**UNITED
        STATES**
 **SECURITIES
        AND EXCHANGE COMMISSION**
 **Washington,
        D.C. 20549**
 
 **FORM
        10-Q**
 
 **(Mark
        One)**
 
 x
              **QUARTERLY
                  REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
                  ACT OF
                  1934**
 
 **For
        the quarterly period ended July 2, 2006**
 OR
 o
              **TRANSITION
                  REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
                  ACT OF
                  1934**
 
 **For
        the transition period from ____________________ to
        ______________________**
 
 Commission
        file number 000-50851
 
 
 NEW
        RIVER
        PHARMACEUTICALS INC.
 (Exact
        name of registrant as specified in its charter)
 
 Virginia
              
              54-1816479(State
                  or other jurisdiction of incorporation or organization)
              
              (IRS
                  Employer Identification No.)1881
                  Grove AvenueRadford,
                  Virginia
              
              24141(Address
                  of Principal Executive Offices)
              
              (Zip
                  Code)
 
 (540)
                  633-7978(Registrant’s
                  Telephone Number, Including Area Code)
  
 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 þ No o
  Indicate
        by check mark whether the registrant is a large accelerated filer, an
        accelerated filer, or a non-accelerated filer. See definition of “accelerated
        filer and large accelerated filer” in Rule 12b-2 of the Exchange Act.
        (Check one):
 
 Large
                  accelerated filero
              Accelerated
                  filerþ
              Non-accelerated
                  filero
 
 Indicate
        by check mark whether the registrant is a shell company (as defined in
        Rule 12b-2 of the Act). Yes o No þ
  As
        of
        August 4, 2006 there were 36,707,064 shares of the registrant’s common stock,
        $.001 par value per share, outstanding.
 
 
  **NEW
        RIVER PHARMACEUTICALS INC.**
 **FORM
        10-Q**
 **FOR
        THE QUARTERLY PERIOD ENDED July 2, 2006**
 
 **INDEX**
 
 **Page****PART
                  I  FINANCIAL INFORMATION****Item
                  1. Consolidated Financial Statements
                  (unaudited).**
              **2****Consolidated
                  Balance Sheets July 2, 2006 and January 1, 2006****Consolidated
                  Statements of Operations Three and six months ended
                  July 2, 2006 and July 3, 2005****Consolidated
                  Statements of Cash Flows Six months ended July 2,
                  2006 and July 3, 2005****Notes
                  to Consolidated Financial Statements****Item
                  2. Management’s Discussion and Analysis of Financial
                  Condition and Results of Operations.**
              **16****Item
                  3. Quantitative and Qualitative Disclosures About Market
                  Risk.**
              **27****Item
                  4. Controls and Procedures.**
              **27****PART
                  II OTHER INFORMATION**
              **28****Item
                  1. Legal Proceedings.**
              **28****Item
                  1A. Risk Factors.**
              **28****Item
                  2. Unregistered Sales of Equity Securities and Use of
                  Proceeds.**
              **42****Item
                  3. Defaults Upon Senior
                  Securities.**
              **42****Item
                  4. Submission of Matters to a Vote of Securities
                  Holders.**
              **42****Item
                  5. Other Information.**
              **42****Item
                  6. Exhibits.**
              **43****SIGNATURES**
              **44**
 *Index*
  **Item
1.**
              **Consolidated
                  Financial Statements**
 
 **NEW
        RIVER PHARMACEUTICALS INC. AND SUBSIDIARY**
 **CONSOLIDATED
        BALANCE SHEETS**
 **(Unaudited)**
 
 **Assets**
              
              **July
                  2,**
                **2006**
              
              **January
                  1,**
                **2006**Current
                  assets:Cash
                  and cash equivalents
              
              $
              19,221,558
              
              $
              3,515,572Short-term
                  investments
              
              
              72,475,000
              
              
              49,250,000Other
                  receivables
              
              
              198,795
              
              
              135,755Due
                  from affiliates
              
              
              5,188
              
              
              —Prepaid
                  expenses
              
              
              491,930
              
              
              798,090Total
                  current assets
              
              
              92,392,471
              
              
              53,699,417Property
                  and equipment:Leasehold
                  improvements
              
              
              94,609
              
              
              94,609Machinery
                  and equipment
              
              
              854,325
              
              
              819,472948,934
              
              
              914,081Less
                  accumulated depreciation and amortization
              
              
              734,129
              
              
              653,427Property
                  and equipment, net
              
              
              214,805
              
              
              260,654Total
                  assets
              
              $
              92,607,276
              
              $
              53,960,071**Liabilities
                  and Shareholders’ Equity (Deficit)**Current
                  liabilities:Capital
                  lease obligation - current
              
              $
              23,582
              
              $
              22,298Accounts
                  payable
              
              
              5,605,846
              
              
              1,548,473Unpaid
                  and accrued research and development expenses
              
              
              4,211,331
              
              
              3,201,732Accrued
                  compensation
              
              
              1,358,828
              
              
              2,203,898Due
                  to affiliates
              
              
              70,162
              
              
              34,138Deferred
                  revenue - current
              
              
              13,274,708
              
              
              —Accrued
                  stock based compensation - current
              
              
              226,758
              
              
              —Total
                  current liabilities
              
              
              24,771,215
              
              
              7,010,539Capital
                  lease obligation - noncurrent
              
              
              15,027
              
              
              27,148Accrued
                  stock-based compensation
              
              
              7,919,291
              
              
              3,404,435Deferred
                  revenue
              
              
              59,900,215
              
              
              50,000,000Total
                  liabilities
              
              
              92,605,748
              
              
              60,442,122Shareholders’
                  Equity (Deficit):Preferred
                  stock, par value $0.001 per share.Authorized
                  25,000,000 shares; none issued and outstanding
              
              
              —
              
              
              —Common
                  stock, par value $0.001 per share. Authorized 150,000,000 shares;
                  issued
                  and outstanding 36,707,064 shares at July 2, 2006 and 36,367,064
                  shares at
                  January 1, 2006
              
              
              36,707
              
              
              36,367Additional
                  paid-in capital
              
              
              66,349,374
              
              
              63,326,824Accumulated
                  deficit
              
              
              (66,384,553
              )
              
              (69,845,242
              )Total
                  shareholders’ equity (deficit)
              
              
              1,528
              
              
              (6,482,051
              )Commitments
                  and contingenciesTotal
                  liabilities and shareholders’ equity (deficit)
              
              $
              92,607,276
              
              $
              53,960,071
 
 See
        accompanying notes to consolidated financial statements.
  2
 *Index*
  **NEWRIVER
        PHARMACEUTICALS INC. AND SUBSIDIARY**
 **CONSOLIDATED
        STATEMENTS OF OPERATIONS**
  **Three
                    months ended**
                
                **Six
                    months ended****July
                    2,**
                  **2006**
                
                **July
                    3,**
                  **2005**
                
                **July
                    2,**
                  **2006**
                
                **July
                    3,**
                  **2005****(Unaudited)**
                
                **(Unaudited)**Collaboration
                    revenues
                
                $
                5,497,701
                
                $
                —
                
                $
                26,825,077
                
                $
                —Operating
                    costs and expenses:Selling,
                    general, and administrative
                
                
                5,278,256
                
                
                1,770,242
                
                
                13,495,760
                
                
                4,945,523Research
                    and development
                
                
                5,581,996
                
                
                5,040,996
                
                
                11,097,909
                
                
                8,825,211Depreciation
                    and amortization of property and equipment
                
                
                39,702
                
                
                39,636
                
                
                80,702
                
                
                74,816Total
                    operating expenses
                
                
                10,899,954
                
                
                6,850,874
                
                
                24,674,371
                
                
                13,845,550Operating
                    income (loss)
                
                
                (5,402,253
                )
                
                (6,850,874
                )
                
                2,150,706
                
                
                (13,845,550
                )Other
                    income (expense):Interest
                    expense
                
                
                (1,189
                )
                
                (1,854
                )
                
                (2,531
                )
                
                (1,854
                )Interest
                    income
                
                
                1,150,095
                
                
                498,294
                
                
                2,023,411
                
                
                820,738Total
                    other income, net
                
                
                1,148,906
                
                
                496,440
                
                
                2,020,880
                
                
                818,884Income
                    (loss) before cumulative effect of change in accounting
                    principle
                
                
                (4,253,347
                )
                
                (6,354,434
                )
                
                4,171,586
                
                
                (13,026,666
                )Cumulative
                    effect of a change in accounting principle
                
                
                —
                
                
                —
                
                
                (710,897
                )
                
                —Net
                    income (loss)
                
                $
                (4,253,347
                )
                $
                (6,354,434
                )
                $
                3,460,689
                
                $
                (13,026,666
                )Net
                  income (loss) per share:Basic
                
                $
                (0.12
                )
                $
                (0.18
                )
                $
                0.09
                
                $
                (0.37
                )Diluted
                
                $
                (0.12
                )
                $
                (0.18
                )
                $
                0.09
                
                $
                (0.37
                )
  See
        accompanying notes to consolidated financial statements.
  3
 *Index*
  **NEW
          RIVER PHARMACEUTICALS INC. AND SUBSIDIARY**
 **CONSOLIDATED
          STATEMENTS OF CASH FLOWS**
 **(Unaudited)**
 **Six
                  months ended****July
                  2, 2006**
              
              **July
                  3, 2005**Cash
                  flows from operating activities:Net
                  income (loss)
              
              $
              3,460,689
              
              $
              (13,026,666
              )Adjustments
                  to reconcile net income (loss) to net cash provided by operating
                  activities:Depreciation
                  and amortization of property and equipment
              
              
              80,702
              
              
              74,816Stock-based
                  compensation
              
              
              1,960,975
              
              
              93,187Changes
                  in operating assets and liabilities:Other
                  receivables
              
              
              (63,040
              )
              
              (46,011
              )Due
                  from affiliates
              
              
              (5,188
              )
              
              —Prepaid
                  expenses
              
              
              306,160
              
              
              6,212Accounts
                  payable
              
              
              4,057,373
              
              
              116,568Unpaid
                  and accrued research and development expenses
              
              
              1,009,599
              
              
              (47,325
              )Accrued
                  compensation
              
              
              (845,070
              )
              
              (719,036
              )Due
                  to affiliates
              
              
              36,024
              
              
              (52,432
              )Accrued
                  stock-based compensation
              
              
              4,030,717
              
              
              279,563Deferred
                  revenue
              
              
              23,174,923
              
              
              50,000,000Cumulative
                  effect of change in accounting principle
              
              
              710,897
              
              
              —Net
                  cash provided by operating activities
              
              
              37,914,761
              
              
              36,678,876Cash
                  flows from investing activities:Proceeds
                  from sale of short-term investments
              
              
              28,075,000
              
              
              40,350,000Purchases
                  of short-term investments
              
              
              (51,300,000
              )
              
              (79,550,000
              )Proceeds
                  from sale of property and equipment
              
              
              —
              
              
              91Purchases
                  of property and equipment
              
              
              (34,853
              )
              
              (73,242
              )Net
                  cash used in investing activities
              
              
              (23,259,853
              )
              
              (39,273,151
              )Cash
                  flows from financing activities:Principal
                  payments on capital lease obligation
              
              
              (10,837
              )
              
              (9,286
              )Net
                  proceeds from issuances of common stock
              
              
              1,061,915
              
              
              579,081Net
                  cash provided by financing activities
              
              
              1,051,078
              
              
              569,795Net
                  increase (decrease) in cash and cash equivalents
              
              
              15,705,986
              
              
              (2,024,480
              )Cash
                  and cash equivalents at beginning of period
              
              
              3,515,572
              
              
              4,018,556Cash
                  and cash equivalents at end of period
              
              $
              19,221,558
              
              $
              1,994,076Supplemental
                cash flow information:Interest
                  paid
              
              $
              (2,531
              )
              
              (1,854
              )
 
 See
        accompanying notes to consolidated financial statements
  4
 *Index*
  **NEW
        RIVER PHARMACEUTICALS INC.**
 **AND
        SUBSIDIARY**
 **NOTES
        TO CONSOLIDATED FINANCIAL STATEMENTS**
 **Three
        and six months ended July 2, 2006 and July 3, 2005**
 **(Unaudited)**
 
 **(1)**
              **ORGANIZATION
                  AND NATURE OF BUSINESS**
 
 **Organization**
 
 New
        River
        Pharmaceuticals Inc. (the Company), a Virginia corporation, was formed in
        1996.
        The Company has a wholly owned subsidiary, Lotus Biochemical (Bermuda) Ltd.
        (Lotus Bermuda), which exists to hold pharmaceutical intellectual property.
        While Lotus Bermuda has held such forms of intellectual property in the past,
        at
        July 2, 2006, Lotus Bermuda holds no such assets; however, Lotus Bermuda
        may be
        used again for such purpose in the future. Alternatively, the Company may
        decide
        to dissolve Lotus Bermuda at some time in the future.
 
 **Nature
        of Business**
 
 The
        Company is a specialty pharmaceutical company developing generational
        improvements of widely prescribed drugs in large and growing markets. Utilizing
        its proprietary Carrierwave TM technology, the Company is developing new molecular entities that are
        derivatives of public domain actives and attempt to address certain deficiencies
        associated with currently marketed drugs. The products in the Company’s pipeline
        that are the most advanced in their development are NRP104 and NRP290, which
        are
        conditionally bioreversible derivatives (CBDs) of *d-* amphetamine
        and hydrocodone, respectively, that are designed to provide overdose protection,
        less potential for abuse and less potential for addiction while affording
        comparable efficacy.
 
 **(2)**
              **SUMMARY
                  OF SIGNIFICANT ACCOUNTING
                  POLICIES**
 
 *(a)*
              *Basis
                  of Presentation*
 
 The
        accompanying unaudited consolidated financial statements include the accounts
        of
        New River Pharmaceuticals Inc. and its wholly owned subsidiary and have been
        prepared in accordance with U.S. generally accepted accounting principles
        for
        interim financial information and pursuant to the rules and regulations of
        the
        Securities and Exchange Commission (SEC) pertaining to Quarterly Reports
        on Form
        10-Q. Certain disclosures required for complete financial statements are
        not
        included herein. All significant intercompany accounts and transactions have
        been eliminated in consolidation. The information as of July 2, 2006 and
        for the
        three and six months ended July 2, 2006 and July 3, 2005 is unaudited but
        includes all adjustments (consisting only of normal recurring adjustments)
        that,
        in the opinion of management, are necessary to state fairly the financial
        information set forth herein. The interim results are not necessarily indicative
        of results to be expected for the full fiscal year. These unaudited consolidated
        financial statements should be read in conjunction with the audited consolidated
        financial statements and footnotes thereto for the year ended January 1,
        2006,
        included in the Company’s Annual Report on Form 10-K, filed with the SEC on
        March 15, 2006.
 
 *(b)*
              *Fiscal
                  Periods*
 
 The
        Company maintains its books using a 52/53-week fiscal year ending on the
        Sunday
        nearest the last day of December. Quarterly periods are closed every 13 weeks
        except during years that include 53 weeks. In such years, the fourth quarter
        will include 14 weeks. Fiscal year 2005 included 52 weeks and ended on January
        1, 2006. Fiscal year 2006 includes 52 weeks and ends December 31,
        2006.
 
 *(c)*
              *Cash
                  and Cash Equivalents*
 
 For
        purposes of the consolidated statements of cash flows, the Company considers
        all
        highly liquid debt instruments purchased with an original maturity of three
        months or less to be cash equivalents. Cash equivalents consisted of money
        market funds and commercial paper of $2,451,641 and $16,745,093, respectively,
        at July 2, 2006 and $299,264 and $3,155,253, respectively, at January 1,
        2006.
  5
 *Index*
  *(d)*
              *Short-Term
                  Investments*
 
 Short-term
        investments are classified in accordance with the provisions of Statement
        of
        Financial Accounting Standards (SFAS) No. 115, “ *Accounting
        for Certain Investments in Debt and Equity*  *Securities.”* At July
        2, 2006 and January 1, 2006, the Company’s short-term investments consisted of
        $72,475,000 and $49,250,000, respectively, of auction rate municipal bonds
        which
        are classified as available-for-sale. The Company records its investment
        in
        these securities at cost, which approximates fair market value due to (i)
        the
        securities’ variable interest rates, which typically reset every 28 to 35 days,
        and, (ii) the fact that the Company has the ability to liquidate readily
        these
        securities despite the long-term nature of their stated contractual maturities.
        As a result, the Company had no cumulative gross unrealized gains (losses)
        from
        its investments in these securities at July 2, 2006 and January 1, 2006.
        All
        income generated from these investments is recorded as interest
        income.
 
 *(e)*
              *Inventories*
 
 In
        accordance with SFAS No. 2, “ *Accounting
        for Research and Development Costs,”* the
        costs
        of producing inventory in the reporting periods prior to the receipt of
        regulatory approval or clearance are recorded as research and development
        expense. Because the Company does not currently have any products on the
        market,
        nor any products currently approved by the U.S. Food and Drug Administration
        (FDA) or other regulatory body for production, the Company did not have any
        inventory at July 2, 2006 and January 1, 2006.
 
 On
        May
        18, 2006, the Company entered into an Active Pharmaceutical Ingredient Supply
        Agreement (the Supply Agreement) with Organichem Corporation (Organichem)
        for
        the non-exclusive manufacture and supply of NRP104 by Organichem for the
        Company. Under the terms of the Supply Agreement, Organichem is to manufacture
        validation batches and commercial batches once regulatory approval is obtained.
        In accordance with the Company’s policy, expenses in connection with validation
        batches manufactured prior to regulatory approval are recorded as research
        and
        development expenses. In order for Organichem to secure necessary quotas
        of
        d-amphetamine to manufacture NRP104, the Company had to issue purchase orders
        to
        Organichem for commercial production batches and present them to the U.S.
        Drug
        Enforcement Administration (DEA). These purchase orders total approximately
        $3.3
        million.
 
 *(f)*
              *Income
                  Taxes*
 
 Income
        taxes are accounted for under the asset and liability method. Deferred tax
        assets and liabilities are recognized for the future tax consequences
        attributable to differences between the financial statement carrying amounts
        of
        existing assets and liabilities and their respective tax bases and operating
        loss and tax credit carryforwards. Valuation allowances are established when
        necessary to reduce deferred tax assets to the amount expected to be realized.
        Deferred tax assets and liabilities are measured using enacted tax rates
        expected to apply to taxable income in the years in which those temporary
        differences are expected to be recovered or settled. The effect on deferred
        tax
        assets and liabilities of a change in tax rates is recognized in income in
        the
        period that includes the enactment date.
 
 In
        June
        2006, the Financial Accounting Standards Board (FASB) issued Interpretation
        48, *“Accounting
        for Uncertainty in Income Taxes”* ,
        (FIN
        48). FIN 48 clarifies the application of SFAS No. 109, “Accounting for Income
        Taxes”, by defining the confidence level that a tax position must meet for any
        part of the benefit of that position to be recognized in a Company’s financial
        statements. FIN 48 requires that the tax effects of a position be recognized
        only if it is “more-likely-than-not” to be sustained based solely on its
        technical merits as of the reporting date. FIN 48 is effective as of the
        beginning of the first fiscal year beginning after December 15, 2006, with
        early
        application permitted if no interim financial statements have been
        issued. The Company is currently evaluating the impact that adopting
        FIN 48 will have on its future financial statements.
  6
 *Index*
 *(g)*
                *Revenue
                    Recognition, Cost of Goods Sold and Sales
                    Returns*
 
 Although
          at July 2, 2006, the Company had no products available for sale, it does
          anticipate having products available for sale in the future. The Company
          anticipates that some of its sales will be to wholesalers who have the
          right to
          return purchased product. In accordance with SFAS No. 48, “ *Revenue
          Recognition When the Right of Return Exists”* (SFAS
          No. 48), until the Company has sufficient sales history to estimate product
          returns, it will have to defer recognition of revenue on such sales until
          the
          products are dispensed through patient prescriptions. Once the Company
          has
          obtained sufficient sales history to estimate product returns, under SFAS
          No.
          48, it will be able to recognize revenue on product shipments, net of a
          reasonable allowance for estimated returns relating to these
          shipments.
 
 The
          Company’s strategy includes entering into collaborative agreements with
          strategic partners for the development and commercialization of its product
          candidates. Such collaboration agreements may have multiple deliverables.
          The
          Company evaluates m ultiple
          deliverable arrangements pursuant to EITF 00-21, *“Revenue
          Arrangements with Multiple Deliverables”* (EITF
          00-21). Pursuant to EITF 00-21, in arrangements with multiple deliverables
          where
          the Company has continuing performance obligations, contract, milestone
          and
          license fees are recognized together with any up-front payments over the
          term of
          the arrangement as performance obligations are completed, unless the deliverable
          has stand alone value and there is objective, reliable evidence of fair
          value of
          the undelivered element in the arrangement. In the case of an arrangement
          where
          it is determined there is a single unit of accounting, all cash flows from
          the
          arrangement are considered in the determination of all revenue to be recognized.
          Cash received in advance of revenue recognition is recorded as deferred
          revenue
          (see note 3).
 
 *(h)*
                *Research
                    and Development*
 
 Research
          and development expenses consist of direct costs and indirect costs. Direct
          research and development costs include salaries and related costs of research
          and development personnel, and the costs of consultants, facilities, materials
          and supplies associated with research and development projects as well
          as
          various laboratory studies. Indirect research and development costs include
          depreciation and other indirect overhead expenses. The Company believes
          that
          regulatory and other uncertainties inherent in the research and development
          of
          new products preclude it from capitalizing such costs. This treatment includes
          up-front and milestone payments made to third parties in connection with
          research and development collaborations. At July 2, 2006, the Company had
          research and development commitments with third parties totaling approximately
          $28,493,000, of which approximately $14,315,000 had not yet been incurred.
          The
          commitments are generally cancelable by the Company at any time upon written
          notice. ****
 
 *(i)*
                *Stock-Based
                    Compensation*
 
 Effective
          January 2, 2006, the Company adopted the provisions of SFAS No. 123(R), *“Share-Based
          Payment,”* (SFAS
          No. 123(R)) and related interpretations, using the modified prospective
          method. SFAS No. 123(R) requires companies to expense the grant-date fair
          value
          of employee equity awards over the vesting period. Using the modified
          prospective method of adopting SFAS 123(R), the Company began recognizing
          compensation expense for the remaining unvested portions of stock option
          and
          stock appreciation rights (SARs) settled in stock granted prior to January
          2,
          2006. The Company also has outstanding SARs that are to be settled in cash.
          In
          accordance with SFAS 123(R), these instruments are measured at fair value
          and
          are recorded as a liability at the end of each reporting period until settled.
          Upon adoption of SFAS 123(R), the Company recognized a cumulative effect
          accounting adjustment related to SARs that are to be settled in cash. Prior
          to
          the adoption of SFAS 123(R), such awards were accounted for as liabilities
          based
          on the intrinsic value of such awards, rather than the fair value, at the
          end of
          the reporting period.
 
 Stock-based
          compensation expense recognized under SFAS 123(R) in the consolidated statements
          of operations for the three and six-month periods ended July 2, 2006 for
          all
          awards was approximately $908,000 and $5,992,000, respectively. The estimated
          fair value of the Company’s stock option and SAR awards to be settled in Company
          common stock, less estimated forfeitures, is amortized over the awards’ vesting
          period on an accelerated basis.
 
 For
          stock
          options and SARs to be settled in stock that were granted prior to the
          adoption
          of SFAS 123(R), the effect on net loss and earnings per share if the Company
          had
          applied the fair value recognition provisions of SFAS 123(R) to these awards
          would have been as follows for the three and six-month periods ended July
          3,
          2005:
  7
 *Index*
  Three
                    months
                  ended
                  July
                    3, 2005
                
                Six
                    months
                  ended
                  July
                    3, 2005Net
                    loss:As
                    reported
                
                $
                (6,354,434
                )
                $
                (13,026,666
                )Add
                    stock-based employee compensation expense included in reported
                    net loss,
                    net of related tax effects
                
                
                88,418
                
                
                93,188Deduct
                    total stock-based employee compensation expense determined under
                    fair-value-based method for all awards, net of related tax
                    effects
                
                
                (209,564
                )
                
                (2,135,718
                )Pro
                    forma
                
                $
                (6,475,580
                )
                $
                (15,069,196
                )Net
                    loss per share:Basic
                    and diluted:As
                    reported
                
                $
                (0.18
                )
                $
                (0.37
                )Pro
                    forma
                
                $
                (0.18
                )
                $
                (0.42
                )
 
 The
          fair
          value of options and SARs is determined by using the Black-Scholes option
          pricing model. Expected volatility was based on a combination of historical
          volatility of the Company’s stock and comparisons to volatilities of common
          stock of peer group companies. Comparison to peer group companies was necessary
          because the Company’s common stock has only been publicly traded for a limited
          time (since August 2004). The expected term for stock options represents
          the
          period of time that the options granted are expected to be outstanding
          based on
          the simplified method provided in Staff Accounting Bulletin No. 107 (SAB
          107),
          which averages an award’s weighted average vesting period and its contractual
          term for “plain vanilla” share options. The expected term for all SARs is the
          vesting period. The per share weighted average fair value of stock options
          granted during the three and six months ended July 2, 2006, was $21.32
          and
          $20.51, respectively, on the date of grant. The per share weighted average
          fair
          value of SARs to be settled in common stock granted during the six months
          ended
          July 2, 2006 was $18.06 on the date of grant. There were no SARs granted
          during
          the three months ended July 2, 2006. For all SARs to be settled in cash,
          which
          are classified as liabilities, the per share weighted average fair market
          value
          was $14.74 at the end of the reporting period. These weighted averages
          were
          determined utilizing the Black-Scholes option pricing model with the following
          weighted average assumptions:
 
 Expected
                    dividend yield
                
                
                0%Risk-free
                    interest rate
                
                
                4.08%
                    - 5.06%Expected
                    life of options
                
                
                5.5
                    - 6.5 yearsExpected
                    life of SARs
                
                
                1
                    - 5 yearsExpected
                    volatility
                
                
                50%
                    - 70%
 
 *(j)*
                *Net
                    Income (Loss) Per Share*
 
 Basic
          net
          income (loss) per share excludes dilution and is computed by dividing net
          income
          (loss) by the weighted average number of shares of common stock outstanding
          for
          the period. Diluted net income per share reflects the potential dilution
          that
          would occur if securities or other contracts to issue common stock were
          exercised or converted into common stock or resulted in the issuance of
          common
          stock that then shared in the net income of the Company. Diluted net (loss)
          per
          share does not reflect the potential dilution that would occur if securities
          or
          other contracts to issue common stock were exercised or converted into
          common
          stock or resulted in the issuance of common stock that then shared in the
          net
          (loss) of the Company because to do so would be anti-dilutive (see
          note 7).
  8
 *Index*
  *(k)*
                *Reclassifications*
 
 Certain
          reclassifications have been made to the consolidated financial statements
          for
          the three and six months ended July 3, 2005, to place them on a basis comparable
          to the consolidated financial statements for the three and six months ended
          July
          2, 2006.
 
 *(l)*
                *Use
                    of Estimates*
 
 The
          preparation of consolidated financial statements in conformity with U.S.
          generally accepted accounting principles requires management to make estimates
          and assumptions that affect certain reported amounts. Actual results could
          differ from management’s estimates.
 
 **(3)**
                **COLLABORATION
                    ARRANGEMENT AND OTHER
                    AGREEMENTS**
 
 On
          January 31, 2005, the Company entered into a collaboration agreement with
          Shire
          Pharmaceuticals Group plc (Shire) relating to the global commercialization
          of
          NRP104 for treatment of attention deficit hyperactivity disorder (ADHD)
          and
          other potential indications. On March 31, 2005, the Company and Shire split
          this
          agreement into two agreements by entering into a United States Collaboration
          Agreement and a rest of world (ROW) Territory License Agreement (collectively,
          the Shire Agreement) to replace the initial collaboration agreement. Shire
          paid
          the Company an upfront fee of $50 million on February 11, 2005 and a milestone
          payment of $50 million on February 6, 2006 as a result of notice from the
          FDA on
          January 26, 2006 of its acceptance of the Company’s new drug application (NDA)
          filing for NRP104. Of the $100 million received to date, up to $50 million
          remains refundable in the event that regulatory approval for NRP104 is
          not
          obtained by certain dates as follows: $25 million on December 31, 2007;
          an
          additional $12.5 million on December 31, 2008; and the remaining $12.5
          million
          on December 31, 2009.
 
 The
          Company evaluated the Shire Agreement in accordance with EITF 00-21 and
          determined that it was an arrangement with multiple deliverables. The Shire
          Agreement also provides for additional payments to the Company in the event
          that
          certain additional milestones are achieved. These potential payments include
          an
          amount of up to $300 million following the first commercial sale of the
          product,
          depending on the characteristics of the FDA approved product labeling,
          and $100
          million upon achieving a significant sales target. **** The
          maximum amount of upfront and milestone payments under the terms of the
          Shire
          Agreement is $505 million. Under the Shire Agreement, the Company will
          provide
          product development for three indications for NRP104: pediatric, adult
          and
          adolescent. The Company determined that the license and research and development
          should be combined and considered as a single unit of accounting. Accordingly,
          the upfront license fee and all milestone payments will be recognized over
          the
          estimated product development period. The Company estimated the total
          proportional effort required for the development of each of these three
          indications. This proportional revenue model is then applied to all upfront
          and
          milestone payments which are no longer subject to contingencies. The Company
          recognized approximately $5.5 million and $26.8 million of collaboration
          revenue
          for the three and six months ended July 2, 2006, respectively, based on
          this
          model. The amount recognized during the six months ended July 2, 2006 includes
          amounts that would have otherwise been recognized in prior periods had
          such
          amounts not been fully refundable in certain circumstances at the end of
          those
          periods. Consequently, the Company anticipates that revenue recognized
          based on
          this model in future periods will be significantly less than amounts recognized
          during the six months ended July 2, 2006 until FDA approval for NRP104
          is
          obtained.
 
 The
          Shire
          Agreement provides the Company, at its option, the right to co-promote
          NRP104 in
          the United States (including its territories and possessions). On July
          25, 2006,
          the Company exercised this right. The co-promotion activities of the Company
          will commence in six months or upon the commercial launch of NRP104, whichever
          occurs later. In exercising its option to co-promote NRP104, the Company
          committed to co-promote the product for at least 24 months and to provide
          25% of
          the total details for the product during the 24-month period. **** The
          Shire
          Agreement also provides for profit sharing on U.S. product sales when and
          if the
          product is approved by the FDA. Shire will retain 75% of profits, as defined
          in
          the Shire Agreement, for the first two years following the launch of the
          product
          and the Company and Shire will share the profits equally thereafter. For
          product
          sales in the rest of the world, Shire will pay the Company a royalty. The
          Shire
          Agreement provides for certain termination rights. Shire may for instance
          terminate the Shire Agreement at any time prior to receiving regulatory
          approval
          in the United States, or within 30 days of receiving the first such regulatory
          approval. In the latter case, Shire may under some circumstances be entitled
          to
          a termination fee of $50 million. In addition, each party may terminate
          in the
          event of an uncured, defined material breach by the other party, entitling
          the
          non-breaching party the right to purchase the interests of the breaching
          party.
          Subject to certain conditions, either party is entitled to terminate in
          the
          event that governmental action restricts or prohibits the transactions
          contemplated by the Shire Agreement under the laws of the United States
          or
          European Union.
  9
 *Index*
 On
            June
            6, 2005, the Company entered into a development and license agreement
            with
            Depomed, Inc. (Depomed) to create pharmaceutical products using Depomed’s
            patented oral drug delivery technology with the Company’s proprietary drug
            compounds. Under terms of the agreement, the Company may acquire worldwide
            rights to use Depomed's Gastric Retention oral drug delivery technology
            in up to
            three of the Company’s proprietary compounds. Once a compound is named and
            entered into development, Depomed will perform feasibility studies through
            an
            initial Phase I trial. In return, the Company will reimburse Depomed
            on a
            cost-plus basis for expenses as defined in each project budget. Once
            preclinical
            and Phase I testing is completed, the Company may exercise an option
            to license
            each product candidate and advance the product into additional clinical
            trials.
            At that time, the Company will make an initial milestone payment, with
            additional milestone payments for each product candidate at later stages
            of
            product development. Upon ultimate commercialization of product candidates
            developed under this agreement, the Company will pay Depomed royalties
            on net
            sales of each product. Through July 2, 2006, the Company had incurred
            no
            development costs under this agreement.
 
 On
            June
            29, 2005, the Company entered into a letter agreement with Optimer
            Pharmaceuticals, Inc. (Optimer) for the development of one or more proprietary
            pharmaceutical products comprising carbohydrate conjugates of iron for
            administration by injection using Optimer’s proprietary carbohydrate synthesis
            technology. Under the letter agreement, Optimer is responsible for synthesizing
            and characterizing compounds for testing.  Optimer commenced work on this
            project during the third quarter of 2005, and the Company is responsible
            for
            reimbursing Optimer for such work at a full time equivalent (FTE) consistent
            with current industry standards.  The Company incurred approximately
            $39,000 and $226,000 of expenses under this agreement during the three
            and six
            months ended July 2, 2006, respectively. The Company will be responsible
            for
            conducting all preclinical and clinical testing on any such compounds.
 
 On
            July
            8, 2005, the Company entered into an exclusive licensing agreement with
            the
            Ernest Gallo Clinic Research Center at the University of California San
            Francisco to investigate a new approach toward improving the use of opioid
            analgesics in the treatment of pain by reducing the development of tolerance.
            Under the agreement, the Company paid a licensing fee of $100,000 and
            will pay
            an annual license maintenance fee, potential milestones and royalty payments
            in
            exchange for an exclusive license to pursue the commercial development
            of the
            technology for the treatment of pain. The Company refers to this as its
            NRP388
            program. The Company anticipates filing an IND on NRP388 following finalization
            of its Chemistry, Manufacturing and Controls strategy.
 
 **(4)**
                  **LIQUIDITY**
 
 The
            Company’s future capital requirements will depend on the progress of its
            research on and development of product candidates; the timing and outcome
            of
            regulatory approvals; the costs involved in preparing, filing, prosecuting,
            maintaining, defending and enforcing patent claims and other intellectual
            property rights; the status of competitive products; the availability
            of
            financing; and the Company’s and or its collaborative partner(s)’ success in
            developing markets for its product candidates (see note 3).
 
 **(5)**
                  **ROYALTY
                      OBLIGATIONS**
 
 Effective
            June 30, 2004, the Company entered into an agreement (the Innovative
            Technologies Agreement) with Innovative Technologies, L.L.C. (Innovative
            Technologies) that effectively amended the Company’s obligation in its entirety
            under previous existing agreements with Innovative Technologies. The
            previous
            agreements were executed in connection with the Company’s acquisition of certain
            of its intellectual property from Innovative Technologies in prior years.
            The
            Innovative Technologies Agreement provides for an upfront fee of $200,000,
            which
            was paid on July 1, 2004, and a 1% royalty on net sales (as defined in
            the
            Innovative Technologies Agreement) for a period of 10 years for up to
            a total of
            $1,000,000, whichever comes first. No royalties have been paid under
            this
            agreement through July 2, 2006.
  10
 *Index*
  **(6)**
                  **RELATED
                      PARTY TRANSACTIONS**
 
 The
            Company has a lease agreement with Third Security, LLC, (Third Security)
            an
            entity controlled by the Company’s current Chairman, President, and Chief
            Executive Officer, Randal J. Kirk, for certain executive and administrative
            office space for an initial period of 24 months. The current monthly
            rental is
            $6,488. The Company also has an administrative services agreement with
            Third
            Security, pursuant to which Third Security provides certain administrative
            services for a fee. The monthly fee is based on an hourly billing rate
            for each
            individual who provides services multiplied by the number of hours of
            services
            performed by such individual. The initial term of the agreement is for
            24 months
            and may be terminated upon written notice at any time by the Company.
            The
            Company recognized approximately $87,000 and $179,000 of expense under
            the
            administrative services and lease agreements for the three and six months
            ended
            July 2, 2006 and approximately $85,000 and $250,000 for the three and
            six months
            ended July 3, 2005, respectively. The unpaid portion of these amounts
            is
            included in Due to Affiliates in the accompanying consolidated balance
            sheets as
            of July 2, 2006 and January 1, 2006.
 
 **(7)**
                  **NET
                      INCOME (LOSS) PER SHARE**
 
 The
            following is a reconciliation of the numerators and denominators of the
            net
            income (loss) per share computations for the periods presented:
 
 **Net
                      income (loss)**
                    **(numerator)**
                  
                  **Shares**
                    **(denominator)**
                  
                  **Per
                      share**
                    **amount**Three
                      month period ended July 3, 2005:Basic
                      net income (loss) per share
                  
                  $
                  (6,354,434
                  )
                  
                  35,819,712
                  
                  $
                  (0.18
                  )Effect
                      of dilutive stock options and SARs
                  
                  
                  —
                  
                  
                  —Diluted
                      net income (loss) per share
                  
                  $
                  (6,354,434
                  )
                  
                  35,819,712
                  
                  $
                  (0.18
                  )Three
                      month period ended July 2, 2006:Basic
                      net income (loss) per share
                  
                  $
                  (4,253,347
                  )
                  
                  36,666,624
                  
                  $
                  (0.12
                  )Effect
                      of dilutive stock options and SARs
                  
                  
                  —
                  
                  
                  —Diluted
                      net income (loss) per share
                  
                  $
                  (4,253,347
                  )
                  
                  36,666,624
                  
                  $
                  (0.12
                  )Six
                      month period ended July 3, 2005:Basic
                      net income (loss) per share
                  
                  $
                  (13,026,666
                  )
                  
                  35,698,798
                  
                  $
                  (0.37
                  )Effect
                      of dilutive stock options and SARs
                  
                  
                  —
                  
                  
                  —Diluted
                      net income (loss) per share
                  
                  $
                  (13,026,666
                  )
                  
                  35,698,798
                  
                  $
                  (0.37
                  )Six
                      month period ended July 2, 2006:Basic
                      net income (loss) per share
                  
                  $
                  3,460,689
                  
                  
                  36,563,479
                  
                  $
                  0.09Effect
                      of dilutive stock options and SARs
                  
                  
                  —
                  
                  
                  895,186Diluted
                      net income (loss) per share
                  
                  $
                  3,460,689
                  
                  
                  37,458,665
                  
                  $
                  0.09
 
 For
            the
            three and six months ended July 3, 2005 and for the three months ended
            July 2,
            2006, the total number of potential shares of common stock to be issued
            pursuant
            to the exercise of stock options and SARs would dilute net loss per share.
            Therefore, these potential shares were not included in the computation
            of
            diluted net loss per share because to do so would have been anti-dilutive.
            For
            the six months ended July 2, 2006, the total number of potential shares
            of
            common stock to be issued pursuant to the exercise of stock options and
            SARs
            that are anti-dilutive was 268,000. Therefore, these potential shares
            were not
            included in the computation of diluted net income per share.
  11
 *Index*
  **(8)**
                  **STOCK-BASED
                      COMPENSATION**
 
 Effective
            June 25, 2004 the Company’s Board of Directors (the Board) approved the 2004
            Incentive Compensation Plan (the Plan), subject to approval by the Company’s
            shareholders. Effective July 2, 2004, the Company’s shareholders approved the
            Plan. The Plan was effective upon the completion of the Company’s initial public
            offering on August 10, 2004. The Plan permits the award of options (both
            incentive stock options and nonqualified options), SARs, stock awards
            and
            incentive awards to eligible persons. Eligible persons include employees,
            employees of affiliates, any person who provides services to the Company
            or to
            an affiliate, members of the Board and members of the board of directors
            of an
            affiliate. The Plan amends and restates the Company’s prior Employee Stock
            Option Plan (the Prior Plan), which permitted the grant of options to
            employees,
            directors and consultants. The Plan also replaces the former Stock Appreciation
            Rights Plan, which permitted the grant of stock appreciation rights,
            which are
            awards with a value based on appreciation in the common stock of the
            Company.
            Options granted under the Prior Plan remain subject to the terms of that
            plan.
            The terms of the Prior Plan are substantially similar to the terms of
            the Plan,
            except that, under the Plan, SARs, stock awards and incentive awards
            (payable in
            cash or shares) may be granted in addition to options. The maximum aggregate
            number of shares of common stock that may be issued under the Plan, including
            shares issued upon the exercise of options granted under the Prior Plan,
            is
            3,240,000 shares, but no more than 1,620,000 shares of common stock may
            be
            issued as stock awards. The term of each stock option issued under the
            Plan is
            fixed, but no option shall be exercisable more than 10 years after the
            date the
            option is granted. Certain options granted under the Plan are exercisable
            at the
            date of grant. All other options vest in accordance with the vesting
            schedule
            established by the Compensation Committee of the Board at the time such
            options
            are granted.
 Stock
              option activity for the six months ended July 2, 2006, was as
              follows:
 
 **Number
                        of****shares**
                    
                    **Weighted
                        average**
                      **exercise
                        price**Balance
                        at January 1, 2006
                    
                    
                    1,216,836
                    
                    
                    6.50Granted
                    
                    
                    175,000
                    
                    
                    31.70Exercised
                    
                    
                    (340,000
                    )
                    
                    1.92Expired
                        or Forfeited
                    
                    
                    (40,000
                    )
                    
                    29.59Balance
                        at July 2, 2006
                    
                    
                    1,011,836
                    
                    
                    11.49
 
 At
              July
              2, 2006, the number, weighted-average exercise price and weighted-average
              remaining contractual life of outstanding options and the number and
              weighted-average exercise price of options currently exercisable are
              as follows
              :
 
 **Options
                        outstanding**
                    
                    **Options
                        exercisable****Range of****exercise prices**
                    
                    **Number of****options**
                    
                    **Weighted-average**
                      **exercise
                        price**
                    
                    **Remaining****contractual
                        life**
                      **(in
                        years)**
                    
                    **Number of****options**
                    
                    **Weighted-average**
                      **exercise
                        price**$1.25
                        - $1.29
                    
                    208,301
                    
                    $
                    1.27
                    
                    5.69
                    
                    131,626
                    
                    $
                    1.29$3.33- $4.00
                    
                    360,867
                    
                    $
                    3.91
                    
                    7.62
                    
                    147,535
                    
                    $
                    3.77$7.11-11.60
                    
                    164,668
                    
                    $
                    11.47
                    
                    8.72
                    
                    160,000
                    
                    $
                    11.60$22.87 - $24.53
                    
                    143,000
                    
                    $
                    22.98
                    
                    9.28
                    
                    -
                    
                    $
                    -$29.59
                        - $33.55
                    
                    135,000
                    
                    $
                    32.32
                    
                    9.61
                    
                    -
                    
                    $
                    -
 
 Aggregate
              intrinsic value of options outstanding and options exercisable at July
              2, 2006
              was approximately $17.1 million and $9.9 million, respectively. Aggregate
              intrinsic value represents the positive difference between the Company’s closing
              stock price on the last trading day of the fiscal period, which was
              $28.50 as of
              June 30, 2006, and the exercise price multiplied by the number of options
              outstanding. The aggregate intrinsic value of stock options exercised
              during the
              three and six months ended July 2, 2006 was $1,878,734 and $9,268,325,
              respectively.
 
 As
              of
              July 2, 2006, there was approximately $3.7 million of total unrecognized
              compensation cost related to unvested stock options. That cost is expected
              to be
              recognized over a weighted-average period of approximately 19.6
              months.
  12
 *Index*
  Effective
              March 29, 2005, the Compensation Committee of the Board granted a total
              of
              1,278,000 SARs to the Company’s three executive officers. Of these SARs, 600,000
              were granted under the Plan and 678,000 were granted under stand alone
              agreements not covered by the Plan. These SARs, of which 958,500 are
              payable in
              cash and 319,500 are payable in common stock, have an exercise price
              of $12.00,
              which was the closing price of the Company’s common stock on the date of grant,
              and vest on the third anniversary of the date of grant. On January
              19, 2006, the
              Compensation Committee of the Board granted a total of 639,000 SARs
              to the same
              three executive officers. Of these SARs, 519,500 were granted under
              the Plan and
              119,500 were granted under stand alone agreements not covered by the
              Plan. These
              SARs, of which 479,250 are payable in cash and 159,750 are payable
              in common
              stock, have an exercise price of $32.71, which was the closing price
              of the
              Company’s common stock on the date of grant, and vest over a three year period
              in equal annual installments. The common stock issued upon the vesting of all
              stock-based SARs will vest upon the second anniversary following the
              exercise of
              the SARs.
 
 The
              Company has established an objective formula that takes into consideration
              the
              Company’s financial position and historical operating cash requirements that
              must be met as a condition of exercise for the SARs payable in cash.
              The Company
              reviews the likelihood of meeting the condition established by the
              formula when
              assessing the accounting treatment for the SARs payable in cash. Currently,
              the
              Company’s assessment is that it is probable that the condition to exercise
              established by the formula will be met, and therefore, the Company
              has accrued
              the projected obligation for these SARs. In the event that the Company
              deems the
              likelihood of meeting the condition to exercise established by the
              formula to be
              remote, then it would no longer continue to accrue the projected obligation
              for
              the SARs payable in cash. The Company recognized total stock-based
              compensation
              expense (credit) of $(90,000) and $4,030,000 related to the SARs to
              be settled
              in cash during the three and six months ended July 2, 2006, respectively
              and
              $301,000 and $567,000 related to SARs to be settled in common stock
              during the
              three and six months ended July 2, 2006, respectively,.
 
 Aggregate
              intrinsic value of outstanding SARs to be settled in cash and in common
              stock at
              July 2, 2006 was $15,815,250 and $5,271,750, respectively. No SARs
              were vested
              as of July 2, 2006.
 
 As
              of
              July 2, 2006, there was approximately $13.0 million and $4.3 million
              of total
              unrecognized compensation cost related to SARs to be settled in cash
              and in
              common stock, respectively. These costs are expected to be recognized
              over
              weighted-average periods of approximately 21.8 and 44.3 months,
              respectively. ****
 
 In
              November 2005, the FASB issued FASB Staff Position No. FAS 123(R)-3,
              (FSP
              123(R)), *“Transition
              Election Related to Accounting for the Tax Effects of Share-Based Payment
              Awards.”* FSP
              123(R)-3 provides an elective alternative transition method for calculating
              the
              pool of excess tax benefits available to absorb tax deficiencies recognized
              subsequent to the adoption of FAS 123(R). Companies may take up to
              one year from
              the effective date of FSP 123(R)-3 to evaluate the available transition
              alternatives and make a one-time election as to which method to adopt.
              The
              Company is currently in the process of evaluating the alternative
              methods.
 
 **(9)**
                    **CONTINGENCIES**
 
 From
              time
              to time, the Company may become involved in other litigation in the
              normal
              course of business. Management believes that any costs resulting from
              such
              litigation will not have a material adverse effect on the Company’s consolidated
              financial condition, results of operations or liquidity.
 
 In
              the
              normal course of business, the Company may enter into agreements that
              incorporate indemnification provisions. While the maximum amount to
              which the
              Company may be exposed under such agreements cannot be reasonably estimated,
              the
              Company maintains insurance coverage that management believes will
              effectively
              mitigate the Company’s obligations under these indemnification provisions. No
              amounts have been recorded in the consolidated financial statements
              with respect
              to the Company’s obligations under such agreements.
 
 **(10)**
                    **STOCK
                        SPLIT**
 
 On
              December 20, 2005, the Board approved a two-for-one split of the Company’s
              common stock, to be effected in the form of a stock dividend. Each
              shareholder
              of record at the close of business on December 30, 2005, was issued
              one
              additional share of common stock for each issued and outstanding share
              owned as
              of that date. The distribution was made on January 12, 2006, and the
              common
              stock commenced trading on a post-split basis effective January 13,
              2006. All
              references in the consolidated financial statements to shares of common
              stock,
              common stock options, common stock prices and per common share amounts
              have been
              adjusted retroactively for all periods presented to reflect this two-for-one
              split.
  13
 *Index*
  **(11)**
                    **SUBSEQUENT
                        EVENT**
 
 On
              July
              19, 2006, the Company entered into a purchase agreement (the Purchase
              Agreement)
              under which it agreed to sell $125.0 million aggregate principal amount
              of its
              3.50% Convertible Subordinated Notes due 2013 (the Initial Notes) to
              Merrill
              Lynch & Co., Merrill Lynch, Pierce, Fenner & Smith Incorporated and W.R.
              Hambrecht + Co., LLC (collectively, the Initial Purchasers). The Company
              also
              granted the Initial Purchasers an option to purchase up to an additional
              $18.75
              million aggregate principal amount of the Notes to cover over-allotments,
              if
              any. On July 24, 2006, the Initial Purchasers exercised in part their
              over-allotment option and purchased an additional $10.0 million aggregate
              principal amount of the notes (the Option Notes and together with the
              Initial
              Notes, the Notes). The net proceeds from the offering (including the
              proceeds
              from the exercise of $10.0 million of the over-allotment option), after
              deducting the Initial Purchasers’ discount of $4.05 million and the estimated
              offering expenses payable by the Company were approximately $130.6
              million.
 
 The
              closing of the sale of the Notes (including the additional $10.0 million
              of
              Notes for the partial exercise of the over-allotment option) occurred
              on July
              25, 2006. The Notes and the shares of the Company’s common stock issuable in
              certain circumstances upon conversion of the Notes, as described below
              and as
              more fully set forth in the Indenture (as defined below), have not
              been
              registered under the Securities Act of 1933, as amended (the Securities
              Act).
              The Company offered and sold the Notes to the Initial Purchasers in
              reliance on
              the exemption from registration provided by Section 4(2) of the Securities
              Act.
              The Initial Purchasers then sold the Notes to qualified institutional
              buyers
              pursuant to the exemption from registration provided by Rule 144A under
              the
              Securities Act. The Company relied on these exemptions from registration
              based
              in part on representations made by the Initial Purchasers in the Purchase
              Agreement.
 
 The
              Notes
              are governed by an indenture, dated as of July 25, 2006 (the Indenture),
              between
              the Company and Wilmington Trust Company, as trustee.
 
 The
              Notes
              will be convertible only under certain circumstances, as described
              below, at an
              initial conversion rate of 29.0803 shares of common stock per $1,000
              principal
              amount of Notes (equivalent to a conversion price of approximately
              $34.39 per
              share), subject to adjustment. Upon conversion of a Note, in lieu of
              shares of
              common stock, a holder will receive cash in an amount equal to the
              lesser of
              $1,000 and the conversion value of the Note (determined in accordance
              with the
              terms of the Indenture) and, if the conversion value is greater than
              $1,000,
              payment of the excess value, at the Company’s option, in the form of cash,
              shares of common stock or a combination of cash and common stock. Holders
              may
              convert their Notes prior to the close of business on the business
              day before
              the final maturity date based on the applicable conversion rate only
              under the
              following circumstances: (1) during any calendar quarter beginning
              after October
              1, 2006 (and only during such calendar quarter), if the closing price
              of the
              common stock for at least 20 trading days in the 30 consecutive trading
              days
              ending on the last trading day of the immediately preceding calendar
              quarter is
              more than 120% of the applicable conversion price per share, which
              is $1,000
              divided by the then applicable conversion rate; (2) during any five
              business day
              period after any five consecutive trading day period in which the trading
              price
              per $1,000 principal amount of Notes for each day of that period was
              less than
              98% of the product of the closing price of the common stock for each
              day in that
              period and the conversion rate per $1,000 principal amount of Notes;
              (3) if
              specified distributions to holders of the common stock are made or
              specified
              corporate transactions occur, in each case as set forth in the Indenture;
              (4) if
              a fundamental change occurs (a “fundamental change” will be deemed to have
              occurred upon a change of control or a termination of trading, each
              as defined
              in the Indenture); or (5) during the one month period from, and including,
              July
              1, 2013 to, but excluding, the maturity date. In the event of a fundamental
              change as specified in the Indenture, the Company will increase the
              conversion
              rate as to Notes converted in connection with the fundamental change
              as
              described in the Indenture.
 
 The
              holders of the Notes who convert their Notes in connection with a fundamental
              change (as defined in the Indenture) may be entitled to a make-whole
              premium in
              the form of an increase in the conversion rate. Additionally, if a
              fundamental
              change occurs, holders of the Notes may require the Company to repurchase
              all or
              a portion of their Notes for cash at a repurchase price equal to 100%
              of the
              principal amount of the Notes to be repurchased, plus accrued and unpaid
              interest, if any, to, but excluding, the repurchase date.
  14
 *Index*
  The
              Notes
              will bear interest at a rate of 3.50% per year, payable semiannually
              in arrears
              in cash on February 1 and August 1 of each year, beginning on February
              1, 2007.
              The Notes will mature on August 1, 2013.
 
 The
              Notes
              are the Company’s direct, unsecured, subordinated obligations, will rank junior
              in right of payment to all of the Company’s existing and future senior
              indebtedness and are effectively junior to any existing and future
              indebtedness
              and other liabilities, including trade payables, of the Company’s existing
              subsidiary and future subsidiaries.
 
 In
              connection with the closing of the sale of the Notes, on July 25, 2006,
              the
              Company entered into a registration rights agreement with the Initial
              Purchasers
              (the Registration Rights Agreement). Under the Registration Rights
              Agreement,
              the Company has agreed, for the benefit of the holders of the Notes,
              to file a
              shelf registration statement with respect to the resale of the Notes
              and the
              shares of common stock issuable upon conversion of the Notes no later
              than 120
              days after the original issuance of the Notes and to use its commercially
              reasonable efforts to cause such shelf registration statement to become
              effective as promptly as practicable, but in no event later than 210
              days after
              the original issuance of the Notes. The Company also has agreed to
              use its
              commercially reasonable efforts to keep the shelf registration statement
              continuously effective until the earliest of (1) the sale pursuant
              to the shelf
              registration statement of the Notes and all of the shares of common
              stock
              issuable upon conversion of the Notes, (2) the expiration of the holding
              period
              applicable to such securities held by non-affiliates under Rule 144(k)
              under the
              Securities Act or any successor provision, subject to certain permitted
              exceptions, and (3) the date that is two years from the original issuance
              of the
              Notes, subject to certain exceptions set forth in the Registration
              Rights
              Agreement. Additional interest will accrue on the Notes (i) if the
              shelf
              registration statement has not been filed with the SEC within 120 days
              after the
              original issuance of the Notes, (ii) if the shelf registration statement
              has not
              become effective within 210 days after the earliest date of the original
              issuance of any of the Notes, (iii) if the shelf registration statement
              shall
              cease to be effective or fail to be usable without being succeeded
              within seven
              business days by a post-effective amendment or a report filed with
              the SEC
              pursuant to the Exchange Act of 1934, as amended, that cures the failure
              of the
              shelf registration statement to be effective or usable, or (iv) the
              use of the
              prospectus included in the shelf registration statement has been suspended
              for
              longer than the permitted period, subject to certain exceptions and
              limitations
              as set forth in the Registration Rights Agreement. If a holder has
              converted
              some or all of its Notes into common stock, the holder will not be
              entitled to
              receive any additional interest with respect to such common stock or
              the
              principal amount of the Notes converted.
 
 In
              connection with the sale of the Notes, the Company entered into a prepaid
              forward purchase contract (the “Forward Purchase Contract”) with an affiliate of
              Merrill Lynch & Co. (the “Dealer”). Pursuant to the Forward Purchase
              Contract, and or through one or more block-trades with affiliates of
              the Dealer,
              the Company repurchased contemporaneously with the sale of the Notes,
              an
              aggregate of $41.0 million of shares of common stock from the dealer
              (1,490,367
              shares of its common stock at $27.51, the last quoted sale price of
              the
              Company’s common stock on July 19, 2006). Additionally, the Company’s Board of
              Directors authorized a stock repurchase program whereby management
              may direct
              the repurchase of up to $10 million in common stock. There have been
              no
              repurchases under this program.
 
 In
              connection with the sale of the Notes, the Company also entered into
              convertible
              note hedge transactions with respect to its common stock (the “Purchased Call
              Options”) with the Dealer. The Purchased Call Options cover, subject to
              customary anti-dilution adjustments, 3,925,845 shares of common stock
              at strike
              prices which correspond to the initial conversion prices of the Notes.
              The
              Company used $42,660,000 of the proceeds from the sale of the Notes
              to purchase
              the Purchased Call Options. The net cost of the convertible note hedge
              will be
              recorded in shareholders’ equity.
 
 The
              Company also entered into separate warrant transactions whereby the
              Company has
              sold to the Dealer warrants to acquire, subject to customary anti-dilution
              adjustments, 3,925,845 shares of common stock (the Sold Warrants).
              The Company
              offered and sold the Sold Warrants to the Dealer in reliance on the
              exemption
              from registration provided by Section 4(2) of the Securities Act. The
              Sold
              Warrants will be exercisable following maturity of the Notes and have
              a strike
              price of $41.27 and expire in October and November 2013. The Company
              received
              aggregate proceeds of $28,890,000 from the sale of the Sold Warrants.
              The net
              proceeds from the warrants will be recorded in shareholders’
equity.
  15
 *Index*
  The
              Forward Purchase Contract, Purchased Call Options and Sold Warrants
              are separate
              contracts entered into by the Company with the Dealer, are not part
              of the terms
              of the Notes and will not affect the holders’ rights under the Notes. The
              Purchased Call Options are expected to offset the potential dilution
              upon
              conversion of the Notes in the event that the market value per share
              of the
              common stock at the time of exercise is greater than the strike price
              of the
              Purchased Call Options, which correspond to the initial conversion
              price of the
              Notes and are simultaneously subject to certain customary
              adjustments.
 
 If
              the
              market value per share of the common stock at the time of conversion
              of the
              Notes is above the strike price of the applicable Purchased Call Options,
              the
              Purchased Call Options entitle the Company to receive from the Dealer
              net shares
              of common stock, cash or a combination of shares of common stock and
              cash,
              depending on the consideration paid on the underlying Notes, based
              on the excess
              of the then current market price of the common stock over the strike
              price of
              the Purchased Call Options. Additionally, if the market price of the
              common
              stock at the time of exercise of the applicable Sold Warrants exceeds
              the strike
              price of the Sold Warrants, the Company will owe the Dealer net shares
              of common
              stock or cash, not offset by the Purchased Call Options, in an amount
              based on
              the excess of the then current market price of the common stock over
              the strike
              price of the applicable Sold Warrants.
  On
                August
                7, 2006, the Company received notice of exercise from the Initial
                Purchasers of
                the exercise of their option to purchase an additional $2.75 million
                aggregate
                principle amoount of notes pursuant to the over-allotment option granted to
                them in the Purchase Agreement. The Company also intends to enter
                into hedging
                transactions in connection with the issuance of these notes on a basis
                similar to those entered into upon issuance of the Notes. Closing of this
                sale is expected to occur on August 10, 2006. The Initial Purchaser's
                remaining
                option to purchase up to an additional $6,000,000 aggregate principal
                amount of
                the Notes to cover over-allotments expired unexercised on August
                7,
                2006.
 
 **Item****2.**
                      **Management’s
                          Discussion and Analysis of Financial Condition and Results
                          of
                          Operations**
 
 *The
                following discussion of our financial condition and results of operations
                should
                be read in conjunction with the consolidated financial statements
                and the notes
                to those statements included in Part I - Item 1 of this Quarterly
                Report on Form
                10-Q and the consolidated financial statements and notes thereto
                in our Annual
                Report on Form 10-K filed on March 15, 2006, with the SEC. All references
                in
                this Quarterly Report on Form 10-Q to “we”, “our,” and “us” are to New River
                Pharmaceuticals Inc.*
  **Information
                Regarding Forward-Looking Statements**
 
 The
                following discussion contains forward-looking statements. All statements,
                other
                than statements of historical facts, included in the following discussion
                regarding our strategy, future operations, future financial position,
                future
                revenues, future costs, prospects, plans and objectives of management
                are
                forward-looking statements. These statements involve known and unknown
                risks,
                uncertainties and other factors that may cause our actual results,
                performance
                or achievements to be materially different from any future results,
                performances
                or achievements expressed or implied by the forward-looking statements.
                Forward-looking statements include, but are not limited to, statements
                about:
 
 ·
                      the
                          ability to execute successfully the collaboration with
                          Shire within a
                          reasonable timeframe or at all;
 
 ·
                      the
                          progress of our product development
                          programs;
 
 ·
                      the
                          status of our preclinical and clinical development of potential
                          drugs;
 
 ·
                      the
                          likely success of our drug products in clinical trials
                          and the regulatory
                          approval process, particularly whether and under what circumstances
                          any of
                          our drug products will be approved by the
                          FDA;
  16
 *Index*
  ·
                      our
                          estimates for future revenues and
                          profitability;
 
 ·
                      our
                          estimates regarding our capital requirements and our needs
                          for additional
                          financing;
 
 ·
                      the
                          likely scheduling and labeling of product
                          candidates;
 
 ·
                      our
                          ability to attract partners with acceptable development,
                          regulatory and
                          commercialization expertise on favorable
                          terms;
 
 ·
                      the
                          likelihood of regulatory approval under the Federal Food,
                          Drug and
                          Cosmetic Act without having to conduct long and costly
                          trials to generate
                          all of the data often required in connection with a traditional
                          new
                          chemical entity;
 
 ·
                      the
                          ability to develop, manufacture, launch and market any
                          of our drug
                          candidates;
 
 ·
                      our
                          ability to develop safer and improved versions of widely-prescribed
                          drugs
                          using our Carrierwave technology;
 
 ·
                      the
                          expected benefits of our Carrierwave technology such as
                          abuse resistance
                          and decreased toxicity;
 
 ·
                      our
                          success in developing our own sales and marketing capabilities
                          for lead
                          product candidate, NRP104; and
 
 ·
                      our
                          ability to obtain favorable patent
                          claims.
 
 In
                some
                cases, you can identify forward-looking statements by terms such
                as “may,”
“will,” “should,” “could,” “would,” “intend,” “expect,” “plan,” “anticipate,”
“believe,” “estimate,” “project,” “predict,” “potential” and similar expressions
                intended to identify forward-looking statements. These statements
                reflect our
                current views with respect to future events and are based on assumptions
                and
                subject to risks and uncertainties. Given these uncertainties, you
                should not
                place undue reliance on these forward-looking statements as our actual
                results
                may differ materially from those anticipated in these forward-looking
                statements. We discuss many of these risks in greater detail in Item
                1A under
                the heading “Risk Factors” in Part II of this Quarterly Report on Form 10Q
                for the quarter ended July 2, 2006. The forward-looking statements
                made in this
                Quarterly Report on Form 10-Q are made only as of the date hereof
                and the
                Company does not intend to update any of these factors or to announce
                publicly
                the results of any revisions to any of its forward-looking statements,
                other
                than as required under the federal securities laws.
 
 You
                should read this Quarterly Report on Form 10-Q completely and with
                the
                understanding that our actual future results may be materially different
                from
                what we expect. We qualify all of our forward-looking statements
                by these
                cautionary statements.
  **Overview**
 
 We
                are a
                specialty pharmaceutical company developing generational improvements
                of widely
                prescribed drugs in large and growing markets. Utilizing our proprietary
                Carrierwave technology, we are developing new molecular entities
                that are
                derivatives of public domain actives and attempt to address certain
                deficiencies
                associated with currently marketed drugs. The products in our pipeline
                that are
                the most advanced in their development are NRP104 and NRP290, which
                are
                conditionally bioreversible derivatives (CBDs) of *d-* amphetamine
                and hydrocodone, respectively, that are designed to provide overdose
                protection,
                less potential for abuse and less potential for addiction while affording
                comparable efficacy. We believe that we are the first company with
                a viable
                product in the pipeline attempting to address both the potential
                abuse and the
                potential overdose risk associated with currently marketed amphetamines
                and
                opioids.
 
 All
                of
                our drug candidates developed to date using our proprietary Carrierwave
                technology are small molecules designed for oral delivery. Each consists
                of an
                active pharmaceutical ingredient, like amphetamine or an opioid,
                attached to an
                adjuvant. Our adjuvants are comprised of various substances such
                as peptides,
                amino acids, lipids and nucleic acids. We refer to our products as
                CBDs because
                (i) they are derivatives of underlying active agents, (ii) our preclinical
                and
                clinical tests to date indicate that it would be impractical to use
                them except
                when taken as directed, and (iii) our preclinical tests to date indicate
                that at
                doses above the therapeutic window there is dose attenuation. As
                such, we
                believe that our CBDs are eligible for composition of matter patent
                claims,
                despite the fact that the drugs on which the CBDs are based are known.
                We
                believe that the breakdown of the active from the adjuvant occurs
                at
                specifically targeted sites of enzymatic activity in the body. In
                the case of
                our current Carrierwave compounds, the site of enzymatic activity
                is primarily
                in the gastrointestinal tract. At the target site, enzymes hydrolyze
                or cleave
                the adjuvant from the active pharmaceutical ingredient, releasing
                the active
                pharmaceutical ingredient into circulation. Consequently, we believe
                that our
                technology may reduce the extent of abuse and prevent
                overdosing.
  17
 *Index*
  NRP104,
                our most advanced compound, is a CBD of *d-* amphetamine,
                a stimulant widely used
                to
                treat ADHD. ADHD is a well-studied childhood psychiatric disorder
                that has been
                recently recognized in adults as well. ADHD interferes with an individual’s
                ability to regulate activity level and behavior and to sustain focus
                on tasks in
                developmentally appropriate ways. The FDA notified us on January
                26, 2006 that
                it had accepted our NDA for NRP104. Based on FDA review-time goals
                applicable to
                this filing, we anticipate potential approval of NRP104 for the treatment
                of
                ADHD in pediatric populations (ages 6 through 12) in the second half
                of
                2006.
 
 We
                have
                developed NRP104 capsules in a range of doses (30 to 70 mg) for the
                treatment of
                ADHD in pediatric population and are developing NRP104 for the adult
                and
                adolescent populations. In May 2006, we initiated a pivotal phase
                3 clinical
                trial for NRP104 for the treatment of ADHD in adult populations.
                The drug
                substance in NRP104 capsules is lisdexamfetamine as the dimesylate
                salt, a new
                chemical entity. NRP104 exerts its pharmacological activity solely
                through
                biotransformation of lisdexamfetamine to *d* amphetamine, which occurs primarily when taken orally. Currently,
                the drug
                substance (lisdexamfetamine) is not scheduled. Based on discussions
                with the
                Review Division and the Controlled Substance Staff (CSS), we have
                conducted a
                series of clinical and non-clinical abuse liability studies on lisdexamfetamine
                and NRP104. The results of the studies show that NRP104 has a potential
                for
                abuse and that abuse of NRP104 may lead to a limited degree of physical
                or
                psychological dependence. There are a number of critical and significant
                differences between lisdexamfetamine and *d-* amphetamine
                across a wide range of properties affecting its relative abuse and
                dependence
                potentials. These differences indicate that the substance lisdexamfetamine
                and
                the drug product NRP104 do not have a high abuse potential and further
                that
                abuse of lisdexamfetamine / NRP104 will not lead to severe psychological
                or
                physical dependence, criteria for Schedule II control. Further, we
                believe that
                an abuse liability study comparing NRP104 with *d-* amphetamine
                and diethylpropion, a Schedule IV substance, in healthy adult volunteers
                with
                histories of stimulant abuse, supports the findings that NRP104 has
                abuse and
                dependence potentials consistent with those required for Schedule
                IV.
 
 Under
                the
                terms of our collaboration agreement with Shire, we, at our option,
                have the
                right to co-promote NRP104 in the United States (including its territories
                and
                possessions). On July 25, 2006, we exercised this right. Our co-promotion
                activities will commence in six months or upon the commercial launch
                of NRP104,
                whichever occurs later. In exercising this option to co-promote NRP104,
                we are
                committed to co-promote the product for at least 24 months and to
                provide 25% of
                the total details for the product during the 24-month period.
 
 NRP290,
                our second most advanced compound, is a CBD of hydrocodone, an opioid widely
                used in combination with other non-opioid analgesics to treat acute
                pain. On
                June 28, 2005, we announced the submission of an investigational
                new drug
                application (IND) to the FDA for NRP290. The IND became effective
                for studies of
                NRP290 in July 2005. Acute pain usually lasts for a short time, typically
                not
                more than a month. Treatment for acute pain may consist of non-opioid
                analgesics
                and non-steroidal anti-inflammatory drugs. In more severe cases of
                acute pain,
                opioids, such as Lortab, Vicodin and Vicoprofen and Demerol, are
                commonly
                prescribed. While opioids are the most effective drugs available
                for treating
                pain, concerns about their potential for abuse and addiction have
                resulted in
                most opioids being classified as Schedule II (e.g., oxycodone, hydrocodone,
                codeine) or Schedule III (e.g., oxycodone and hydrocodone combination
                products)
                drugs by the DEA, making their use subject to more stringent restrictions
                and
                controls than more favorably scheduled and unscheduled drugs. Repeated
                administration of opioids, including hydrocodone, can create physical
                and
                psychological dependence as well as increased tolerance, and opioids
                generally
                carry the potential for abuse and overdose. Overdose can result in
                respiratory
                depression, coma, hypotension, cardiac arrest and death. Current
                formulations of
                some opiate drugs are often abused as crushing or solubilizing creates
                a rapidly
                available, large dose of active substance that can be ingested, inhaled
                or
                injected. We have completed two pharmacokinetic clinical studies
                for NRP290, the
                results of which showed comparable bioavailability and the absence
                of intact
                NRP290 conjugates in the bloodstream and we have scheduled an End
                of Phase II
                Meeting with the FDA with respect to NRP290 during the fourth quarter
                of
                2006.
  18
 *Index*
  Under
                our
                NRP409 program, our Carrierwave triiodothyronine (T3) hormone is
                being developed
                as a replacement or supplemental therapy in patients with primary
                hypothyroidism
                and other indications. We hope that by reducing the variability of
                the hormone’s
                availability, while reducing the safety risk associated with other
                T3 based
                therapies, NRP409 will mark the first significant improvement in
                thyroid hormone
                replacement therapy (HRT) in approximately half a century. We filed
                an IND for
                NRP409 on June 29, 2006. We expect to begin enrollment in clinical
                studies of
                NRP409 by the third quarter of 2006. We anticipate that NRP409 should
                warrant a
                relatively abbreviated development pathway and hope to file an NDA
                by the end of
                2007. While the U.S. market for thyroid HRTs is significant, the
                field of
                endocrinology is concentrated enough that we expect to be able to
                commercialize
                and market NRP409 without a partner.
 
 Under
                our
                NRP388 program, we entered into an exclusive licensing agreement
                with the Ernest
                Gallo Clinic Research Center at the University of California San
                Francisco to
                investigate a new approach toward improving the use of opioid analgesics
                in the
                treatment of pain by reducing the development of tolerance. We anticipate
                filing
                the IND on NRP388 following finalization of our Chemistry, Manufacturing
                and
                Control strategy.
 In
                  July 2006, we issued $135,000,000 principal amount of Notes due in 2013
                  in
                  a private placement pursuant to Rule 144A. The aggregate principal
                  amount of the
                  Notes sold reflects a partial exercise by the Initial Purchasers
                  of their option
                  to purchase additional Notes to cover over-allotments. The Notes
                  will bear
                  interest at the rate of 3.5% per year. Interest will be payable
                  in cash
                  semiannually in arrears on February 1 and August 1 of each year,
                  beginning
                  February 1, 2007. Concurrent with the issuance of the Notes, we
                  purchased
                  convertible note hedges in private transactions at a cost of $42,660,000
                  to
                  cover, subject to customary anti-dilution adjustments, 3,925,845 shares of
                  our common stock at strike prices that correspond to the initial
                  conversion
                  prices of the Notes. We also sold warrants in private transactions
                  and received
                  net proceeds of $28,890,000 to acquire 3,925,845 shares of our
                  common stock,
                  subject to customary anti-dilution adjustments. Contemporaneously
                  with the
                  closing of the sale of the Notes, a portion of the net proceeds
                  from the Notes
                  issuances and the proceeds of the warrant transactions were used
                  to repurchase
                  $41 million or 1,490,367 shares of our common stock under a prepaid forward
                  purchase agreement. Additionally, our Board authorized a stock
                  repurchase
                  program whereby management may direct the repurchase of up to $10
                  million in
                  common stock. On August 7, 2006, we received notice from the Initial
                  Purchasers
                  of the exercise of their option to purchase an additional $2.75
                  million
                  aggregate principal amount of notes pursuant to the over-allotment
                  option
                  granted to them in the Purchase Agreement. We intend to enter into hedging
                  transactions in connection with the issuance of these notes on a basis
                  similar to those entered into upon the issuance of the Notes. Closing of
                  this sale is expected to occur on August 10, 2006.
 Throughout
                our history, we have incurred significant losses. We may incur additional
                losses
                for our fiscal year ending December 31, 2006. As of July 2, 2006,
                we had an
                accumulated deficit of approximately $66.4 million.
 
 *Revenues.* If our
                development efforts result in clinical success, regulatory approval
                and
                successful commercialization of our products, we could generate revenues
                from
                sales of our products. If, as an alternative to commercializing a
                particular
                product, we enter into license agreements or other collaboration
                arrangements
                with corporate partners, such as our collaboration with Shire, we
                could
                recognize revenue from license fees, milestone payments, profit sharing,
                or
                royalties from product sales.
 
 *Selling,
                General and Administrative Expenses.* Selling,
                general and administrative expenses consist primarily of legal costs
                associated
                with patent filings, board of director fees, insurance expense, personnel
                and
                benefits costs, stock-based compensation costs, costs associated
                with completing
                the collaboration agreements with Shire, shared marketing expenses
                under our
                collaboration agreements with Shire, and fees charged to us by an
                affiliate,
                Third Security, for services provided to us under an administrative
                services
                agreement. Administrative services that Third Security is providing
                under the
                administrative services agreement include support for taxation, legal,
                information technology, and market research functions as well as
                other
                miscellaneous services that we may need from time to time.
  19
 *Index*
  *Research
                and Development Expenses* .
                Our
                current research and development efforts are primarily focused on
                developing our
                lead product candidates. Our research and development expenses consist
                of direct
                and indirect costs. Our direct costs include salaries and related
                expenses for
                personnel, including stock-based compensation, costs of materials
                used in
                research and development, costs of facilities and external development
                costs
                that consist of fees paid to professional service providers for conducting
                various studies and trials. Indirect costs include various overhead
                costs. We
                believe that significant investment in product development is a competitive
                necessity, and we plan to continue these investments in order to
                be in a
                position to realize the potential of our product candidates and proprietary
                technologies.
 
 We
                use
                our research and development employee and infrastructure resources
                across
                several projects, and many of our costs are not attributable to an
                individually
                named project but are directed to broadly applicable research efforts.
                Accordingly, we do not account for internal research and development
                costs on a
                project-by-project basis, and we cannot state precisely the total
                costs incurred
                for each of our clinical and preclinical projects on a project-by-project
                basis.
 
 The
                following table summarizes, from inception and for the three and
                six month
                periods ended July 2, 2006, the total external development costs
                associated with
                (i) our Carrierwave technology and our earlier related iodothyronine
                technology,
                all of which costs are included in the Carrierwave line item in the
                table below
                as historically we made no efforts to separate such costs, (ii) each
                of our
                current lead product candidates and (iii) other preclinical
                development.
 
 **Three
                          months ended**
                        **July
                          2, 2006**
                      
                      **Six
                          months ended**
                        **July
                          2, 2006**
                      
                      **Inception
                          to**
                        **July
                          2, 2006**NRP104
                      
                      $
                      3,404
                      
                      $
                      6,334
                      
                      $
                      26,113NRP290
                      
                      
                      120
                      
                      
                      214
                      
                      
                      2,153Other
                          preclinical development
                      
                      
                      391
                      
                      
                      958
                      
                      
                      1,917Carrierwave/thyroid
                      
                      
                      —
                      
                      
                      —
                      
                      
                      5,488Total
                      
                      $
                      3,915
                      
                      $
                      7,506
                      
                      $
                      35,671
 
 We
                expect
                that the majority of our research and development expenses in the
                future will be
                incurred in support of our current and future preclinical and clinical
                development programs rather than technology development. These expenditures
                are
                subject to numerous uncertainties relating to timing and cost to
                completion. We
                test compounds in numerous preclinical studies for safety, toxicology
                and
                efficacy. We expect then to conduct early-stage clinical trials for
                each drug
                candidate. We anticipate funding these trials ourselves. As we obtain
                results
                from trials, we may elect to discontinue or delay clinical trials
                for certain
                products in order to focus our resources on more promising products.
                Completion
                of clinical trials may take several years or more, and the length
                of time
                generally varies substantially according to the type, complexity,
                novelty and
                intended use of a product candidate.
 
 The
                commencement and completion of clinical trials for our products may
                be delayed
                by many factors, including lack of efficacy during clinical trials,
                unforeseen
                safety issues, slower than expected patient recruitment, or government
                delays.
                In addition, we may encounter regulatory delays or rejections as
                a result of
                many factors, including results that do not support the intended
                safety or
                efficacy of our product candidates, perceived defects in the design
                of clinical
                trials and changes in regulatory policy during the period of product
                development. As a result of these risks and uncertainties, we are
                unable to
                estimate accurately the specific timing and costs of our clinical
                development
                programs or the timing of material cash inflows, if any, from our
                product
                candidates. Our business, financial condition and results of operations
                may be
                materially adversely affected by any delays in, or termination of,
                our clinical
                trials or a determination by the FDA that the results of our trials
                are
                inadequate to justify regulatory approval, insofar as cash in-flows
                from the
                relevant drug or program would be delayed or would not occur.
  20
 *Index*
  *Other
                Income (Expense)* .
                Other
                income (expense) primarily consists of interest income and interest
                expense.
                Interest income consists of interest earned on cash and cash equivalents
                and
                short-term investments. Interest expense consists of interest on
                capital lease
                obligations.
 
 *Cumulative
                Effect of Change in Accounting Principle* ***.*** As a
                result of adopting the provisions of SFAS 123(R), *“Share-Based
                Payment”* (SFAS
                123(R)) we recognized a cumulative effect accounting adjustment related
                to
                outstanding stock appreciation rights (SARs) that are to be settled
                in cash.
                These awards were previously accounted for based on their intrinsic
                value at the
                end of each reporting period. Under SFAS 123(R), these awards are
                re-measured as
                of January 2, 2006, the date of adoption of SFAS 123(R), and at the
                end of each
                reporting period based on their fair value.
  **Results
                of Operations**
 
 We
                anticipate that our results of operations will fluctuate for the
                foreseeable
                future due to several factors, such as the progress of our research
                and
                development efforts, the timing and outcome of regulatory submissions,
                and the
                potential receipt of milestone payments under our collaboration agreements
                with
                Shire. Due to these uncertainties, accurate predictions of future
                operations are
                difficult or impossible.
  **Three
                Months Ended July 2, 2006 Compared to Three Months Ended July 3,
                2005**
 
 *Revenues.* During
                the three months ended July 2, 2006, we recognized approximately
                $5,498,000 of
                revenue from our collaboration agreements with Shire. Such amount
                represents the
                proportional revenue recognition of certain non-refundable payments
                received
                over the related performance period of the deliverables under the
                collaboration
                agreements.
 
 *Selling,
                General and Administrative Expenses.* Selling,
                general and administrative expenses increased by $3,508,000, or 198%,
                to
                $5,278,000 for the three months ended July 2, 2006 from $1,770,000
                for the three
                months ended July 3, 2005. This increase was primarily attributed
                to
                approximately $2,751,000 of shared marketing expenses with Shire
                in accordance
                with the collaboration agreements, an increase of approximately $356,000
                in
                salaries and bonus accruals due to the addition of employees and
                annual salary
                increases, and an increase in stock-based compensation expense of
                $345,000,
                primarily associated with the adoption of SFAS 123(R). Stock-based
                compensation
                expense for the three months ended July 2, 2006 was $627,000 and
                represents the
                cost related to stock options and SARs granted to certain executives
                and
                management personnel that is being recognized over the vesting period
                of such
                options and SARs.
 
 *Research
                and Development Expenses.* Research
                and development expenses increased $541,000, or 10.7%, to $5,582,000
                for the
                three months ended July 2, 2006 from $5,041,000 for the three months
                ended July
                3, 2005. Increases in salaries and related fringe benefit costs,
                bonus accruals
                and stock-based compensation primarily accounted for this increase.
                Salaries and
                related fringe benefit costs and bonus accruals increased by approximately
                $510,000 due to the addition of research and development personnel
                and annual
                salary increases. Stock-based compensation increased approximately
                $209,000 and
                is associated with the adoption of SFAS 123(R). Stock-based compensation
                expense
                for the three months ended July 2, 2006 was $280,000 and represents
                the cost
                related to SARs and options granted to research and development personnel
                that
                is being recognized over the vesting period of such SARs and options.
                These
                increases were partially offset by a decrease in external development
                costs of
                approximately $259,000. The decrease is due to the Phase 3 clinical
                trials for
                the pediatric indication of NRP104 coming to an end and the beginning
                of the
                adult indication studies.
  21
 *Index*
  The
                following table shows the aggregate changes in our research and development
                expenses.
 
 **Three
                          Months Ended****Research
                          and development expenses**
                      
                      **July
                          2, 2006**
                      
                      **July
                          3, 2005****(in
                          thousands)**Direct
                          project costs:Personnel,
                          benefits and related costs
                      
                      $
                      1,250
                      
                      $
                      531Consultants,
                          supplies, materials and other direct costs
                      
                      
                      287
                      
                      
                      222External
                          development costs
                      
                      
                      3,915
                      
                      
                      4,174Total
                          direct costs
                      
                      
                      5,452
                      
                      
                      4,927Indirect
                          costs
                      
                      
                      130
                      
                      
                      114Total
                      
                      $
                      5,582
                      
                      $
                      5,041
 
 *Other
                Income.* For
                the
                three months ended July 2, 2006, other income included approximately
                $1,150,000
                of interest income earned primarily from investing the proceeds received
                pursuant to the collaboration agreements with Shire. Other income
                for the three
                months ended July 3, 2005 included approximately $498,000 of interest
                income
                earned primarily from investing the proceeds from our initial public
                offering
                and the initial upfront payment from Shire pursuant to the collaboration
                agreements.
  **Six
                Months Ended July 2, 2006 Compared to Six Months Ended July 3,
                2005**
 
 *Revenues.* During
                the six months ended July 2, 2006, we recognized approximately $26,825,000
                of
                revenue from our collaboration agreements with Shire. Such amount
                represents the
                proportional revenue recognition of certain non-refundable payments
                received
                over the related performance period of the deliverables under the
                collaboration
                agreements.
 
 *Selling,
                General and Administrative Expenses.* Selling,
                general and administrative expenses increased by $8,550,000, or 173%,
                to
                $13,496,000 for the six months ended July 2, 2006 from $4,946,000
                for the six
                months ended July 3, 2005. This increase was primarily attributed
                to an increase
                of approximately $4,461,000 of shared marketing expenses with Shire
                under the
                collaboration agreements, an increase of approximately $635,000 in
                salaries and
                bonus accruals due to the addition of employees and annual salary
                increases, and
                an increase in stock-based compensation expense of $4,487,000, primarily
                associated with the adoption of SFAS 123(R). Stock-based compensation
                expense
                for the six months ended July 2, 2006, was $4,785,000 and represents
                the cost
                related to stock options and SARs granted to certain executives and
                management
                personnel that is being recognized over the vesting period of such
                options and
                SARs. These increases were partially offset by a $1,500,000 fee incurred
                and
                paid to an investment banking firm during the six months ended July
                3, 2005 for
                managing the process through which we were able to evaluate various
                partnering
                alternatives prior to successful completion of our collaboration
                agreements with
                Shire.
 
 *Research
                and Development Expenses.* Research
                and development expenses increased $2,273,000, or 25.8%, to $11,098,000
                for the
                six months ended July 2, 2006 from $8,825,000 for the six months
                ended July 3,
                2005. Increases in salaries and related fringe benefit costs, bonus
                accruals,
                stock-based compensation and external development expenses primarily
                accounted
                for this increase. Salaries and related fringe benefit costs and
                bonus accruals
                increased by approximately $797,000 due to the addition of research
                and
                development personnel and annual salary increases. Stock-based compensation
                increased approximately $1,132,000 and is associated with the adoption
                of SFAS
                123(R). Stock-based compensation expense for the six months ended
                July 2, 2006
                was $1,207,000 and represents the cost related to SARs and options
                granted to
                research and development personnel that is being recognized over
                the vesting
                period of such SARs and options. External development increased $421,000
                and is
                related to the start-up of clinical trials for the adult indication
                for
                NRP104.
  22
 *Index*
  The
                following table shows the aggregate changes in our research and development
                expenses.
 
 **Six
                          Months Ended****Research
                          and development expenses**
                      
                      **July
                          2, 2006**
                      
                      **July
                          3, 2005****(in
                          thousands)**Direct
                          project costs:Personnel,
                          benefits and related costs
                      
                      $
                      2,932
                      
                      $
                      1,002Consultants,
                          supplies, materials and other direct costs
                      
                      
                      432
                      
                      
                      476External
                          development costs
                      
                      
                      7,506
                      
                      
                      7,085Total
                          direct costs
                      
                      
                      10,870
                      
                      
                      8,563Indirect
                          costs
                      
                      
                      228
                      
                      
                      262Total
                      
                      $
                      11,098
                      
                      $
                      8,825
 
 *Other
                Income.* For
                the
                six months ended July 2, 2006, other income included approximately
                $2,023,000 of
                interest income earned primarily from investing the proceeds received
                pursuant
                to the collaboration agreements with Shire. Other income for the
                six months
                ended July 3, 2005 included approximately $821,000 of interest income
                earned
                primarily from investing the proceeds from our initial public offering
                and the
                initial upfront payment from Shire pursuant to the collaboration
                agreements.
 
 **Liquidity
                and Capital Resources**
 
 Our
                operations from 2001 through July 2, 2006, have been funded primarily
                from
                proceeds of approximately $17,282,000 raised from various private
                placements of
                our common stock, $33,600,000 of gross proceeds from the initial
                public offering
                of our common stock on August 10, 2004, and $50,000,000 received
                on each of
                February 11, 2005 and February 6, 2006 in accordance with the terms
                of our
                collaboration agreements with Shire, as follows:
 
 **Fiscal
                          year**
                      
                      **Number
                          of shares****(1)**
                      
                      **Price
                          per share****(1)**
                      
                      **Gross
                          Proceeds**2001
                      
                      
                      300,000
                      
                      $
                      3.33
                      
                      $
                      1,000,0002002
                      
                      
                      2,245,000
                      
                      
                      1.25
                      
                      
                      2,806,2502002
                      
                      
                      4,077,720
                      (2)
                      
                      1.25
                      
                      
                      5,097,1512003
                      
                      
                      2,823,200
                      
                      
                      1.25
                      
                      
                      3,529,0002004
                      
                      
                      1,940,000
                      
                      
                      2.50
                      
                      
                      4,850,0002004
                          - Initial public offering
                      
                      
                      8,400,000
                      
                      
                      4.00
                      
                      
                      33,600,0002005
                          - Shire collaboration
                      
                      
                      —
                      
                      
                      —
                      
                      
                      50,000,0002006
                          - Shire collaboration
                      
                      
                      —
                      
                      
                      —
                      
                      
                      50,000,00019,785,920
                      
                      
                      
                      
                      $
                      150,882,401
 
 (1)
                      As
                          adjusted for a one-for-two reverse stock split effective
                          August 3, 2004
                          and a two-for-one stock split effected in the form of a
                          stock dividend
                          effective January 13, 2006.
 (2)
                      Represents
                          shares issued upon the conversion of a convertible promissory
                          note by RJK,
                          L.L.C., an entity controlled by Mr. Kirk, our Chairman,
                          President and
                          Chief Executive Officer, in the original amount of $5,000,000
                          plus accrued
                          interest of $97,151. We received the $5,000,000 of proceeds
                          from the note
                          issuance in August 2001.
 
 At
                July
                2, 2006, we had cash and cash equivalents of $19,222,000 compared
                to $3,516,000
                at January 1, 2006. Our cash equivalents are highly liquid investments
                in money
                market funds and commercial paper. We maintain cash balances with
                financial
                institutions in excess of insured limits. We also maintained short-term
                investments of $72,475,000 and $49,250,000 at July 2, 2006 and January
                1, 2006,
                respectively, in auction rate municipal bonds. We record these short-term
                investments at cost, which approximates fair market value due to
                (i) the
                securities’ variable interest rates, which typically reset every 28 to 35 days,
                and (ii) the fact that we have the ability to liquidate readily these
                securities, despite the long-term nature of their stated contractual
                maturities.
                We do not anticipate any losses with respect to such cash and cash
                equivalents
                and short-term investment balances.
  23
 *Index*
  Cash
                provided by operations was $37,915,000 for the six months ended July
                2, 2006
                compared to $36,679,000 for the six months ended July 3, 2005. We
                received an
                upfront payment of $50,000,000 in February 2005 under the terms of
                our
                collaboration agreement with Shire and a milestone payment of $50,000,000
                under
                the same agreement in February 2006. Cash used in investing activities
                was
                $23,260,000 for the six months ended July 2, 2006 compared to $39,273,000
                for
                the six months ended July 3, 2005. The decrease is due to a higher
                amount of our
                cash being in cash equivalent investments rather than short-term
                investments.
  The
                  following table summarizes our contractual obligations at July
                  2, 2006 and the
                  effects such obligations are expected to have on our liquidity
                  and cash flows in
                  future periods.
  **Total**
                          
                          **Due
                              within 1 year**
                          
                          **Thereafter****(in
                              thousands)**Operating
                              lease obligations
                          
                          $
                          270
                          
                          $
                          270
                          
                          $
                          —Capital
                              lease obligations
                          
                          
                          39
                          
                          
                          24
                          
                          
                          15Research
                              and development contracts
                          
                          
                          14,315
                          
                          
                          14,315
                          
                          
                          —Inventory
                              purchase commitments
                          
                          
                          3,278
                          
                          
                          3,278
                          
                          
                          —Total
                              contractual cash obligations
                          
                          $
                          17,902
                          
                          $
                          17,887
                          
                          $
                          15
 
 Excluded
                    from the table above is the obligation for the Notes that were
                    issued in July
                    2006 subsequent to the periods ending July 2, 2006. These obligations
                    are more
                    fully discussed in the notes to the consolidated financial statements
                    (note 11 -
                    Subsequent Event) and in the overview section of Management’s Discussion and
                    Analysis of Financial Condition and Results of Operations.
 
 As
                    a
                    result of the exercise of our co-promotion right for NRP104 under
                    our
                    collaboration agreement with Shire on July 25, 2006, we are committed
                    to
                    co-promote the product for at least 24 months and to provide
                    25% of the total
                    details for the product during the 24-month period. The total
                    cost of this
                    commitment cannot be reasonably estimated at this time.
 
 Also
                    excluded from the table are royalty payments that we may be obligated
                    to pay to
                    Innovative Technologies L.L.C. in the future. Such future royalty
                    payments are
                    contingent on product sales and are based on 1% of net sales
                    (as defined in the
                    Innovative Technologies agreement) for a period of 10 years or
                    up to a total of
                    $1 million, whichever occurs first. Also excluded from the table
                    are payments
                    that we may be obligated to make under our agreements with Depomed,
                    Inc.,
                    Optimer Pharmaceuticals, Inc., and the Ernest Gallo Clinic Research
                    Center at
                    the University of California San Francisco. Such payments are
                    contingent upon
                    the achievement of certain milestones, royalties on future product
                    sales, and
                    development costs which are reimbursed at a full-time equivalent
                    rate or
                    cost-plus basis, the total cost of which cannot reasonably be
                    estimated.
 
 As
                    of
                    July 2, 2006, our long-term contractual obligations consist of
                    a capital lease
                    for equipment used in our research operations. Our operating
                    leases are for our
                    research and development facilities and our administrative offices.
                    The lease
                    for the research and development facilities expired at the end
                    of July 2006 and
                    was renewed for a one year period and requires monthly payments
                    of approximately
                    $11,500. We may renew this lease for successive one-year periods
                    thereafter.
                    Effective June 1, 2006, we entered into a lease agreement for
                    research and
                    development facilities which are intended to expand our current
                    research
                    capabilities and to replace our current facilities. This lease
                    is with the same
                    landlord as our existing facilities and upon moving into these
                    new facilities,
                    we will be allowed to cancel the remaining term of our current
                    lease. Rent for
                    the new facilities does not commence for the new facilities until
                    construction
                    for the final up-fit of the facilities begins, which had not
                    begun as of July 2,
                    2006. Rent for the new facilities will require monthly payments
                    of approximately
                    $23,668 per month. We maintain an operating lease agreement with
                    Third Security
                    for offices occupied by certain of our executive and administrative
                    staff. The
                    lease is for 24 months with a current monthly rental of approximately
                    $6,500 and
                    expires in August 2006. We may renew this lease for three successive
                    one-year
                    periods thereafter and intend to renew for the first of these
                    one-year periods
                    in August 2006 under terms similar to the current terms. We also
                    have
                    in-progress research and development contracts performed by third
                    parties. As of
                    July 2, 2006, we had commitments, which consist primarily of
                    external
                    development work, with third parties totaling approximately $28,493,000
                    of which
                    approximately $14,315,000 had not yet been incurred.
  24
 *Index*
  On
                    May
                    18, 2006, we entered into an Active Pharmaceutical Ingredient
                    Supply Agreement
                    (the Supply Agreement) with Organichem Corporation (Organichem)
                    for the
                    non-exclusive manufacture and supply of NRP104 by Organichem
                    for us. Under the
                    terms of the Supply Agreement, Organichem is to manufacture validation
                    batches
                    and commercial batches once regulatory approval is obtained.
                    Because regulatory
                    approval has not been obtained for NRP104, the costs of validation
                    batches are
                    classified as research and development costs. Accordingly, remaining
                    commitments
                    with Organichem for the manufacture of NRP104 validation batches
                    are included in
                    the research and development commitments total in the preceding
                    paragraph and in
                    the table above. Although production of commercial batches of
                    NRP104 has not
                    begun, the we were required to issue purchase orders to Organichem
                    for such
                    batches in order for Organichem to secure the necessary quotas from the DEA
                    to procure d-amphetamine to manufacture NRP104. The total of these purchase
                    commitments is approximately $3,278,000.
 
 We
                    may
                    incur losses from operations for fiscal year 2006. We expect
                    to incur increasing
                    research and development expenses, including expenses related
                    to additional
                    clinical trials and personnel. We expect that our general and
                    administrative
                    expenses will continue to increase in the future as we continue
                    to expand our
                    business development, add infrastructure and incur costs related
                    to the exercise
                    of our co-promote option with Shire, and incur additional costs
                    related to being
                    a public company.
 
 Our
                    future capital requirements will depend on a number of factors,
                    including
                    milestone payments received under our collaboration agreements
                    with Shire, the
                    progress of our research and development of product candidates,
                    the timing and
                    outcome of regulatory approvals, the costs involved in preparing,
                    filing,
                    prosecuting, maintaining, defending and enforcing patent claims
                    and other
                    intellectual property rights, the status of competitive products,
                    the
                    availability of financing and our success in developing markets
                    for our product
                    candidates. We believe our existing cash and cash equivalents
                    and short-term
                    investments will be sufficient to fund our operating expenses
                    and capital
                    equipment requirements for at least the next 18 months.
 
 To
                    the
                    extent our capital resources are insufficient to meet future
                    capital
                    requirements, we will need to raise additional capital or incur
                    indebtedness to
                    fund our operations. We cannot assure that additional debt or
                    equity financing
                    will be available on acceptable terms, if at all. If adequate
                    funds are not
                    available, we may be required to delay, reduce the scope of or
                    eliminate our
                    research and development programs, reduce our commercialization
                    efforts or
                    obtain funds through arrangements with collaborative partners
                    or others that may
                    require us to relinquish rights to certain product candidates
                    that we might
                    otherwise seek to develop or commercialize independently. Future
                    equity
                    offerings could (i) dilute the ownership of equity investors
                    and (ii) reduce the
                    market price for our common stock. In the event that we issue
                    debt securities in
                    the future, holders of these debt securities would receive distribution
                    of
                    assets prior to holders of common stock upon liquidation.
 
 **Off-Balance
                    Sheet Arrangements**
 
 We
                    do not
                    have any off-balance sheet arrangements that have or are reasonably
                    likely to
                    have a current or future effect on our financial condition, revenues
                    or
                    expenses, results of operations, liquidity, capital expenditures
                    or capital
                    resources that we believe is material to investors.
 
 **Effects
                    of Inflation**
 
 Our
                    only
                    liquid assets are cash and cash equivalents and short-term investments.
                    Because
                    of their liquidity, these assets should not be significantly
                    affected by
                    inflation. We also believe that we have intangible assets in
                    the value of our
                    intellectual property. In accordance with U.S. generally accepted
                    accounting
                    principles, we have not capitalized the value of this intellectual
                    property on
                    our consolidated balance sheet. Due to the nature of this intellectual
                    property,
                    we believe that these intangible assets should not be significantly
                    affected by
                    inflation. Because we intend to retain and continue to use our
                    equipment,
                    furniture and fixtures and leasehold improvements, we believe
                    that the
                    incremental inflation related to replacement costs of such items
                    will not
                    materially affect our operations. However, the rate of inflation
                    affects our
                    expenses, such as those for employee compensation and contract
                    services, which
                    could increase our level of expenses and the rate at which we
                    use our
                    resources.
  25
 *Index*
  **Critical
                    Accounting Policies and Estimates**
 
 Our
                    discussion and analysis of our financial condition and results
                    of operations are
                    based on our consolidated financial statements, which have been
                    prepared in
                    accordance with U.S. generally accepted accounting principles.
                    The preparation
                    of these financial statements requires us to make estimates and
                    judgments that
                    affect the reported amounts of assets, liabilities and expenses.
                    On an ongoing
                    basis, we evaluate our estimates and judgments, including those
                    related to
                    revenue recognition, accrued expenses, fair valuation of stock
                    related to
                    stock-based compensation and income taxes. We base our estimates
                    on historical
                    experience and on various other assumptions that we believe to
                    be reasonable
                    under the circumstances, the results of which form the basis
                    for making
                    judgments about the carrying values of assets and liabilities
                    that are not
                    readily apparent from other sources. Actual results may differ
                    from these
                    estimates. Our senior management has reviewed these critical
                    accounting policies
                    and estimates with our audit committee.
 We
                    believe the following critical accounting policies affect our
                    more significant
                    judgments and estimates used in the preparation of our consolidated
                    financial
                    statements.
 
 *Revenue
                    Recognition* .
                    Although we currently have no products available for sale, we
                    do anticipate
                    having products in the future. We anticipate that some of our
                    sales will be to
                    wholesalers who have the right to return purchased products.
                    In accordance with
                    SFAS No. 48, “ *Revenue
                    Recognition When the Right of Return Exists* ”
(SFAS
                    No. 48), until we have sufficient sales history to estimate product
                    returns, we
                    will have to defer recognition of revenue on such sales until
                    the products are
                    dispensed through patient prescriptions. Once we have obtained
                    sufficient sales
                    history to estimate product returns, under SFAS 48, we will be
                    able to recognize
                    revenue on product shipments, net of a reasonable allowance for
                    estimated
                    returns relating to these shipments.
 
 Our
                    strategy includes entering into collaborative agreements with
                    strategic partners
                    for the development and commercialization of our product candidates.
                    Such
                    collaboration agreements may have multiple deliverables. We evaluate
                    m ultiple
                    deliverable arrangements pursuant to EITF 00-21, *“Revenue
                    Arrangements with Multiple Deliverables”* (EITF
                    00-21). Pursuant to EITF 00-21, in arrangements with multiple
                    deliverables where
                    we have continuing performance obligations, contract, milestone
                    and license fees
                    are recognized as revenue together with any up-front payments
                    over the term of
                    the arrangement as performance obligations are completed, unless
                    the deliverable
                    has stand alone value and there is objective, reliable evidence
                    of fair value of
                    the undelivered element in the arrangement. In the case of an
                    arrangement where
                    it is determined there is a single unit of accounting, all cash
                    flows from the
                    arrangement are considered in the determination of all revenue
                    to be recognized.
                    Cash received in advance of revenue recognition is recorded as
                    deferred
                    revenue.
 
 *Accrued
                    Expenses* .
                    As part
                    of the process of preparing consolidated financial statements,
                    we are required
                    to estimate accrued expenses. This process involves identifying
                    services that
                    have been performed on our behalf and estimating the level of
                    service performed
                    and the associated cost incurred for such service as of each
                    balance sheet date
                    in our consolidated financial statements. Examples of estimated
                    accrued expenses
                    include professional service fees, such as fees of lawyers and
                    contract service
                    fees. In connection with such service fees, our estimates are
                    most affected by
                    our understanding of the status and timing of services provided
                    relative to the
                    actual levels of services incurred by such service providers.
                    The majority of
                    our service providers invoice us monthly in arrears for services
                    performed. In
                    the event that we do not identify certain costs that have begun
                    to be incurred
                    or we under- or over-estimated the level of services performed
                    or the costs of
                    such services, our reported expenses for such period would be
                    too low or too
                    high. The date on which certain services commence, the level
                    of services
                    performed on or before a given date and the cost of such services
                    are often
                    subject to management’s judgment. We make these judgments based upon the facts
                    and circumstances known to us in accordance with U.S. generally
                    accepted
                    accounting principles.
 
 *Stock-Based
                    Compensation* .
                    Effective January 2, 2006, we adopted the provisions of SFAS
                    No. 123(R) and
                    related interpretations, using the modified prospective method.
                    SFAS No. 123(R)
                    requires companies to expense the grant-date fair value of employee
                    equity
                    awards over the vesting period. Using the modified prospective
                    method of
                    adopting SFAS 123(R), we began recognizing compensation expense
                    for the
                    remaining unvested portions of stock option and SARs settled
                    in stock that were
                    granted prior to January 2, 2006. We also have outstanding SARs
                    that are to be
                    settled in cash. In accordance with SFAS 123(R), these instruments
                    are measured
                    at fair value and are recorded as a liability at the end of each
                    reporting
                    period until settled.
  26
 *Index*
  *Income
                    Taxes* .
                    As part
                    of the process of preparing our consolidated financial statements,
                    we are
                    required to estimate our income taxes in each of the jurisdictions
                    in which we
                    operate. We account for income taxes under the asset and liability
                    method.
                    Deferred tax assets and liabilities are recognized for the future
                    tax
                    consequences attributable to differences between the financial
                    statement
                    carrying amounts of existing assets and liabilities and their
                    respective tax
                    bases and operating loss and tax credit carryforwards. Deferred
                    tax assets and
                    liabilities are measured using enacted tax rates expected to
                    apply to taxable
                    income in the years in which those temporary differences are
                    expected to be
                    recovered or settled. The effect on deferred tax assets and liabilities
                    of a
                    change in tax rates is recognized in income in the period that
                    includes the
                    enactment date. Valuation allowances are provided if, based upon
                    the weight of
                    available evidence, it is more likely than not that some or all
                    of the deferred
                    tax assets will not be realized.
  We
                    have
                    not recorded any tax provision or benefit for the three and six
                    months ended
                    July 2, 2006 and July 3, 2005. We have provided a valuation allowance
                    for the
                    full amount of our net deferred tax assets since realization
                    of any future
                    benefit from deductible temporary differences and net operating
                    loss carry
                    forwards cannot be sufficiently assured. At January 1, 2006,
                    we had federal net
                    operating loss carry forwards of approximately $72,127,000 available
                    to reduce
                    future taxable income, which will begin to expire in 2019.
 
 In
                    June
                    2006, the FASB issued Interpretation 48, *“Accounting
                    for Uncertainty in Income Taxes”* ,
                    (FIN
                    48). FIN 48 clarifies the application of SFAS No. 109, “Accounting for Income
                    Taxes”, by defining the confidence level that a tax position must meet
                    for any
                    part of the benefit of that position to be recognized in a Company’s financial
                    statements. FIN 48 requires that the tax effects of a position
                    be recognized
                    only if it is “more-likely-than-not” to be sustained based solely on its
                    technical merits as of the reporting date. FIN 48 is effective
                    as of the
                    beginning of the first fiscal year beginning after December 15,
                    2006, with early
                    application permitted if no interim financial statements have
                    been issued. We
                    are currently evaluating the impact that adopting FIN 48 will
                    have on our future
                    financial statements.
 
 **Item
                              3****.**
                          **Quantitative
                              and Qualitative Disclosures About Market
                              Risk**
 
 As
                    of
                    July 2, 2006, our exposure to market risk was confined to our
                    cash and cash
                    equivalents that have maturities of less than three months and
                    our short-term
                    investments in auction rate municipal bonds. We record our investment
                    in auction
                    rate municipal bonds at cost, which approximates fair market
                    value due to (i)
                    the securities’ variable interest rates, which typically reset every 28 to 35
                    days, and, (ii) the fact that the Company has the ability to
                    liquidate readily
                    these securities, despite the long-term nature of their stated
                    contractual
                    maturities. We currently do not hedge interest rate exposure.
                    Because of the
                    short-term maturities of our cash and cash equivalents and the
                    reset terms of
                    our investments in auction rate municipal bonds, we do not believe
                    that an
                    increase in market rates would have any significant impact on
                    their realized
                    value. As more fully discussed in the notes to the consolidated
                    financial
                    statements (note 11 - Subsequent Event) and in the overview section
                    of
                    Management’s Discussion and Analysis of Financial Condition and Results
                    of
                    Operations, we have entered into certain hedging transactions
                    subsequent to July
                    2, 2006 in connection with our issuance of $135,000,000 of Notes.
  **Item
                              4.**
                          **Controls
                              and Procedures.**
 
 Pursuant
                    to Rule 13a-15(b) under the Securities Exchange Act of 1934,
                    as amended (the
                    Exchange Act), we carried out an evaluation, with the participation
                    of our
                    management, including our Chief Executive Officer and Chief Financial
                    Officer,
                    of the effectiveness of our disclosure controls and procedures
                    (as defined under
                    Rule 13a-15(e) and 15d - 15(e) under the Exchange Act) as of
                    July 2, 2006. Based
                    upon that evaluation, our Chief Executive Officer and Chief Financial
                    Officer
                    concluded that our design and operation of disclosure controls
                    and procedures
                    are effective to ensure that information required to be disclosed
                    by us in
                    reports that we file or submit under the Exchange Act, is accumulated
                    and
                    communicated to our management and is recorded, processed, summarized
                    and
                    reported as specified in SEC rules and forms.
 
 There
                    has
                    been no change in our internal control over financial reporting
                    during the
                    quarter ended July 2, 2006 that has materially affected, or is
                    reasonably likely
                    to materially affect, our internal control over financial
                    reporting.
 
  27
 *Index*
  **PART
                    II**
 **OTHER
                    INFORMATION**
  **Item
                              1.**
                          **Legal
                              Proceedings**
 
 We
                    are
                    not presently involved in any legal proceedings that, in our
                    opinion, could have
                    a material adverse effect on our business or financial condition.
 
 **Item
                              1A.**
                          **Risk
                              Factors**
 
 The
                    risk
                    factors appearing in Item 1A of our annual report on Form 10-K
                    for the year
                    ended January 1, 2006, are amended and restated in their entirety
                    as
                    follows:
 
 **We
                    have a history of operating losses and may incur additional substantial
                    losses
                    in 2006. We may never achieve profitability.**
 
 Since
                    the
                    end of 1997, we have incurred losses in each year of our operations,
                    and we may
                    continue to incur operating losses in 2006. These operating losses
                    have
                    adversely affected and may continue to adversely affect our working
                    capital,
                    total assets and shareholders’ equity.
 
 The
                    process of developing our products requires significant clinical,
                    development
                    and laboratory testing and clinical trials. In addition, commercialization
                    of
                    our product candidates will require that we obtain necessary
                    regulatory
                    approvals and establish sales, marketing and manufacturing capabilities,
                    either
                    through internal hiring or through contractual relationships
                    with others. We may
                    incur substantial losses in 2006 as a result of anticipated increases
                    in our
                    research and development costs, including costs associated with
                    conducting
                    preclinical testing and clinical trials, regulatory compliance
                    activities and
                    developing our sales and marketing capabilities. We have incurred
                    operating
                    losses of approximately $31.8 million for the fiscal year ended
                    January 1, 2006,
                    approximately $16.3 million for the fiscal year ended January
                    2, 2005,
                    approximately $4.8 million for the fiscal year ended December
                    28, 2003. We had
                    net income of approximately $3.5 million for the six months ended
                    July 2, 2006,
                    however, we expect to incur additional operating losses at least
                    until receipt
                    of regulatory approval for NRP104. As of January 1, 2006 and
                    July 2, 2006, we
                    had an accumulated deficit of approximately $69.8 million and
                    $66.4 million,
                    respectively.
  Our
                      ability to generate revenues and achieve profitability will
                      depend on numerous
                      factors, including success in:
 
 ·
                            developing
                                and testing product candidates;
 
 ·
                            receiving
                                regulatory approvals;
 
 ·
                            commercializing
                                our products; and
 
 ·
                            establishing
                                a favorable competitive position.
 
 Many
                      of
                      these factors will depend on circumstances beyond our control.
                      We cannot assure
                      you that we will ever have a product approved by the FDA, that
                      we will bring any
                      product to market or, if we are successful in doing so, that
                      we will ever become
                      profitable.
 
 **Our
                      product candidates are based on a technology that could ultimately
                      prove
                      ineffective or unsafe.**
  Our
                      product candidates are created using our proprietary Carrierwave
                      technology. Our
                      test results to date are limited to clinical studies in humans
                      and preclinical
                      studies in animals with respect to NRP104 and NRP290 and laboratory
                      tests and
                      preclinical trial in animals with respect to other product
                      candidates. We have
                      not fully characterized the mechanism of absorption of our
                      CBDs. Ultimately, our
                      research and preclinical findings, which currently indicate
                      that our Carrierwave
                      technology possesses beneficial properties, may prove to be
                      incorrect, in which
                      case the product candidates created using our Carrierwave technology
                      may not
                      differ substantially from competing drugs and may in fact be
                      inferior to them.
                      If these products are substantially identical or inferior to
                      drugs already
                      available, the market for our Carrierwave drugs would be reduced
                      or
                      eliminated.
  28
 *Index*
  Based
                      on
                      our preclinical and clinical studies to date, we believe our
                      lead product
                      candidates are safe and have no known side effects other than
                      those associated
                      generally with therapeutic amounts of amphetamine and opioids.
                      However, we may
                      not be able to prove that our product candidates are safe.
                      No assessment of the
                      efficacy, safety or side effects of a product candidate can
                      be considered
                      complete until all clinical trials needed to support a submission
                      for marketing
                      approval are complete. Other than NRP104, for which we have
                      submitted an NDA,
                      our product candidates will require additional laboratory,
                      animal and human
                      testing. Success in earlier clinical and preclinical trials
                      does not mean that
                      subsequent trials will confirm the earlier findings, or that
                      experience with use
                      of a product in large-scale commercial distribution will not
                      identify additional
                      safety or efficacy issues. If we find that any of our products
                      are not safe, or
                      if efficacy of the products cannot be consistently demonstrated,
                      we may not be
                      able to commercialize the products, or may be required to cease
                      distribution of
                      the relevant products. The safety of our Carrierwave formulations
                      may vary with
                      each drug and the ingredients used in each formulation, and
                      therefore even if
                      safety and effectiveness are established for one of our CBDs,
                      this would not
                      necessarily be predictive of the safety or effectiveness of
                      any of our other
                      product candidates, which would need to be separately established.
 
 **If
                      we are unable to develop and commercialize our product candidates
                      successfully,
                      we may never achieve profitability.**
  We
                      have
                      not commercialized any products or recognized any revenue from
                      product sales
                      utilizing our Carrierwave technology. All of the compounds
                      produced using our
                      Carrierwave technology, other than NRP104 and NRP290, are in
                      early stages of
                      development. On January 26, 2006, the FDA accepted for review
                      our NDA for
                      NRP104. There can be no assurance, however, that the FDA will
                      approve that NDA
                      or, if the FDA requires additional data prior to approval,
                      we will be able to
                      generate the required data. We must conduct significant additional
                      research and
                      development activities before we will be able to apply for
                      regulatory approval
                      to commercialize any other products utilizing our Carrierwave
                      technology. We
                      must successfully complete adequate and well-controlled studies
                      designed to
                      demonstrate the safety and efficacy of the product candidates
                      and obtain
                      regulatory approval before we are able to commercialize these
                      product
                      candidates. There is no guarantee that we will receive regulatory
                      approval with
                      respect to any of our product candidates. Even if we succeed
                      in developing and
                      commercializing one or more of our product candidates utilizing
                      our Carrierwave
                      technology, we may never generate sufficient or sustainable
                      revenue to enable us
                      to be profitable.
 
 **We
                      face intense competition in the markets targeted by our lead
                      product candidates.
                      Many of our competitors have substantially greater resources
                      than we do, and we
                      expect that all of our product candidates under development
                      will face intense
                      competition from existing or future drugs.**
  We
                      have
                      devoted substantial research efforts and capital to the development
                      of our
                      Carrierwave technology and our lead product candidates. We
                      expect that all of
                      our product candidates, if approved, will face intense competition
                      from existing
                      and future drugs marketed by other companies.
 
 The
                      markets for amphetamines and other stimulants to treat ADHD
                      and opioids to treat
                      pain are well developed and populated with established drugs
                      marketed by large
                      pharmaceutical, biotechnology and generic drug companies. Amphetamines
                      or other
                      stimulants currently marketed for ADHD include Ritalin (Novartis
                      AG), Concerta
                      (McNeil Consumer & Specialty Pharmaceuticals), Dexedrine (GlaxoSmithKline
                      PLC), Dextrostat (Shire), Cylert (Abbott Laboratories, Inc.)
                      and Adderall
                      (Shire). In addition, Eli Lilly and Company markets a non-stimulant
                      drug,
                      Strattera, for ADHD. Opioids currently marketed for acute pain
                      include Anexsia
                      (Mallinckrodt Inc.), Endocet (Endo Laboratories), Hydrocet
                      (Amarin
                      Pharmaceuticals, Inc.), Lortab (UCB Pharma Inc.), Norco (Watson
                      Pharmaceuticals,
                      Inc.), and Vicodin (Abbott Laboratories, Inc.). Opioids currently
                      marketed for
                      chronic pain include OxyContin (Purdue Pharmaceuticals LP),
                      Duragesic (Janssen
                      Pharmaceutical Products, L.P.), MSContin (Purdue Frederick
                      Company) and Avinza
                      (Ligand Pharmaceuticals Inc.). Each of these companies has
                      significantly greater
                      financial and other resources than we do. In addition, generic
                      equivalent
                      versions of many of these existing drug products are available
                      and these
                      products are therefore subject to substantial price competition.
                      If we obtain
                      regulatory approval to market one or more of our product candidates,
                      we will
                      compete with these established brand and generic drugs and
                      will need to show
                      that our drugs have safety or efficacy advantages in order
                      to take market share
                      and be successful.
  29
 *Index*
  Currently,
                      and as a direct consequence of the public debate of the social
                      and economic
                      costs of illegal diversion and abuse of, addiction to, and
                      overdose from
                      stimulants and narcotics, several companies are pursuing formulations
                      that are
                      less prone to abuse and are less toxic. Companies specifically
                      engaged in
                      developing abuse resistant drugs include Purdue Pharma LP,
                      Nastech
                      Pharmaceutical Company Inc. and Pain Therapeutics Inc. Other
                      companies,
                      including Johnson & Johnson and Noven Pharmaceuticals, Inc., are
                      investigating alternative delivery mechanisms to control the
                      delivery and
                      availability of scheduled drugs. These technologies include
                      transdermal skin
                      patches, metered dose inhalers and extended release subcutaneous
                      injections and
                      implants. These competitors may:
 
 ·
                            successfully
                                market products that compete with our
                                products;
 
 ·
                            successfully
                                identify drug candidates or develop products earlier
                                than we do;
                                or
 
 ·
                            develop
                                products that are more effective, have fewer side
                                effects or cost less
                                than our products.
 
 Additionally,
                      if a competitor receives FDA approval before we do for a drug
                      that is similar to
                      one of our product candidates, FDA approval for our product
                      candidate may be
                      precluded or delayed due to periods of non-patent exclusivity
                      and/or the listing
                      with the FDA by the competitor of patents covering its newly-approved
                      drug
                      product. Periods of non-patent exclusivity for new versions
                      of existing drugs
                      such as our current product candidates can extend up to three
                      and one-half
                      years.
 
 These
                      competitive factors could require us to conduct substantial
                      new research and
                      development activities to establish new product targets, which
                      would be costly
                      and time-consuming. These activities would adversely affect
                      our ability to
                      commercialize products and achieve revenue and profits.
 
 **If
                      we fail to protect our intellectual property rights, our ability
                      to pursue the
                      development of our technologies and products would be negatively
                      affected.**
  Our
                      success will depend in part on our ability to obtain patents
                      and maintain
                      adequate protection of our technologies and products. If we
                      do not adequately
                      protect our intellectual property, competitors may be able
                      to use our
                      technologies to produce and market drugs in direct competition
                      with us and erode
                      our competitive advantage. Some foreign countries lack rules
                      and methods for
                      defending intellectual property rights and do not protect proprietary
                      rights to
                      the same extent as the United States. Many companies have had
                      difficulty
                      protecting their proprietary rights in these foreign countries.
                      We may not be
                      able to prevent misappropriation of our proprietary rights.
 
 Patent
                      positions can be uncertain and involve complex legal and factual
                      questions. We
                      can protect our proprietary rights from unauthorized use by
                      third parties only
                      to the extent that our proprietary technologies are covered by valid and
                      enforceable patents or are effectively maintained as trade
                      secrets. As of August
                      2, 2006, we held two issued U.S. patents relating to our generic
                      Carrierwave
                      technology and one issued U.S. patent covering NRP290. In addition,
                      as of August
                      2, 2006, we had three issued U.S. patents for an earlier developed
                      iodothyronine
                      stability and delivery technology. We have applied for additional
                      patents
                      relating to our technologies and our products and plan to file
                      additional patent
                      applications in the future. We have U.S. patent applications
                      pending covering
                      each of our product candidates. Additionally, we have Patent
                      Cooperation Treaty
                      applications pending covering abuse resistant aspects of our
                      technology, as well
                      as, national stage applications pending in up to 18 countries
                      depending on the
                      specific product candidate. We also have national stage applications
                      covering
                      our core technology platform in Europe, Japan, China, South
                      Korea, Canada,
                      Australia, India and Israel.
  Others
                        may challenge our patents, or our patent applications may
                        not result in issued
                        patents. Moreover, any patents issued to us may not provide
                        us with meaningful
                        protection, or others may challenge, circumvent or force
                        us to narrow our
                        patents. Third parties may also independently develop products
                        similar to our
                        products, duplicate our unpatented products or design around
                        any patents on
                        products we develop. Additionally, extensive time is required
                        for development,
                        testing and regulatory review of a potential product. While
                        extensions of patent
                        terms due to regulatory delays may be available, it is possible
                        that, before any
                        of our product candidates can be commercialized, any related
                        patent, even with
                        an extension, may expire or remain in force for only a short
                        period following
                        commercialization, thereby reducing any advantages of the
                        patent.
  30
 *Index*
  In
                        addition to patents, we rely on a combination of trade secrets,
                        confidentiality,
                        nondisclosure and other contractual provisions, and security
                        measures to protect
                        our confidential and proprietary information. These measures
                        may not adequately
                        protect our trade secrets or other proprietary information.
                        If they do not
                        adequately protect our rights, third parties could use our
                        technology, and we
                        could lose any competitive advantage we may have. In addition,
                        others may
                        independently develop similar proprietary information or
                        techniques or otherwise
                        gain access to our trade secrets, which could impair any
                        competitive advantage
                        we may have.
 
 **We
                        have not commissioned an extensive investigation concerning
                        our freedom to
                        practice or the validity or enforceability of our Carrierwave
                        technology and
                        have only recently commissioned an investigation concerning
                        our freedom to
                        practice or the validity or the enforceability for our product
                        candidates, and
                        we may be held to infringe the intellectual property rights
                        of
                        others.**
  Our
                        ability to freely practice our product candidates is dependent
                        upon the duration
                        and scope of patents held by third parties. Our patent, prior
                        art and
                        infringement investigations have been conducted primarily
                        by us. Although we
                        have consulted with our patent counsel in connection with
                        our intellectual
                        property investigations, our patent counsel has only recently
                        undertaken an
                        extensive independent analysis to determine whether our product
                        candidates
                        infringe upon any issued patents or whether our issued patents
                        or patent
                        applications relating to our product candidates could be
                        invalidated or rendered
                        unenforceable for any reason or could be subject to interference
                        proceedings.
                        Further, we have not commissioned our patent counsel to undertake
                        an extensive
                        independent analysis to determine whether our Carrierwave
                        technology could
                        infringe upon any issued patents or whether our issued patents
                        or patent
                        applications relating to our Carrierwave technology could
                        be invalidated or
                        rendered unenforceable for any reason or could be subject
                        to interference
                        proceedings.
 
 There
                        may
                        be patents or patent applications of which we are unaware,
                        and avoiding patent
                        infringement may be difficult. We may inadvertently infringe
                        third-party
                        patents. Third-party patents may impair or block our ability
                        to conduct our
                        business. There are no unresolved communications, allegations,
                        complaints or
                        threats of litigation related to the possibility that we
                        might infringe patents
                        held by others.
 
 Claims
                        may be asserted against us that our products or technology
                        infringes patents or
                        other intellectual property owned by others. We may be exposed
                        to future
                        litigation by third parties based on claims that our products
                        or activities
                        infringe the intellectual property rights of others. In the
                        event of litigation,
                        any claims may not be resolved in our favor. Any litigation
                        or claims against
                        us, whether or not valid, may result in substantial costs
                        and may result in an
                        award of damages, lost profits, attorneys’ fees, and tripling of those damages
                        in the event that a court finds an infringement to have been
                        willful. A lawsuit
                        could also place a significant strain on our financial resources,
                        divert the
                        attention of management and harm our reputation. In addition,
                        intellectual
                        property litigation or claims could force us to do one or
                        more of the
                        following:
 
 ·
                              cease
                                  making, using, selling, offering to sell or importing
                                  any products that
                                  infringe a third party’s intellectual property through an
                                  injunction;
 
 ·
                              obtain
                                  a license or an assignment from the holder of the
                                  infringed intellectual
                                  property right, which license or assignment may
                                  be costly or may not be
                                  available on reasonable terms, if at all;
                                  or
 
 ·
                              redesign
                                  our products, which would be costly and time-consuming
                                  and may not be
                                  possible.
 
 **We
                        may be involved in lawsuits to protect or enforce our patents,
                        which could be
                        expensive and time-consuming.**
  As
                        of
                        August 2, 2006, our intellectual property included six U.S.
                        patents, two foreign
                        patents and 122 pending U.S., Patent Cooperation Treaty or
                        national stage
                        applications. We have licensed aspects of our Carrierwave
                        technology with
                        respect to NRP104 pursuant to our collaboration agreement
                        with Shire. As of
                        August 2, 2006, we had 71 applications covering anti-abuse
                        aspects of
                        amphetamine, hydrocodone and oxycodone generally with other
                        commonly abused
                        substances. Of these, NRP104 is the focus of 23 applications,
                        NRP290 is the
                        focus of eleven applications, NRP369 is the focus of fourteen
                        applications, and
                        NRP409 is the focus of two applications.
  31
 *Index*
  Competitors
                        may infringe our patents, and we may file infringement claims
                        to counter
                        infringement or unauthorized use. This can be expensive,
                        particularly for a
                        company of our size, and time-consuming. In addition, in
                        an infringement
                        proceeding, a court may decide that a patent of ours is not
                        valid or is
                        unenforceable, or may refuse to stop the other party from
                        using the technology
                        at issue on the grounds that our patents do not cover its
                        technology. An adverse
                        determination of any litigation or defense proceedings could
                        put one or more of
                        our patents at risk of being invalidated or interpreted narrowly.
 
 Also,
                        a
                        third party may assert that our patents are invalid and/or
                        unenforceable. There
                        are no unresolved communications, allegations, complaints
                        or threats of
                        litigation related to the possibility that our patents are
                        invalid or
                        unenforceable. Any litigation or claims against us, whether
                        or not merited, may
                        result in substantial costs, place a significant strain on
                        our financial
                        resources, divert the attention of management and harm our
                        reputation. An
                        adverse decision in a litigation could result in inadequate
                        protection for our
                        product candidates and/or reduce the value of any license
                        agreements we have
                        with third parties.
 
 Interference
                        proceedings brought before the U.S. Patent and Trademark
                        Office may be necessary
                        to determine priority of invention with respect to our patents
                        or patent
                        applications. During an interference proceeding, it may be
                        determined that we do
                        not have priority of invention for one or more aspects in
                        our patents or patent
                        applications and could result in the invalidation in part
                        or whole of a patent
                        or could put a patent application at risk of not issuing.
                        Even if successful, an
                        interference may result in substantial costs and distraction
                        to our
                        management.
 
 Furthermore,
                        because of the substantial amount of discovery required in
                        connection with
                        intellectual property litigation or interference proceedings,
                        there is a risk
                        that some of our confidential information could be compromised
                        by disclosure. In
                        addition, there could be public announcements of the results
                        of hearings,
                        motions or other interim proceedings or developments. If
                        investors perceive
                        these results to be negative, the price of our common stock
                        could be adversely
                        affected.
 
 **If
                        preclinical testing or clinical trials for our product candidates
                        are
                        unsuccessful or delayed, we will be unable to meet our anticipated
                        development
                        and commercialization timelines.**
  Other
                        than NRP104, our potential drug candidates require preclinical
                        testing and
                        clinical trials prior to submission of any regulatory application
                        for commercial
                        sales. Additional clinical study requirements could be imposed
                        on us either
                        prior to approval or as post-approval requirements. We currently
                        employ two
                        clinical trial managers. We rely and expect to continue to
                        rely on third
                        parties, including clinical research organizations and outside
                        consultants, to
                        conduct, supervise or monitor some or all aspects of preclinical
                        testing or
                        clinical trials involving our product candidates. We have
                        less control over the
                        timing and other aspects of these preclinical testing or
                        clinical trials than if
                        we performed the monitoring and supervision entirely on our
                        own. Third parties
                        may not perform their responsibilities for our preclinical
                        testing or clinical
                        trials on our anticipated schedule or, for clinical trials,
                        consistent with a
                        clinical trial protocol. Delays in preclinical and clinical
                        testing could
                        significantly increase our product development costs and
                        delay product
                        commercialization. In addition, many of the factors that
                        may cause, or lead to,
                        a delay in the clinical trials may also ultimately lead to
                        denial of regulatory
                        approval of a product candidate.
 The
                          commencement of clinical trials can be delayed for a variety
                          of reasons,
                          including delays in:
 
 ·
                                demonstrating
                                    sufficient safety and efficacy to obtain regulatory
                                    approval to commence a
                                    clinical trial;
 
 ·
                                reaching
                                    agreement on acceptable terms with prospective
                                    contract research
                                    organizations and trial sites;
 
 ·
                                manufacturing
                                    sufficient quantities of a product candidate;
                                    and
 
 ·
                                obtaining
                                    institutional review board approval to conduct
                                    a clinical trial at a
                                    prospective site.
  32
 *Index*
  Once
                          a
                          clinical trial has begun, it may be delayed, suspended
                          or terminated by us or
                          the FDA or other regulatory authorities due to a number
                          of factors,
                          including:
 
 ·
                                ongoing
                                    discussions with the FDA or other regulatory
                                    authorities regarding the
                                    scope or design of our clinical
                                    trials;
 
 ·
                                •failure
                                    to conduct clinical trials in accordance with
                                    regulatory
                                    requirements;
 
 ·
                                lower
                                    than anticipated recruitment or retention rate
                                    of patients in clinical
                                    trials;
 
 ·
                                inspection
                                    of the clinical trial operations or trial sites
                                    by the FDA or other
                                    regulatory authorities resulting in the imposition
                                    of a clinical
                                    hold;
 
 ·
                                lack
                                    of adequate funding to continue clinical trials;
 
 ·
                                adverse
                                    effects or safety issues; or
 
 ·
                                negative
                                    results of clinical trials.
 
 If
                          clinical trials are unsuccessful, and we are not able to
                          obtain regulatory
                          approvals for our product candidates under development,
                          we will not be able to
                          commercialize these products, and therefore may not be
                          able to generate
                          sufficient revenues to support our business.
 
 **If
                          the FDA does not accept our filing for NRP290 under Section
                          505(b)(1) and we are
                          unable to file for approval under Section 505(b)(2) of
                          the Federal Food, Drug
                          and Cosmetic Act or if we are required to generate additional
                          data related to
                          safety and efficacy in order to obtain approval under Section
                          505(b)(1) or
                          505(b)(2), we may be unable to meet our anticipated development
                          and
                          commercialization timelines.**
  Our
                          current plans for filing NDAs for our product candidates
                          include efforts to
                          minimize the data we will be required to generate in order
                          to obtain marketing
                          approval for our product candidates and therefore possibly
                          obtain a shortened
                          review period for the applications. The FDA has accepted
                          our NDA for NRP104
                          under Section 505(b)(1), and we believe it may also accept
                          our planned NDA for
                          NRP290 under that section as well. The FDA could change
                          its determination on
                          this issue, however, and require that we either generate
                          additional data to
                          support an approval under Section 505(b)(1) or submit or
                          convert an application
                          to a Section 505(b)(2) application so that we can rely
                          on data generated by
                          third parties, to which we do not have a right of reference.
                          If we are required
                          to rely on data generated with products already approved
                          by the FDA and covered
                          by third-party patents we would be required to certify
                          that we do not infringe
                          the listed patents for those products or that such patents
                          are invalid or
                          unenforceable. As a result of such a certification, the
                          third party would have
                          45 days from notification of our certification to initiate
                          an action for patent
                          infringement against us. In the event that an action is
                          brought in response to
                          such a certification, the approval of our NDA could be
                          subject to a stay of up
                          to 30 months or more while we defend against such a suit.
                          Approval of our
                          product candidates may therefore be delayed until patent
                          exclusivity expires or
                          until we successfully challenge the applicability of those
                          patents to our
                          product candidates. Alternatively, we may elect to generate
                          sufficient
                          additional clinical data of our own so that we can maintain
                          our application
                          under Section 505(b)(1).
 
 Even
                          if
                          no exclusivity periods apply to our applications, the FDA
                          has broad discretion
                          to require us to generate additional data on the safety
                          and efficacy of our
                          product candidates to supplement third-party data on which
                          we may be permitted
                          to rely. In either event, we could be required, before
                          obtaining marketing
                          approval for any of our product candidates, to conduct
                          substantial new research
                          and development activities beyond those we currently plan
                          to engage in order to
                          obtain approval of our product candidates. Such additional
                          new research and
                          development activities would be costly and time-consuming.
                          If we are required to
                          generate additional data to support approval, we may be
                          unable to meet our
                          anticipated development and commercialization timelines,
                          may be unable to
                          generate the additional data at a reasonable cost, or at
                          all, and may be unable
                          to obtain marketing approval of our product candidates.
  33
 *Index*
  **If
                          the FDA requires that NRP104 be scheduled by the DEA before
                          the product is
                          commercially sold, we will be unable to begin commercial
                          sale of that product
                          until the DEA completes scheduling proceedings, and if
                          NRP104 is scheduled by
                          the DEA in Schedule II under the Controlled Substances
                          Act (CSA), the potential
                          market for the drug may be significantly reduced.**
  The
                          DEA
                          has indicated that NRP104 is not a scheduled drug at the
                          present time. Based on
                          data generated in our studies of the potential for abuse,
                          however, and on the
                          fact that the drug is designed to deliver quantities of
                          amphetamine, the FDA and
                          the DEA may, pursuant to their statutory responsibilities
                          under the CSA,
                          conclude that the drug should be scheduled in one of the
                          CSA schedules at the
                          time it is first approved for commercial sale. The process
                          for scheduling a drug
                          under these circumstances involves the forwarding by the
                          FDA to the DEA of its
                          medical and scientific findings, and its recommendation
                          that the drug be
                          scheduled on the appropriate schedule level. The DEA then
                          publishes a notice in
                          the Federal Register of a proposal to place the drug in
                          an appropriate CSA
                          schedule. Interested persons are then afforded an opportunity
                          to comment on the
                          proposal and to request a hearing. After consideration
                          of the comments received,
                          and potentially the holding of a formal administrative
                          hearing, the DEA then
                          publishes a regulation placing the drug in an appropriate
                          CSA schedule. If the
                          FDA is unwilling to permit the sale of the drug until it
                          is placed in an
                          appropriate CSA schedule, it may not grant NDA approval
                          until completion of
                          scheduling proceedings by the DEA. We intend to seek timely
                          conclusion of any
                          consideration of the CSA scheduling of NRP104 so that these
                          considerations do
                          not result in any delay in our ability to market the drug.
                          Because of the
                          opportunity for public participation in the process, however,
                          we cannot predict
                          how long the FDA and the DEA may take to conclude any scheduling
                          actions with
                          respect to the drug that they may believe are warranted.
 
 The
                          drug
                          products with which our lead product candidate NRP104 is
                          expected to compete are
                          amphetamine products currently classified by the DEA under
                          the CSA on
                          Schedule II, the most restrictive schedule applicable to drug products
                          marketed for legitimate medical use. The DEA has concluded
                          that, based on its
                          chemical structure, NRP104 is not a scheduled substance
                          at the present time. Our
                          commercialization strategy for this product depends in
                          large part on our ability
                          to obtain approval to market the drug either as an unscheduled
                          drug or as a drug
                          classified by the DEA in a less restrictive schedule than
                          Schedule II. A
                          decision as to whether and how NRP104 should be scheduled
                          at the time it is
                          approved for commercial sale will be made by the DEA based
                          on the medical and
                          scientific determinations of the FDA which, in turn, will
                          be based in large part
                          on data we generated regarding the relative potential for
                          abuse of the drug
                          compared to existing Schedule II drugs. If the determination is made that
                          the drug should be controlled in Schedule II, the potential market for our
                          drug may be significantly reduced, which may have a material
                          adverse effect on
                          us. Furthermore, because amphetamine is a Schedule II substance, the amount
                          of it that we can obtain for clinical trials and commercialization
                          of NRP104 is
                          limited by the DEA and our quota may not be sufficient
                          to complete any
                          additional clinical trials or meet commercial demand. In
                          addition, we cannot
                          predict the consideration by the FDA and the DEA of the
                          results of our studies
                          of the potential for abuse of NRP104.
 
 **We
                          have engaged in extensive financial and operational transactions
                          with Randal J.
                          Kirk, our Chairman, President and Chief Executive Officer,
                          and his affiliates,
                          and therefore these transactions may not be as favorable
                          to us as if we had
                          negotiated them with unaffiliated third parties.**
  Our
                          company was formed by, and has historically been controlled
                          and managed and,
                          prior to the initial public offering of our common stock,
                          principally funded by,
                          Randal J. Kirk, our Chairman, President and Chief Executive
                          Officer, and
                          affiliates of Mr. Kirk. As a result, we have engaged in
                          a variety of financial
                          and operational transactions with Mr. Kirk and these affiliates.
                          While we
                          believe that each of these transactions was on terms no
                          less favorable to us
                          than terms we could have obtained from unaffiliated third
                          parties, none of these
                          transactions was negotiated on an arm’s length basis. Accordingly, their terms
                          may not be as favorable to us as if we had negotiated them
                          with unaffiliated
                          third parties. It is our intention to ensure that all future
                          transactions, if
                          any, between us and our officers, directors, principal
                          shareholders and their
                          affiliates, are approved by the audit committee or a majority
                          of the independent
                          and disinterested members of the Board, and are on terms
                          no less favorable to us
                          than those that we could obtain from unaffiliated third
                          parties.
  34
 *Index*
  **As
                          of July 2, 2006 Randal J. Kirk controlled approximately
                          53.5% of our common
                          stock and is able to control or significantly influence
                          corporate actions, which
                          may result in Mr. Kirk taking actions that advance his
                          interests to the
                          detriment of our other shareholders.**
  As
                            of
                            July 2, 2006, Randal J. Kirk, Chairman, President and
                            Chief Executive Officer,
                            and shareholders affiliated with him controlled approximately
                            53.5% of our
                            common stock. Mr. Kirk is able to control or significantly
                            influence all matters
                            requiring approval by our shareholders, including the
                            election of directors and
                            the approval of mergers or other business combination
                            transactions. The
                            interests of Mr. Kirk may not always coincide with the
                            interests of other
                            shareholders, and he may take actions that advance his
                            interests to the
                            detriment of our other shareholders.
 
 **We
                            rely on Third Security, LLC, to provide us with certain
                            services. If Third
                            Security, LLC ceases to provide these services and we
                            are unable to establish
                            and maintain the necessary infrastructure to be self-sufficient,
                            our business
                            will be adversely affected.**
  We
                            rely
                            on Third Security, LLC to provide support for tax, legal,
                            information
                            technology, and market research functions as well as
                            provide the miscellaneous
                            services that we may need from time to time until the
                            earlier of August 9, 2006
                            or our termination of the administrative services agreement
                            we have with Third
                            Security. Currently, we expect to renew this agreement
                            under similar terms upon
                            its expiration. If Third Security will not agree to renew
                            the agreement and
                            ceases to provide these services and we are unable to
                            add the necessary
                            personnel and establish the necessary infrastructure
                            to support our operations
                            as a result, our business will be adversely affected.
                            Third Security is owned by
                            Randal J. Kirk, our Chairman, President and Chief Executive
                            Officer, who, with
                            shareholders affiliated with him as of July 2, 2006,
                            controlled approximately
                            53.5% of our common stock. The administrative services
                            agreement has terms no
                            less favorable than those that we would have entered
                            into with an unaffiliated
                            third party, and the agreement was approved by a majority
                            of the independent and
                            disinterested members of our Board.
 
 **Our
                            executive officers and other key personnel are critical
                            to our business, and our
                            future success depends on our ability to retain them.**
  We
                            are
                            highly dependent on the principal members of our management
                            and scientific team,
                            particularly, Mr. Kirk, our Chairman, President and Chief
                            Executive Officer,
                            Krish S. Krishnan, our Chief Financial Officer and Chief
                            Operating Officer, and
                            Suma M. Krishnan, our Vice President, Product Development
                            and chief scientist.
                            In order to pursue our product development, marketing
                            and commercialization
                            plans, we will need to hire additional personnel with
                            experience in clinical
                            testing, government regulation, manufacturing, marketing
                            and business
                            development. We may not be able to attract and retain
                            personnel on acceptable
                            terms given the intense competition for such personnel
                            among biotechnology,
                            pharmaceutical and healthcare companies, universities
                            and non-profit research
                            institutions. We have no employment agreements with any
                            of our executive
                            officers and while we have employment agreements with
                            certain of our employees,
                            all of our employees are at-will employees who may terminate
                            their employment at
                            any time. We do not currently have key personnel insurance
                            on any of our
                            officers or employees. The loss of any of our key personnel,
                            or the inability to
                            attract and retain qualified personnel, may significantly
                            delay or prevent the
                            achievement of our research, development or business
                            objectives and could
                            materially adversely affect our business, financial condition
                            and results of
                            operations.
 
 **We
                            rely on third parties to manufacture the compounds used
                            in our trials, and we
                            intend to rely on them for the manufacture of any approved
                            products for
                            commercial sale. If these third parties do not manufacture
                            our product
                            candidates in sufficient quantities and at an acceptable
                            cost, clinical
                            development and commercialization of our product candidates
                            could be delayed,
                            prevented or impaired.**
  We
                            have
                            no manufacturing facilities, and we have no experience
                            in the clinical or
                            commercial-scale manufacture of drugs or in designing
                            drug manufacturing
                            processes. Certain specialized manufacturers provide
                            us with modified and
                            unmodified pharmaceutical compounds, including finished
                            products, for use in our
                            preclinical and clinical studies. If we fail to contract
                            for manufacturing on
                            acceptable terms or if third-party manufacturers do not
                            perform as we expect,
                            our development programs could be materially adversely
                            affected. This may result
                            in delays in filing for and receiving FDA approval for
                            one or more of our
                            products. Any such delays could cause our prospects to
                            suffer
                            significantly.
  35
 *Index*
  We
                            intend
                            to rely on third parties to manufacture some or all of
                            our products that reach
                            commercialization. We believe that there are a variety
                            of manufacturers that we
                            may be able to retain to produce these products. However,
                            once we retain a
                            manufacturing source, if our manufacturers do not perform
                            in a satisfactory
                            manner, we may not be able to develop or commercialize
                            potential products as
                            planned.
 
 **Failure
                            by our third-party manufacturers to comply with the regulatory
                            guidelines set
                            forth by the FDA and DEA with respect to our product
                            candidates could delay or
                            prevent the completion of clinical trials, the approval
                            of any product
                            candidates or the commercialization of our products.**
  Our
                            reliance on third-party manufacturers exposes us to the
                            following additional
                            risks, any of which could delay or prevent the completion
                            of our clinical
                            trials, the approval of our product candidates by the
                            FDA or other regulatory
                            agencies or the commercialization of our products, result
                            in higher costs or
                            deprive us of potential product revenues:
 
 ·
                                  Manufacturers
                                      are obligated to operate in accordance with
                                      FDA-mandated current good
                                      manufacturing practice (cGMP) requirements.
                                      A failure of any of our
                                      third-party manufacturers to establish and
                                      follow cGMP requirements and to
                                      document their adherence to such practices
                                      may lead to significant delays
                                      in the availability of material for clinical
                                      trials, may delay or prevent
                                      filing or approval of marketing applications
                                      for our products, and may
                                      cause delays or interruptions in the availability
                                      of our products for
                                      commercial distribution following FDA
                                      approval.
 
 ·
                                  Replacing
                                      our third-party manufacturers or contracting
                                      with additional manufacturers
                                      may require re-validation of the manufacturing
                                      processes and procedures in
                                      accordance with cGMP and compliance with supplemental
                                      approval
                                      requirements. Any such necessary re-validation
                                      and supplemental approvals
                                      may be costly and time-consuming.
 
 Drug
                            manufacturers are subject to ongoing periodic unannounced
                            inspections by the
                            FDA, the DEA and corresponding state and foreign agencies
                            to ensure strict
                            compliance with cGMP requirements and other requirements
                            under Federal drug
                            laws, other government regulations and corresponding
                            foreign standards. If our
                            third-party manufacturers or we fail to comply with applicable
                            regulations,
                            sanctions could be imposed on us, including fines, injunctions,
                            civil penalties,
                            failure by the government to grant marketing approval
                            of drugs, delays,
                            suspension or withdrawal of approvals, seizures or recalls
                            of product, operating
                            restrictions and criminal prosecutions.
 
 **We
                            may need additional capital in the future. If additional
                            capital is not
                            available or is available at unattractive terms, we may
                            be forced to delay,
                            reduce the scope of or eliminate our research and development
                            programs, reduce
                            our commercialization efforts or curtail our operations.**
  In
                            order
                            to develop and bring our product candidates to market,
                            we must commit
                            substantial resources to costly and time-consuming research,
                            preclinical and
                            clinical trials and marketing activities. We anticipate
                            that our existing cash
                            and cash equivalents and short-term investments will
                            enable us to maintain our
                            current planned operations for at least the next 18 months.
                            We anticipate using
                            our cash and cash equivalents and short-term investments
                            to fund further
                            research and development with respect to our lead product
                            candidates and
                            commercialization activities. We may, however, need to
                            raise additional funding
                            sooner if our business or operations change in a manner
                            that consumes available
                            resources more rapidly than we anticipate. Our requirements
                            for additional
                            capital will depend on many factors, including:
 
 ·
                                  successful
                                      commercialization of our product candidates;
 
 ·
                                  continued
                                      progress of research and development of product
                                      candidates utilizing our
                                      Carrierwave technology;
 
 ·
                                  the
                                      time and costs involved in obtaining regulatory
                                      approval for our product
                                      candidates;
 
 ·
                                  costs
                                      associated with protecting our intellectual
                                      property
                                      rights;
 
 ·
                                  development
                                      of marketing and sales capabilities;
  36
 *Index*
  ·
                                  payments
                                      received under our collaboration agreements
                                      with Shire and any future
                                      collaborative agreements, if any;
                                      and
 
 ·
                                  market
                                      acceptance of our products.
 
 As
                            of
                            July 2, 2006, we have no committed additional sources
                            of capital. To the extent
                            our capital resources are insufficient to meet future
                            capital requirements, we
                            will need to raise additional funds to continue the development
                            of our product
                            candidates. To the extent we raise additional capital
                            through the sale of equity
                            securities, the issuance of those securities could result
                            in dilution to our
                            shareholders. In addition, if we obtain debt financing,
                            a substantial portion of
                            our operating cash flow may be dedicated to the payment
                            of principal and
                            interest on such indebtedness, thus limiting funds available
                            for our business
                            activities. If adequate funds are not available, we may
                            be required to delay,
                            reduce the scope of or eliminate our research and development
                            programs, reduce
                            our commercialization efforts or curtail our operations.
                            In addition, we may be
                            required to obtain funds through arrangements with collaborative
                            partners, such
                            as our agreements with Shire, or others that may require
                            us to relinquish rights
                            to technologies, product candidates or products that
                            we would otherwise seek to
                            develop or commercialize ourselves or license rights
                            to technologies, product
                            candidates or products on terms that are less favorable
                            to us than might
                            otherwise be available.
 
 **Even
                            if we obtain regulatory approval to market our product
                            candidates, our product
                            candidates may not be accepted by the market.**
  Even
                              if
                              we obtain regulatory approval to market our product
                              candidates, our product
                              candidates may not gain market acceptance among physicians,
                              patients, healthcare
                              payors and the medical community. The degree of market
                              acceptance of any
                              pharmaceutical product that we develop will depend
                              on a number of factors,
                              including:
 
 ·
                                    cost-effectiveness;
 
 ·
                                    the
                                        safety and effectiveness of our products,
                                        including any potential side
                                        effects, as compared to alternative products
                                        or treatment
                                        methods;
 
 ·
                                    the
                                        timing of market entry as compared to competitive
                                        products;
 
 ·
                                    the
                                        rate of adoption of our products by doctors
                                        and
                                        nurses;
 
 ·
                                    product
                                        labeling or product insert required by the
                                        FDA for each of our
                                        products;
 
 ·
                                    determination
                                        of scheduled or unscheduled status by the
                                        FDA and
                                        DEA;
 
 ·
                                    reimbursement
                                        policies of government and third-party
                                        payors;
 
 ·
                                    effectiveness
                                        of our sales, marketing and distribution
                                        capabilities and the
                                        effectiveness of such capabilities of our
                                        collaborative partners;
                                        and
 
 ·
                                    unfavorable
                                        publicity concerning our products or any
                                        similar
                                        products.
 
 Our
                              product candidates, if successfully developed, will
                              compete with a number of
                              products manufactured and marketed by major pharmaceutical
                              companies,
                              biotechnology companies and manufacturers of generic
                              drugs. Our products may
                              also compete with new products currently under development
                              by others.
                              Physicians, patients, third-party payors and the medical
                              community may not
                              accept and utilize any of our product candidates. Physicians
                              may not be inclined
                              to prescribe the drugs created utilizing our Carrierwave
                              technology unless our
                              drugs bring substantial and demonstrable advantages
                              over other drugs currently
                              marketed for the same indications. If our products
                              do not achieve market
                              acceptance, we will not be able to generate significant
                              revenues or become
                              profitable.
  37
 *Index*
  **If
                              we fail to establish marketing, sales and distribution
                              capabilities, or fail to
                              enter into arrangements with third parties to do this
                              on our behalf, we will not
                              be able to create a market for our product candidates.**
  Currently,
                              we do not have any sales, marketing or distribution
                              capabilities. On July 25,
                              2006, under the terms of our collaboration agreement
                              with Shire, we exercised
                              our right to co-promote NRP104 in the United States
                              (including its territories
                              and possessions). In order to generate sales of any
                              product candidates that
                              receive regulatory approval, we must either acquire
                              or develop an internal
                              marketing and sales force with technical expertise
                              and with supporting
                              distribution capabilities or make arrangements with
                              third parties to perform
                              these services for us. The acquisition or development
                              of a sales and
                              distribution infrastructure would require substantial
                              resources, which may
                              divert the attention of our management and key personnel
                              and defer our product
                              development efforts. To the extent that we enter into
                              marketing and sales
                              arrangements with other companies, our revenues will
                              depend on the efforts of
                              others. These efforts may not be successful. If we
                              fail to develop sales,
                              marketing and distribution channels, or enter into
                              arrangements with third
                              parties, we will experience delays in product sales
                              and incur increased
                              costs.
 
 **In
                              the event that we are successful in bringing any products
                              to market, our
                              revenues may be adversely affected if we fail to obtain
                              acceptable prices or
                              adequate reimbursement for our products from third-party
                              payors.**
  Our
                              ability to commercialize pharmaceutical products successfully
                              may depend in part
                              on the availability of reimbursement for our products
                              from:
 
 ·
                                    government
                                        and health administration authorities;
 
 ·
                                    private
                                        health insurers; and
 
 ·
                                    other
                                        third-party payors, including Medicare.
 
 We
                              cannot
                              predict the availability of reimbursement for newly
                              approved health care
                              products. Third-party payors, including Medicare, are
                              challenging the prices
                              charged for medical products and services. Government
                              and other third-party
                              payors increasingly are limiting both coverage and
                              the level of reimbursement
                              for new drugs. Third-party insurance coverage may not
                              be available to patients
                              for any of our products.
 
 The
                              continuing efforts of government and third-party payors
                              to contain or reduce the
                              costs of health care may limit our commercial opportunity.
                              If government and
                              other third-party payors do not provide adequate coverage
                              and reimbursement for
                              any prescription product we bring to market, doctors
                              may not prescribe them or
                              patients may ask to have their physicians prescribe
                              competing drugs with more
                              favorable reimbursement. In some foreign markets, pricing
                              and profitability of
                              prescription pharmaceuticals are subject to government
                              control. In the United
                              States, we expect that there will continue to be federal
                              and state proposals for
                              similar controls. In addition, we expect that increasing
                              emphasis on managed
                              care in the United States will continue to put pressure
                              on the pricing of
                              pharmaceutical products. Cost control initiatives could
                              decrease the price that
                              we receive for any products in the future. Further,
                              cost control initiatives
                              could impair our ability to commercialize our products
                              and our ability to earn
                              revenues from this commercialization.
 
 **We
                              could be forced to pay substantial damage awards if
                              product liability claims
                              that may be brought against us are successful.**
  The
                              use
                              of any of our product candidates in clinical trials,
                              and the sale of any
                              approved products, may expose us to liability claims
                              and financial losses
                              resulting from the use or sale of our products. We
                              have obtained limited product
                              liability insurance coverage for our clinical trials
                              of $20 million per
                              occurrence and in the aggregate, subject to a deductible
                              of $100,000 per
                              occurrence and $1 million per year in the aggregate.
                              However, such insurance may
                              not be adequate to cover any claims made against us.
                              Furthermore, if NRP104 is
                              approved for commercialization, we will need to obtain
                              additional product
                              liability insurance coverage. In addition, we may not
                              be able to maintain
                              insurance coverage at a reasonable cost or in sufficient
                              amounts or scope to
                              protect us against losses.
  38
 *Index*
  **We
                              use hazardous chemicals in our business. Potential
                              claims relating to improper
                              handling, storage or disposal of these chemicals could
                              be time-consuming and
                              costly.**
  Our
                              research and development processes involve the controlled
                              use of hazardous
                              chemicals. These hazardous chemicals are reagents and
                              solvents typically found
                              in a chemistry laboratory. Our operations also produce
                              hazardous waste products.
                              Federal, state and local laws and regulations govern
                              the use, manufacture,
                              storage, handling and disposal of hazardous materials.
                              While we attempt to
                              comply with all environmental laws and regulations,
                              including those relating to
                              the outsourcing of the disposal of all hazardous chemicals
                              and waste products,
                              we cannot eliminate the risk of accidental contamination
                              from or discharge of
                              hazardous materials and any resultant injury. Compliance
                              with environmental laws
                              and regulations may be expensive. Current or future
                              environmental regulations
                              may impair our research, development or production
                              efforts. We might have to pay
                              civil damages in the event of an improper or unauthorized
                              release of, or
                              exposure of individuals to, hazardous materials. We
                              are not insured against
                              these environmental risks.
 
 In
                              our
                              collaborations with third parties, they might also
                              work with hazardous materials
                              in connection with our collaborations. We may agree
                              to indemnify our
                              collaborators in some circumstances against damages
                              and other liabilities
                              arising out of development activities or products produced
                              in connection with
                              these collaborations.
 
 **If
                              Shire, our collaboration partner on NRP104, or any
                              other collaborative partners
                              we retain, do not satisfy their obligations, we will
                              be unable to develop our
                              partnered product candidates.**
  We
                              have
                              entered into collaborative agreements with Shire relating
                              to the global
                              commercialization of NRP104 for treatment of ADHD and
                              other potential
                              indications. This collaboration includes product development,
                              manufacturing,
                              marketing and sales. We do not have day-to-day control
                              over the activities of
                              Shire with respect to NRP104. In the event we enter
                              into any other collaborative
                              agreements, we may not have day-to-day control over
                              the activities of such
                              collaborative partner with respect to any of these
                              product candidates. Shire may
                              not fulfill its obligations with respect to commercialization
                              under our
                              collaboration with Shire. In addition, future collaborative
                              partners may not
                              fulfill their obligations under future collaborative
                              agreements. If any future
                              collaborative partner fails to fulfill its obligations
                              under an agreement with
                              us, we may be unable to assume the development of the
                              products covered by that
                              agreement or enter into alternative arrangements with
                              a third party. In
                              addition, if Shire or any other collaborative partner
                              fails to fulfill its
                              obligations under an agreement with us, we may encounter
                              delays in the
                              commercialization of the product candidate that is
                              the subject of the agreement.
                              Accordingly, our ability to receive any revenue from
                              the product candidates
                              covered by these agreements will be dependent on the
                              efforts of our
                              collaborative partner. We could also become involved
                              in disputes with Shire or
                              another collaborative partner, which could lead to
                              delays in or termination of
                              our development and commercialization programs and
                              time-consuming and expensive
                              litigation or arbitration. In addition, any such dispute
                              could diminish our
                              collaborators’ commitment to us and reduce the resources they devote
                              to
                              developing and commercializing our products. Conflicts
                              or disputes with our
                              collaborators, and competition from them, could harm
                              our relationships with our
                              other collaborators, restrict our ability to enter
                              future collaboration
                              agreements and delay the research, development or commercialization
                              of our
                              product candidates. If any collaborative partner terminates
                              or breaches its
                              agreement, or otherwise fails to complete its obligations
                              in a timely manner,
                              our chances of successfully developing or commercializing
                              these product
                              candidates would be materially and adversely affected.
                              We may not be able to
                              enter into other collaborative agreements with partners
                              on terms favorable to
                              us, or at all. Our inability to enter into collaborative
                              arrangements with
                              collaborative partners, or our failure to maintain
                              such arrangements, would
                              limit the number of product candidates that we could
                              develop and ultimately,
                              decrease our sources of any future revenues.
 
 **Our
                              indebtedness could adversely affect our financial health
                              and limit our ability
                              to react to changes in our industry or to implement
                              our strategic
                              initiatives.**
 
 After
                              the
                              private placement of the Notes, we had $135.0 million
                              of indebtedness
                              outstanding. Our indebtedness could have important
                              consequences to us. For
                              example, it could:
 
 ·
                                    require
                                        us to dedicate a substantial portion of our
                                        cash flow from operations to
                                        payments on our indebtedness, thereby reducing
                                        the availability of our
                                        cash flow to fund our business activities,
                                        including our research and
                                        development programs;
  39
 *Index*
  ·
                                    limit
                                        our ability to secure additional financing
                                        to implement our strategic
                                        initiatives;
 
 ·
                                    increase
                                        our vulnerability to general adverse economic
                                        and industry
                                        conditions;
 
 ·
                                    limit
                                        our flexibility in planning for, or reacting
                                        to, changes in our business
                                        and the industry in which we
                                        operate;
 
 ·
                                    place
                                        us at a disadvantage compared to our competitors
                                        that may have
                                        proportionately less debt; and
 
 ·
                                    restrict
                                        us from making strategic acquisitions, introducing
                                        new technologies or
                                        otherwise exploiting business
                                        opportunities.
 
 We
                              cannot
                              assure you that we will be able to generate sufficient
                              cash flow to pay the
                              interest on our debt, including the Notes, or that
                              future working capital,
                              borrowings or equity financing will be available to
                              pay or refinance any such
                              debt. In addition, holders of the Notes may require
                              us to purchase for cash all
                              or a portion of their Notes upon the occurrence of
                              certain specific kinds of
                              fundamental change events (as defined in the indenture
                              governing the Notes),
                              including a change in control of our company. We cannot
                              assure you that we will
                              have sufficient financial resources or be able to arrange
                              financing to pay the
                              repurchase price, including the related make whole
                              premium, upon the occurrence
                              of a fundamental change event. In addition, the requirement
                              to pay the
                              fundamental change repurchase price, including the
                              related make whole premium,
                              may discourage a change in control of our company.
 **The
                                convertible note hedge and warrant transactions may
                                affect the value of our
                                common stock.**
  On
                                July
                                25, 2006, in connection with the private placement
                                of our Notes, we entered into
                                convertible note hedge transactions and warrant transactions
                                with affiliates of
                                Merrill Lynch. These transactions are expected to
                                offset the potential dilution
                                upon conversion of the Notes. In connection with
                                hedging these transactions,
                                such affiliates of Merrill Lynch:
 
 ·
                                      will
                                          enter into various over-the-counter derivative
                                          transactions with respect
                                          to our common stock, and may purchase our
                                          common stock;
                                          and
 
 ·
                                      may
                                          enter into, or may unwind, various over-the-counter
                                          derivatives and/or
                                          purchase or sell our common stock in secondary
                                          market
                                          transactions.
 
 Such
                                activities could have the effect of increasing, or
                                preventing a decline in, the
                                price of our common stock. Such effect is expected
                                to be greater in the event we
                                elect to settle converted Notes entirely in cash.
                                The affiliates of Merrill
                                Lynch party to these transactions are likely to modify
                                their hedge positions
                                from time to time prior to conversion or maturity
                                of the Notes or termination of
                                the transactions by purchasing and selling shares
                                of our common stock, other of
                                our securities, or other instruments they may wish
                                to use in connection with
                                such hedging. In addition, we intend to exercise
                                options we hold under the
                                convertible note hedge transactions whenever Notes
                                are converted. In order to
                                unwind their hedge position with respect to those
                                exercised options, the
                                affiliates of Merrill Lynch party to these transactions
                                expect to sell shares of
                                our common stock in secondary market transactions
                                or unwind various
                                over-the-counter derivative transactions with respect
                                to our common stock during
                                the conversion reference period for the converted
                                Notes.
  The
                                effect, if any, of any of these transactions and
                                activities on the market price
                                of our common stock will depend in part on market
                                conditions and cannot be
                                ascertained at this time, but any of these activities
                                could adversely affect the
                                value of our common stock. In addition, in the event
                                that these transactions
                                fail to offset all of the dilution resulting from
                                the conversion of the Notes,
                                the issuance of additional shares of our common stock
                                as a consequence of such
                                conversion would result in some dilution to our shareholders
                                and could adversely
                                affect the value of our common stock.
  40
 *Index*
  **Certain
                                provisions of Virginia law, and our amended and restated
                                articles of
                                incorporation and amended and restated bylaws could
                                make it more difficult for
                                our shareholders to remove our Board and management.**
  Certain
                                provisions of Virginia law, the state in which we
                                are incorporated, and our
                                amended and restated articles of incorporation and
                                amended and restated bylaws
                                could make it more difficult for our shareholders,
                                should they choose to do so,
                                to remove our Board or management. These provisions
                                include:
 
 ·
                                      a
                                          provision allowing our Board to issue preferred
                                          stock with rights senior
                                          to those of the common stock without any
                                          vote or action by the holders of
                                          our common stock. The issuance of preferred
                                          stock could adversely affect
                                          the rights and powers, including voting
                                          rights, of the holders of common
                                          stock;
 
 ·
                                      a
                                          provision allowing the removal of directors
                                          only for
                                          cause;
 
 ·
                                      the
                                          requirement in our bylaws that shareholders
                                          provide advance notice when
                                          nominating our directors or submitting
                                          other shareholder proposals;
                                          and
 
 ·
                                      the
                                          inability of shareholders to convene a
                                          shareholders’ meeting without the
                                          chairman of the board, the chief executive
                                          officer or a majority of the
                                          Board first calling the meeting.
 
 **The
                                price of our common stock may be volatile.**
  In
                                the
                                past, the price of our common stock has experienced
                                volatility due to a number
                                of factors, some of which are beyond our control.
                                The price of our common stock
                                may continue to experience volatility in the future
                                from time to time. Among the
                                factors that could affect our stock price are:
 
 ·
                                      our
                                          operating and financial performance and
                                          prospects;
 
 ·
                                      announcement
                                          of FDA approval or disapproval of our products
                                          or other product-related
                                          actions;
 
 ·
                                      decisions
                                          by the DEA regarding the assignment of
                                          scheduling to our
                                          products;
 
 ·
                                      developments
                                          involving our discovery efforts and clinical
                                          trials;
 
 ·
                                      developments
                                          or disputes concerning patents or proprietary
                                          rights, including
                                          announcements of infringement, interference
                                          or other litigation against us
                                          or our potential licensees;
 
 ·
                                      developments
                                          involving our efforts to commercialize
                                          our products, including
                                          developments impacting the timing of
                                          commercialization;
 
 ·
                                      announcements
                                          concerning our competitors, or the biotechnology,
                                          pharmaceutical or drug
                                          delivery industry in general;
 
 ·
                                      public
                                          concerns as to the safety or efficacy of
                                          our products or our competitors’
                                          products;
 
 ·
                                      changes
                                          in government regulation of the pharmaceutical
                                          or medical
                                          industry;
 
 ·
                                      changes
                                          in the reimbursement policies of third
                                          party insurance companies or
                                          government agencies;
 
 ·
                                      actual
                                          or anticipated fluctuations in our operating
                                          results;
 
 ·
                                      developments
                                          involving corporate collaborators, if any;
 
 ·
                                      changes
                                          in accounting principles;
 
 ·
                                      the
                                          loss of any of our key scientific or management
                                          personnel;
  41
 *Index*
  ·
                                      quarterly
                                          variations in key financial performance
                                          measures, such as earnings per
                                          share, net income and revenue;
 
 ·
                                      changes
                                          in revenue or earnings estimates or publication
                                          of research reports by
                                          financial analysts;
 
 ·
                                      speculation
                                          in the press or investment community;
 
 ·
                                      strategic
                                          actions by us or our competitors, such
                                          as acquisitions or
                                          restructurings;
 
 ·
                                      sales
                                          of our common stock or other actions by
                                          investors with significant
                                          shareholdings;
 
 ·
                                      general
                                          market conditions for pharmaceutical companies;
                                          and
 
 ·
                                      domestic
                                          and international economic, legal, political
                                          and regulatory factors
                                          unrelated to our performance.
  The
                                stock
                                markets in general have experienced substantial volatility
                                that has often been
                                unrelated to the operating performance of particular
                                companies. These broad
                                market fluctuations may adversely affect the trading
                                price of our common stock.
 
 **Item
                                          2.**
                                      **Unregistered
                                          Sales of Equity
                                          Securities.**
 
 None.
 
 **Item3.**
                                      **Defaults
                                          Upon Senior Securities.**
 
 None.
 
 **Item4.**
                                      **Submission
                                          of Matters to a Vote of Securities
                                          Holders.**
 
 On
                                May 4,
                                2006, we had our Annual Meeting of Shareholders.
                                During that meeting
                                shareholders elected our entire Board of Directors.
                                The persons elected to our
                                Board of Directors, and the number of shares withheld
                                with respect to each of
                                these persons, were as follows:
 
 Votes
                                          For
                                      
                                      Votes
                                          WithheldCesar
                                          L. Alvarez
                                      
                                      
                                      35,177,227
                                      
                                      
                                      45,454David
                                          S. Barlow
                                      
                                      
                                      35,203,842
                                      
                                      
                                      18,839Larry
                                          D. Horner
                                      
                                      
                                      35,185,985
                                      
                                      
                                      36,696Randal
                                          J. Kirk
                                      
                                      
                                      34,936,462
                                      
                                      
                                      286,219Krish
                                          S. Krishnan
                                      
                                      
                                      35,069,856
                                      
                                      
                                      152,825Burton
                                          E. Sobel
                                      
                                      
                                      35,104,371
                                      
                                      
                                      118,310
  Our
                                shareholders also ratified the appointment of KPMG
                                LLP as our independent
                                registered accounting firm. The number of shares
                                cast in favor of the
                                ratification of KPMG LLP, the number against, and
                                the number abstaining were as
                                follows:
 
 For
                                      Against
                                      Abstain35,196,148
                                      16,071
                                      10,462
 
 There
                                were no broker non-votes for this ratification.
  **Item5.**
                                      **Other
                                          Information.**
 
 None.
 
 42
 *Index*
  **Item
                                          6.**
                                      **Exhibits**
 
 (a)
                                      Exhibits.
  Exhibit
                                  10.21 - Lease Agreement, dated June 19, 2006 by
                                  and between Virginia Tech Foundation, Inc. and
                                  New River Pharmaceuticals Inc.
  Exhibit
                                  31(a)- Certification pursuant to Rule 13a-14(a)
                                  under the Securities Exchange Act of 1934, as adopted
                                  pursuant to Section 302 of
                                  the Sarbanes-Oxley Act of 2002 by Randal J. Kirk
 
 Exhibit
                                  31(b) - Certification pursuant to Rule 13a-14(a)
                                  under the Securities Exchange Act of 1934, as adopted
                                  pursuant to Section 302 of
                                  the Sarbanes-Oxley Act of 2002 by Krish S. Krishnan
 
 Exhibit
                                  32(a) - Certification pursuant to 18 U.S.C.
                                  Section 1350, as adopted pursuant to Section 906
                                  of the Sarbanes-Oxley Act of
                                  2002 by Randal J. Kirk
 
 Exhibit
                                  32(b) - Certification pursuant to 18 U.S.C.
                                  Section 1350, as adopted pursuant to Section 906
                                  of the Sarbanes-Oxley Act of
                                  2002 by Krish S. Krishnan
  43
 *Index*
  **SIGNATURES**
 
 Pursuant
                                to the requirements of the Securities Exchange Act
                                of 1934, the registrant has
                                duly caused this report to be signed on its behalf
                                by the undersigned thereunto
                                duly authorized.
 
 **NEW
                                          RIVER PHARMACEUTICALS INC.**(Registrant)Date:
                                          August 8, 2006
                                      /s/
                                          Randal J. KirkRandal
                                          J. KirkChairman,
                                          President and Chief Executive Officer(Principal
                                          executive officer)Date:
                                          August 8, 2006
                                      /s/
                                          Krish S. KrishnanKrish
                                          S. KrishnanChief
                                          Operating Officer, Chief Financial Officer
                                          and
                                          Secretary(Principal
                                          financial and accounting
                                          officer)






44