Agreement dated as of August 10, 2006, between Temple
      University and the Company
                  
                  10-Q
                  10.4
                  001-31982
                  11/7/200610.34
                  Amendment
      to Consulting Agreement effective as of December 31, 2006, between Dr.
      Reza Fassihi and the Company*
                  
                  10-K
                  10.42
                  001-319822
                  3/13/200723.1
                  Consent
      of Grant Thornton LLP
                  X31.1
                  Certification
      of Chief Executive Officer pursuant to Section 302 of the Sarbanes-Oxley
      Act of 2002
                  X31.2
                  Certification
      of Chief Financial Officer pursuant to Section 302 of the Sarbanes-Oxley
      Act of 2002
                  X32.1
                  Certification
      of Chief Executive Officer pursuant to 18 U.S.C. Section 1350 as adopted
      pursuant to Section 906 of the Sarbanes-Oxley Act of 2002
                  X32.2
                  Certification
      of Chief Financial Officer pursuant to 18 U.S.C. Section 1350 as adopted
      pursuant to Section 906 of the Sarbanes-Oxley Act of 2002
                  X
 
 †
                  Confidential
      treatment granted as to certain portions, which portions are omitted and
      filed separately with the SEC.
 ††
                  Portions
      of such exhibit have been omitted pursuant to a request for confidential
      treatment filed with the SEC.
 *
                  Management
      contract or compensatory plan or
arrangement.




62