**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 October 1, 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 Avenue
                Radford,
                  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
        November 6, 2006 there were 36,718,740 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 October 1, 2006**
 
 **INDEX**
  PagePART
                  I FINANCIAL INFORMATIONItem
                  1. Consolidated Financial Statements
                  (unaudited).
              2Consolidated
                  Balance Sheets October 1, 2006 and January 1,
                  2006Consolidated
                  Statements of Operations Three and nine months
                  ended October 1, 2006 and October 2, 2005Consolidated
                  Statements of Cash Flows Nine months ended
                  October 1, 2006 and October 2, 2005Notes
                  to Consolidated Financial StatementsItem
                  2. Management’s Discussion and Analysis of Financial
                  Condition and Results of Operations.
              17Item
                  3. Quantitative and Qualitative Disclosures About Market
                  Risk.
              28Item
                  4. Controls and Procedures.
              29PART
                  II OTHER INFORMATION
              30Item
                  1. Legal Proceedings.
              30Item
                  1A. Risk Factors.
              30Item
                  2. Unregistered Sales of Equity Securities and Use of
                  Proceeds.
              30Item
                  3. Defaults Upon Senior Securities.
              30Item
                  4. Submission of Matters to a Vote of Securities
                  Holders.
              30Item
                  5. Other Information.
              30Item
                  6. Exhibits.
              31SIGNATURES
              32
  *Index*
  **Item
                  1.**
              **Consolidated
                  Financial
                  Statements**
  **NEW
                  RIVER PHARMACEUTICALS INC. AND
                  SUBSIDIARY**
                **CONSOLIDATED
                  BALANCE SHEETS**
                **(Unaudited)****Assets**
              
              **October
                  1, 2006**
              
              **January
                  1, 2006**Current
                  assets:Cash
                  and cash equivalents
              
              $
              73,974,851
              
              $
              3,515,572Short-term
                  investments
              
              
              88,825,000
              
              
              49,250,000Other
                  receivables
              
              
              371,289
              
              
              135,755Prepaid
                  expenses and other current assets
              
              
              1,494,873
              
              
              798,090Total
                  current assets
              
              
              164,666,013
              
              
              53,699,417Property
                  and equipment:Leasehold
                  improvements
              
              
              99,644
              
              
              94,609Machinery
                  and equipment
              
              
              1,110,950
              
              
              819,472Construction
                  in progress
              
              
              301,689
              
              
              —1,512,283
              
              
              914,081Less
                  accumulated depreciation and amortization
              
              
              676,981
              
              
              653,427Property
                  and equipment, net
              
              
              835,302
              
              
              260,654Convertible
                  notes issuance costs
              
              
              4,414,620
              
              
              —Total
                  assets
              
              $
              169,915,935
              
              $
              53,960,071**Liabilities
                  and Shareholders’ Equity (Deficit)**Current
                  liabilities:Capital
                  lease obligation - current
              
              $
              24,252
              
              $
              22,298Accounts
                  payable
              
              
              7,743,639
              
              
              1,548,473Unpaid
                  and accrued research and development expenses
              
              
              8,406,226
              
              
              3,201,732Accrued
                  compensation
              
              
              2,254,728
              
              
              2,203,898Due
                  to affiliates
              
              
              174,460
              
              
              34,138Interest
                  payable
              
              
              879,566
              
              
              —Deferred
                  revenue - current
              
              
              8,178,482
              
              
              —Accrued
                  stock based compensation - current
              
              
              2,009,308
              
              
              —Total
                  current liabilities
              
              
              29,670,661
              
              
              7,010,539Capital
                  lease obligation - noncurrent
              
              
              8,707
              
              
              27,148Accrued
                  stock-based compensation
              
              
              7,194,806
              
              
              3,404,435Deferred
                  revenue
              
              
              59,970,988
              
              
              50,000,000Convertible
                  notes
              
              
              137,750,000
              
              
              —Total
                  liabilities
              
              
              234,595,162
              
              
              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 36,708,732 shares at October 1, 2006 and 36,367,064
                  shares
                  at January 1, 2006
              
              
              36,709
              
              
              36,367Additional
                  paid-in capital
              
              
              15,277,219
              
              
              63,326,824Accumulated
                  deficit
              
              
              (79,993,155
              )
              
              (69,845,242
              )Total
                  shareholders’ equity (deficit)
              
              
              (64,679,227
              )
              
              (6,482,051
              )Commitments
                  and contingenciesTotal
                  liabilities and shareholders’ equity (deficit)
              
              $
              169,915,935
              
              $
              53,960,071
 
 See
        accompanying notes to consolidated financial statements.
  2
 *Index*
  **NEW
                    RIVER PHARMACEUTICALS INC. AND
                    SUBSIDIARY**
                  
                  **CONSOLIDATED
                    STATEMENTS OF OPERATIONS****Three
                    months ended**
                
                **Nine
                    months ended****October
                    1,**
                  **2006**
                
                **October
                    2,**
                  **2005**
                
                **October
                    1,**
                  **2006**
                
                **October
                    2,**
                  **2005****(Unaudited)**
                
                **(Unaudited)**Collaboration
                    revenues
                
                $
                5,025,453
                
                $
                —
                
                $
                31,850,530
                
                $
                —Operating
                    costs and expenses:Selling,
                    general, and administrative
                
                
                6,224,842
                
                
                4,327,045
                
                
                19,720,602
                
                
                9,272,568Research
                    and development
                
                
                13,292,263
                
                
                5,247,036
                
                
                24,390,172
                
                
                14,072,247Depreciation
                    and amortization of property and equipment
                
                
                34,698
                
                
                41,562
                
                
                115,400
                
                
                116,378Total
                    operating expenses
                
                
                19,551,803
                
                
                9,615,643
                
                
                44,226,174
                
                
                23,461,193Operating
                    loss
                
                
                (14,526,350
                )
                
                (9,615,643
                )
                
                (12,375,644
                )
                
                (23,461,193
                )Other
                    income (expense):Loss
                    on disposal of fixed assets
                
                
                (10,226
                )
                
                —
                
                
                (10,226
                )
                
                —Interest
                    expense
                
                
                (993,897
                )
                
                (1,633
                )
                
                (996,428
                )
                
                (3,487
                )Interest
                    income
                
                
                1,921,871
                
                
                515,814
                
                
                3,945,282
                
                
                1,336,552Total
                    other income, net
                
                
                917,748
                
                
                514,181
                
                
                2,938,628
                
                
                1,333,065Loss
                    before cumulative effect of change in accounting principle
                
                
                (13,608,602
                )
                
                (9,101,462
                )
                
                (9,437,016
                )
                
                (22,128,128
                )Cumulative
                    effect of a change in accounting principle
                
                
                —
                
                
                —
                
                
                (710,897
                )
                
                —Net
                    loss
                
                $
                (13,608,602
                )
                $
                (9,101,462
                )
                $
                (10,147,913
                )
                $
                (22,128,128
                )Net
                    loss per share: Basic and diluted
                
                $
                (0.38
                )
                $
                (0.25
                )
                $
                (
                    0.28
                )
                $
                (0.62
                )
 
 See
        accompanying notes to consolidated financial statements.
  3
 *Index*
  
 **NEW
                  RIVER PHARMACEUTICALS INC. AND
                  SUBSIDIARY**
                **CONSOLIDATED
                  STATEMENTS OF CASH FLOWS**
                **(Unaudited)****Nine
                  months ended****October
                  1, 2006**
              
              **October
                  2, 2005**Cash
                  flows from operating activities:Cumulative
                  effect of change in accounting principle
              
              
              710,897
              
              
              —Net
                  loss
              
              $
              (10,147,913
              )
              $
              (22,128,128
              )Adjustments
                  to reconcile net income (loss) to net cash provided by operating
                  activities:Depreciation
                  and amortization of property and equipment
              
              
              115,400
              
              
              116,378Amortization
                  of convertible notes issuance cost
              
              
              117,308
              
              
              —Loss
                  on disposal of fixed assets
              
              
              10,226
              
              
              —Stock-based
                  compensation
              
              
              5,937,237
              
              
              2,485,869Changes
                  in operating assets and liabilities:Other
                  receivables
              
              
              (235,534
              )
              
              —Prepaid
                  expenses and other current assets
              
              
              (696,783
              )
              
              (864,966
              )Accounts
                  payable
              
              
              5,724,277
              
              
              517,202Unpaid
                  and accrued research and development expenses
              
              
              5,204,494
              
              
              (132,098
              )Accrued
                  compensation
              
              
              50,829
              
              
              319,120Due
                  to affiliates
              
              
              140,322
              
              
              34,918Interest
                  payable
              
              
              879,566
              
              
              —Accrued
                  stock-based compensation
              
              
              5,088,783
              
              
              (44,057
              )Deferred
                  revenue
              
              
              18,149,470
              
              
              50,000,000Net
                  cash provided by operating activities
              
              
              31,048,579
              
              
              30,304,238Cash
                  flows from investing activities:Proceeds
                  from sale of short-term investments
              
              
              56,925,000
              
              
              53,075,000Purchases
                  of short-term investments
              
              
              (96,500,000
              )
              
              (86,700,000
              )Proceeds
                  from sale of property and equipment
              
              
              —
              
              
              91Purchases
                  of property and equipment
              
              
              (229,385
              )
              
              (75,611
              )Net
                  cash used in investing activities
              
              
              (39,804,385
              )
              
              (33,700,520
              )Cash
                  flows from financing activities:Principal
                  payments on capital lease obligation
              
              
              (16,487
              )
              
              (14,338
              )Proceeds
                  from issuance of warrants
              
              
              29,478,500
              
              
              —Prepaid
                  forward purchase of Company stock
              
              
              (41,000,000
              )
              
              —Proceeds
                  from convertible notes offering, net of issuance costs
              
              
              133,218,072
              
              
              —Purchase
                  of convertible note hedges
              
              
              (43,529,000
              )
              
              —Net
                  proceeds from issuances of common stock
              
              
              1,064,000
              
              
              1,115,656Net
                  cash provided by financing activities
              
              
              79,215,085
              
              
              1,101,318Net
                  increase (decrease) in cash and cash equivalents
              
              
              70,459,279
              
              
              (2,294,964
              )Cash
                  and cash equivalents at beginning of period
              
              
              3,515,572
              
              
              4,018,556Cash
                  and cash equivalents at end of period
              
              $
              73,974,851
              
              $
              1,723,592
  See
        accompanying notes to consolidated financial statements
  4
 *Index*
  **NEW
        RIVER PHARMACEUTICALS INC.**
  **AND
        SUBSIDIARY**
 **NOTES
        TO CONSOLIDATED FINANCIAL STATEMENTS**
 **Three
        and nine months ended October 1, 2006 and October 2, 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
        October 1, 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 Company’s most advanced product
        candidate is NRP104, a conditionally bioreversible derivative (CBD) of
        d-amphetamine. On October 6, 2006, the Company received an approvable letter
        from the U.S. Food and Drug Administration (FDA) with respect to NRP104 for
        the
        treatment of Attention-Deficit/Hyperactivity Disorder (ADHD). The Company’s most
        advanced product candidate in development is NRP290, a CBD of hydrocodone.
        NRP104 and NRP290 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 October 1, 2006 and
        for
        the three and nine months ended October 1, 2006 and October 2, 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 on December 31,
        2006.
  5
 *Index*
  *(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 $18,160,662 and $55,785,815, respectively,
        at October 1, 2006 and $299,264 and $3,155,253, respectively, at January
        1,
        2006.
  *(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
        October 1, 2006 and January 1, 2006, the Company’s short-term investments
        consisted of $88,825,000 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 October
        1,
        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 FDA or other regulatory body for
        production, the Company did not have any inventory at October 1, 2006 and
        January 1, 2006.
  Effective
        May 18, 2006, the Company entered into an Active Pharmaceutical Ingredient
        Supply Agreement with Organichem Corporation (Organichem) for the non-exclusive
        manufacture and supply of NRP104 by Organichem for the Company. Under the
        terms
        of this 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 $3.2 million.
  Effective
        August 18, 2006, the Company entered into a Manufacturing Services Supply
        Agreement with Patheon Pharmaceuticals Inc. (Patheon) for the non-exclusive
        manufacture and supply of NRP104 capsules by Patheon for the
        Company.   Under the terms of this agreement, Patheon 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 October 2006, purchase
        orders in the total amount of approximately $906,000 were issued to Patheon
        under this agreement. The Company issued a purchase order in the amount of
        approximately $370,000 for manufacture of the validation batches and a purchase
        order in the amount of approximately $536,000 for commercial batches for
        commercial launch.
 
 *(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.
  6
 *Index*
  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.
  *(g)*
              *Revenue
                  Recognition, Cost of Goods Sold and Sales
                  Returns*
  Although
        at October 1, 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 October 1, 2006, the Company
        had
        research and development commitments with third parties totaling approximately
        $33,905,000 of which approximately $12,974,000 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 options
        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.
  7
 *Index*
  Stock-based
        compensation expense recognized under SFAS 123(R) in the consolidated statements
        of operations for the three and nine-month periods ended October 1, 2006
        for all
        awards was approximately $5,034,000 and $11,026,000, 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 nine-month periods ended October
        2,
        2005:
  Three
                  months ended October 2, 2005
              
              Nine
                  months ended October 2, 2005Net
                  loss:As
                  reported
              
              $
              (9,101,462
              )
              $
              (22,128,128
              )Add
                  stock-based employee compensation expense included in reported
                  net loss,
                  net of related tax effects
              
              
              321,124
              
              
              414,311Deduct
                  total stock-based employee compensation expense determined under
                  fair-value-based method for all awards, net of related tax
                  effects
              
              
              (209,584
              )
              
              (2,349,179
              )Pro
                  forma
              
              $
              (8,989,922
              )
              $
              (24,062,996
              )Net
                  loss per share:Basic
                  and diluted:As
                  reported
              
              $
              (0.25
              )
              $
              (0.62
              )Pro
                  forma
              
              $
              (0.25
              )
              $
              (0.67
              )
 
 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 nine months ended October 1, 2006, was $16.26
        and
        $20.12, respectively, on the date of grant. The per share weighted average
        fair
        value of SARs to be settled in common stock granted during the nine months
        ended
        October 1, 2006 was $18.06 on the date of grant. There were no SARs granted
        during the three months ended October 1, 2006. However, on August 24, 2006,
        the
        Board approved the modification of certain of the outstanding options and
        SARs
        by accelerating the vesting of such awards. This modification resulted in
        the
        majority of such awards being treated for accounting purposes as new awards.
        Accordingly, the awards were measured on the date of the modification as
        follows: (i) expense that was recognized on the initial grant of the awards
        through the date of the modification was reversed and (ii) the fair value
        of the
        award on the modification date was expensed in full because these awards
        were
        fully vested at that date. The total stock-based compensation expense recognized
        for awards for which vesting was accelerated was approximately $3.7 million
        for
        the three months ended October 1, 2006. For all SARs to be settled in cash,
        which are classified as liabilities, the per share weighted average fair
        market
        value was $12.07 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:
  8
 *Index*
  Expected
                  dividend yield
              
              
              0
              %Risk-free
                  interest rate
              
              
              4.08%
                  - 5.06
              %Expected
                  life of options
              
              
              5.5
                  - 6.5 yearsExpected
                  life of SARs
              
              
              0
                  - 5 yearsExpected
                  volatility
              
              
              70
              %
 
 *(j)*
              *Net
                  Loss Per Share*
  Basic
        net
        loss per share excludes dilution and is computed by dividing net loss by
        the
        weighted average number of shares of common stock outstanding for the period.
        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 8).
  *(k)*
              *Reclassifications*
  Certain
        reclassifications have been made to the consolidated financial statements
        for
        the three and nine months ended October 2, 2005, to place them on a basis
        comparable to the consolidated financial statements for the three and nine
        months ended October 1, 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 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 $5.0 million and $31.9 million of collaboration
        revenue
        for the three and nine months ended October 1, 2006, respectively, based
        on this
        model. The amount recognized during the nine months ended October 1, 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 nine months ended October 1, 2006 until FDA approval
        for
        NRP104 is obtained.
  9
 *Index*
  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. In the event that NRP104 is approved with
        a
        Schedule III, IV or V classification or is unscheduled (“favorable scheduling”),
        the Company and Shire will divide operating profits as follows: the Company
        will
        receive 25% of profits for the first two years following launch, and the
        Company
        and Shire will share the profits equally thereafter. However, in the event
        that
        NRP104 receives a final Schedule II classification, the Shire Agreement allows
        for an alternative profit-sharing scheme. Under this scenario, the Company’s
        share of U.S. product profits for the first two years will be at least 25%,
        though it may increase to a value determined by a preset formula. After the
        first two years, it will be at least 50%, though it may increase to a value
        determined by a preset formula. ****On
        October 6, 2006, the Company received an approvable letter from the FDA for
        30mg, 50mg and 70mg capsules of NRP104. According to the FDA, marketing approval
        of NRP104 is contingent upon final scheduling by the DEA. The FDA did not
        request any additional studies as a condition for approval of NRP104. The
        approvable letter indicates that the Controlled Substance Staff of the FDA
        has
        initially recommended that NRP104 be placed in Schedule II of the Controlled
        Substance Act. 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.
  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 October 1, 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. 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. During October 2006, the Company executed its right to terminate
        each
        of these agreements.
  (4)
              **CONVERTIBLE
                    NOTES**
  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 and on August 7, 2006, the Initial Purchasers exercised
        in
        part their over-allotment option and purchased an additional $10.0 million
        and
        $2.75 million, respectively, aggregate principal amount of the notes (the
        Option
        Notes and together with the Initial Notes, the Notes). The Initial Purchaser’s
        remaining option to purchase up to an additional $6.0 million aggregate
        principal amount of the Notes to cover over-allotments expired unexercised
        on
        August 7, 2006. The net proceeds from the offering (including the proceeds
        from
        the exercise of $12.75 million of the over-allotment option) after deducting
        the
        Initial Purchasers’ discount of $4.1 million and the offering expenses payable
        by the Company, were approximately $133.2 million.
  10
 *Index*
  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 closing of the sale of the additional $2.75 million of Notes
        for
        the second partial exercise of the overallotment option was on August 10,
        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.
 
 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.
 
 11
 *Index*
 
 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). The Dealer may deliver the shares
        pursuant to the Forward Purchase Contract at its discretion, in full or in
        part,
        over a period of seven years from the date of the contract. Shares purchased
        pursuant to the Forward Purchase Contract are treated as retired for purposes
        of
        the Company’s basic and diluted earnings per share calculations. 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, 4,005,816 shares of common stock at
        strike
        prices which correspond to the initial conversion prices of the Notes. The
        Company used $43,529,000 of the proceeds from the sale of the Notes to purchase
        the Purchased Call Options. The net cost of the convertible note hedges are
        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, 4,005,816 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 $29,478,500 from the sale of the Sold Warrants. The
        net
        proceeds from the warrants are recorded in shareholders’ equity.
 
 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.
 
 12
 *Index*
 
 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. When the average market price of the
        Company’s common stock for the applicable reporting period exceeds the strike
        price of the Sold Warrants, potential shares issuable pursuant to the Sold
        Warrants will be dilutive and will be included in the Company’s diluted earnings
        per share calculation.
 
 **(5)**
              **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).
  **(6)**
              **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 October 1, 2006.
  **(7)**
              **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. The current monthly rental is $6,210. 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
        agreement may be terminated upon written notice at any time by the Company.
        During August 2006, the Company exercised one year options under both the
        lease
        and administrative services agreements. The Company recognized approximately
        $120,000 and $299,000 of expense under the administrative services and lease
        agreements for the three and nine months ended October 1, 2006 and approximately
        $108,000 and $358,000 for the three and nine months ended October 2, 2005,
        respectively. The unpaid portion of these amounts is included in Due to
        Affiliates in the accompanying consolidated balance sheets as of October
        1, 2006
        and January 1, 2006.
  **(8)**
              **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:
  13
 *Index*
  **Net
                  income (loss)****(numerator)**
              
              **Shares****(denominator)**
              
              **Per
                  share****amount**Three
                  month period ended October 2, 2005:Basic
                  net (loss) per share
              
              $
              (9,101,462
              )
              
              36,063,634
              
              $
              (0.25
              )Effect
                  of dilutive securities
              
              
              —
              
              
              —Diluted
                  net (loss) per share
              
              $
              (9,101,462
              )
              
              36,063,634
              
              $
              (0.25
              )Three
                  month period ended October 1, 2006:Basic
                  net (loss) per share
              
              $
              (13,608,602
              )
              
              35,561,269
              
              $
              (0.38
              )Effect
                  of dilutive securiities
              
              
              —
              
              
              —Diluted
                  net (loss) per share
              
              $
              (13,608,602
              )
              
              35,561,269
              
              $
              (0.38
              )Nine
                  month period ended October 2, 2005:Basic
                  net (loss) per share
              
              $
              (22,128,128
              )
              
              35,820,410
              
              $
              (0.62
              )Effect
                  of dilutive securities
              
              
              —
              
              
              —Diluted
                  net (loss) per share
              
              $
              (22,128,128
              )
              
              35,820,410
              
              $
              (0.62
              )Nine
                  month period ended October 1, 2006:Basic
                  net (loss) per share
              
              $
              (10,147,913
              )
              
              36,229,409
              
              $
              (0.28
              )Effect
                  of dilutive securities
              
              
              —
              
              
              —Diluted
                  net income (loss) per share
              
              $
              (10,147,913
              )
              
              36,229,409
              
              $
              (0.28
              )
 
 For
        the
        three and nine months ended October 1, 2006 and October 2, 2005, 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, which totaled 696,668 and 895,973 for the three and nine
        months ended October 1, 2006, respectively, were not included in the computation
        of diluted net loss per share because to do so would have been anti-dilutive.
  **(9)**
              **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.
  14
 *Index*
 Stock
          option activity for the nine months ended October 1, 2006, was as
          follows:
 **Number
                  of shares**
              
              **Weighted
                  average exercise price**Balance
                  at January 1, 2006
              
              
              1,216,836
              
              
              6.50Granted
              
              
              193,000
              
              
              31.12Exercised
              
              
              (341,668
              )
              
              3.11Expired
                  or Forfeited
              
              
              (43,000
              )
              
              29.12Balance
                  at October 1, 2006
              
              
              1,025,168
              
              
              11.32
 
 At
        October 1, 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
              
              
              206,633
              
              $
              1.28
              
              
              5.43
              
              
              164,959
              
              $
              1.28$3.33- $4.00
              
              
              360,867
              
              $
              3.91
              
              
              7.37
              
              
              245,867
              
              $
              3.86$7.11-11.60
              
              
              164,668
              
              $
              11.47
              
              
              8.47
              
              
              160,000
              
              $
              11.60$22.31 - $26.17
              
              
              158,000
              
              $
              23.27
              
              
              9.12
              
              
              -
              
              $
              -$28.67
                  - $33.55
              
              
              135,000
              
              $
              32.32
              
              
              9.36
              
              
              -
              
              $
              -
 
 Aggregate
        intrinsic value of options outstanding and options exercisable at October
        1,
        2006 was approximately $13.9 million and $11.7 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 $25.73
        as of
        September 29, 2006, and the exercise price multiplied by the number of options
        outstanding. The aggregate intrinsic value of stock options exercised during
        the
        three and nine months ended October 1, 2006 was $40,949 and $9.3 million,
        respectively.
  As
        of
        October 1, 2006, there was approximately $3.1 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 18.9
        months.
  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. On August 24, 2006, in recognition of employee performance, the
        Board
        approved a modification to certain of the SARs to be settled in common stock
        and
        in cash by accelerating the vesting to fully vested status. In the case of
        SARs
        to be settled in common stock upon the exercise of the SARs, the two year
        holding requirement was waived.
  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 of $1,056,000 and $5,086,000 related to the SARs to be settled in
        cash
        during the three and nine months ended October 1, 2006, respectively and
        $2,351,000 and $2,917,000 related to SARs to be settled in common stock during
        the three and nine months ended October 1, 2006, respectively,.
  15
 *Index*
  Aggregate
        intrinsic value of outstanding SARs to be settled in cash and in common stock
        at
        October 1, 2006 was $13,160,000 and $4,387,000, respectively. Aggregate
        intrinsic value of vested SARs to be settled in cash and in common stock
        at
        October 1, 2006 was $1,755,000 and $1,755,000, respectively.
  As
        of
        October 1, 2006, there was approximately $8.2 million and $2.4 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 18.8 and 41.3 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.
  **(10)**
              **CONTINGENCIES**
  From
        time
        to time, the Company may become involved in 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.
  **(11)**
              **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.
  **(12)**
              **RECENT
                  ACCOUNTING PRONOUNCEMENTS**
  In
        September 2006, the Financial Accounting Standards Board (“FASB”) issued SFAS
        No. 157, *Fair
        Value Measurements* (“SFAS
        No. 157”). SFAS No. 157 establishes a common definition for fair value
        to be applied to GAAP guidance requiring use of fair value, establishes a
        framework for measuring fair value, and expands disclosure about such fair
        value
        measurements. SFAS No. 157 is effective for fiscal years beginning after
        November 15, 2007. The Company is currently assessing the impact of SFAS
        No. 157 on its consolidated financial position and results of operations.
  16
 *Index*
  In
        September 2006, the SEC staff issued Staff Accounting Bulletin No. 108, *Considering
        the Effects of Prior Year Misstatements when Quantifying Misstatements in
        Current Year Financial Statements* (“SAB
        108”). SAB 108 establishes an approach that requires quantification of financial
        statement misstatements based on the effects of
        the
        misstatements on each of the Company’s financial statements and the related
        financial statement disclosures. SAB 108 is effective for the year ending
        December 31, 2006. The Company is currently evaluating the impact
        of SAB 108
        on its consolidated financial position and results of operations and does
        not
        anticipate the impact to be material to its financial statements.
  **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;
  ·
              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.
  17
 *Index*
  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 our Quarterly Report on Form 10-Q for
        the quarter ended July 2, 2006, filed on August 8, 2006, with the SEC. 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.
 
 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 actives 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.
 
 NRP104
        (lisdexamfetamine dimesylate), our most advanced compound, is a CBD of *d-* amphetamine,
        a stimulant widely used to treat ADHD. NRP104 is a new chemical entity in
        which
        d-amphetamine is covalently linked to l-lysine, a naturally occurring amino
        acid. Studies indicate that NRP104 remains inactive until converted in the
        body
        and the active, d-amphetamine, is gradually released. We developed NRP104
        as a
        once-a-day medication to provide efficacy throughout the day up to 6 p.m.
        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.
 
 18
 *Index*
 
 On
        September 12, 2006, we announced that the desired safety and efficacy endpoints
        were met in our NRP104.302 study, a long-term, open-label and single-arm
        study
        of NRP104 in doses of 30mg, 50mg or 70mg per day in pediatric patients diagnosed
        with ADHD. A total of 293 patients with ADHD were enrolled in this multi-center
        trial, the results of which were submitted to the FDA.
 
 On
        October 6, 2006 we received an approvable letter from the FDA for 30mg, 50mg
        and
        70mg capsules of NRP104 for the treatment of ADHD in children aged 6 - 12.
        According to the FDA, marketing approval of NRP104 is contingent upon final
        scheduling by the U.S. Drug Enforcement Administration (DEA). The FDA did
        not
        request any additional studies as a condition for approval of NRP104. The
        approvable letter indicates that the Controlled Substance Staff of the FDA
        has
        initially recommended that NRP104 be placed in Schedule II of the Controlled
        Substance Act (CSA). Under the CSA, the scheduling recommendation of FDA
        and of
        its parent agency, the Department of Human and Health Services (DHHS), is
        required to be transmitted to the DEA, which initiates and ultimately completes
        the formal scheduling process under the CSA, including publication of a proposed
        and final scheduling action in the Federal Register.
 
 On
        October 24, 2006, we submitted our responses to the FDA to address questions
        and
        clarifications raised by the FDA in the approvable letter. Pending
        final labeling discussions and a scheduling assignment from the DEA, we are
        preparing for a product launch in the second quarter of 2007.
 
 In
        May
        2006, we initiated a pivotal phase 3 clinical trial for NRP104 for the treatment
        of ADHD in adult populations. On September 12, 2006 we announced that the
        enrollment numbers have been met for the NRP104.303 study, which will examine
        the safety and efficacy of NRP104 as a treatment for ADHD in adult populations
        (ages 18-52). We anticipate filing a supplemental new drug application (NDA)
        on
        three doses of NRP104 (30mg, 50mg, and 70mg) for the treatment of ADHD in
        adult
        populations in the second quarter of 2007.
 
 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.
 
 On
        October 13, 2006, we met with the FDA for our End of Phase II Meeting with
        respect to NRP290 and obtained the FDA’s input with respect to the clinical and
        non clinical studies required to support the filing of the NDA application
        on
        NRP290.
 
 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 believe that by reducing the variability of the
        hormone’s availability, while reducing the safety risk associated with other T3
        based therapies, NRP409 may 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 anticipate commencing clinical studies
        on
        NRP409 in the first quarter of 2007. 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.
 
 19
 *Index*
 
 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. In October 2006,
        we
        terminated this program to focus on internal pipeline projects based on our
        Carrierwave technology.
  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. In October 2006, we terminated this program to focus on internal
        pipeline projects based on our Carrierwave technology.
  During
        the quarter ended October 1, 2006, we sold $137,750,000 aggregate principal
        amount of 3.5% convertible subordinated notes due 2013 (Notes) to qualified
        institutional buyers in a private placement pursuant to Rule 144A under the
        Securities Act of 1933, as amended. 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 $43,529,000 to cover, subject to customary
        anti-dilution adjustments, 4,005,816 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 $29,478,500
        to acquire 4,005,816 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 $41.0 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. To date there have been no purchases under the program.
  Throughout
        our history, we have incurred significant losses. We may incur additional
        losses
        for our fiscal year ending December 31, 2006. As of October 1, 2006, we had
        an
        accumulated deficit of approximately $80.0 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.
  *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.
  20
 *Index*
  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 nine months
        ended October 1, 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 October 1, 2006**
              
              **Nine
                  months ended October 1, 2006**
              
              **Inception
                  to**
                **October
                  1, 2006****(in
                  thousands)**NRP104
              
              $
              6,737
              
              $
              13,070
              
              $
              32,849NRP290
              
              
              743
              
              
              957
              
              
              2,896NRP409
              
              
              438
              
              
              1,067
              
              
              1,233Other
                  preclinical development
              
              
              22
              
              
              353
              
              
              1,144Carrierwave/thyroid
              
              
              —
              
              
              —
              
              
              5,488Total
              
              $
              7,940
              
              $
              15,447
              
              $
              43,610
 
 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.
  21
 *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 primarily of interest on
        the
        Notes.
  *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 October 1, 2006 Compared to Three Months Ended October 2,
        2005**
  *Revenues.* During
        the three months ended October 1, 2006, we recognized approximately $5,025,000
        of revenue from our collaboration agreement with Shire. Such amount represents
        the revenue recognition of certain non-refundable payments received over
        the
        related performance period of the deliverables under the collaboration
        agreement.
  *Selling,
        General and Administrative Expenses.* Selling,
        general and administrative expenses increased by $1,898,000, or 44%, to
        $6,225,000 for the three months ended October 1, 2006 from $4,327,000 for
        the
        three months ended October 2, 2005. This increase was primarily attributed
        to
        approximately $3,190,000 of shared marketing expenses with Shire in accordance
        with the collaboration agreements, net of a decrease of approximately $710,000
        in stock-based compensation expense. Stock-based compensation expense for
        the
        three months ended October 1, 2006 was $1,036,000 and represented the cost
        related to stock options and SARs granted to certain executives and management
        personnel that is being recognized in accordance with SFAS 123(R) over the
        vesting period of such options and SARs. Stock-based compensation expense
        for
        the three months ended October 2, 2005 was $1,746,000 and related to SARs
        prior
        to the adoption of SFAS 123(R).
  *Research
        and Development Expenses.* Research
        and development expenses increased $8,045,000, or 153%, to $13,292,000 for
        the
        three months ended October 1, 2006 from $5,247,000 for the three months ended
        October 2, 2005. Increases in external development costs and stock-based
        compensation primarily accounted for this increase. The increase in external
        development costs was approximately $4,287,000. This increase is due to
        manufacturing costs of validation batches of NRP104 as such costs are not
        capitalized prior to receipt of regulatory approval and an increase in external
        development work associated with NRP409. Stock-based compensation increased
        approximately $3,631,000 and is associated with the modification of certain
        SARs
        and outstanding options that accelerated vesting in recognition of an employee’s
        performance. Stock-based compensation expense for the three months ended
        October
        1, 2006 was $3,998,000 and represents the cost related to SARs and options
        granted to research and development personnel that is being recognized in
        accordance with SFAS 123(R) over the vesting period of such SARs and options.
        Stock-based compensation expense for the three months ended October 2, 2005
        was
        $367,000 and related to SARs prior to the adoption of SFAS 123(R).
  22
 *Index*
  The
        following table shows the aggregate changes in our research and development
        expenses.
  **Three
                  Months Ended****Research
                  and development expenses**
              
              **October
                  1, 2006**
              
              **October
                  2, 2005****(in
                  thousands)**Direct
                  project costs:Personnel,
                  benefits and related costs
              
              $
              5,002
              
              $
              1,017Consultants,
                  supplies, materials and other direct costs
              
              
              204
              
              
              486External
                  development costs
              
              
              7,940
              
              
              3,653Total
                  direct costs
              
              
              13,146
              
              
              5,156Indirect
                  costs
              
              
              146
              
              
              91Total
              
              $
              13,292
              
              $
              5,247
 
 *Other
        Income.* For
        the
        three months ended October 1, 2006, other income included approximately
        $1,922,000 of interest income earned primarily from investing the proceeds
        received pursuant to the collaboration agreement with Shire and the proceeds
        received from our Notes, net of interest expense on the Notes subsequent
        to
        issuance. Other income for the three months ended October 2, 2005 included
        approximately $516,000 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 agreement.
  **Nine
        Months Ended October 1, 2006 Compared to Nine Months Ended October 2,
        2005**
  *Revenues.* During
        the nine months ended October 1, 2006, we recognized approximately $31,850,000
        of revenue from our collaboration agreement with Shire. Such amount represents
        the revenue recognition of certain non-refundable payments received over
        the
        related performance period of the deliverables under the collaboration
        agreement.
  *Selling,
        General and Administrative Expenses.* Selling,
        general and administrative expenses increased by $10,448,000, or 113%, to
        $19,721,000 for the nine months ended October 1, 2006 from $9,273,000 for
        the
        nine months ended October 2, 2005. This increase was primarily attributed
        to an
        increase of approximately $7,378,000 of shared marketing expenses with Shire
        under the collaboration agreements and an increase in stock-based compensation
        expense of $3,777,000, primarily associated with the adoption of SFAS 123(R).
        Stock-based compensation expense for the nine months ended October 1, 2006,
        was
        $5,821,000 and represents the cost related to stock options and SARs granted
        to
        certain executives and management personnel that is being recognized in
        accordance with SFAS 123(R) over the vesting period of such options and SARs.
        Stock-based compensation expense for the nine months ended October 2, 2005
        was
        $2,044,000 and related to SARs prior to the adoption of SFAS 123(R). These
        increases were partially offset by a $1,500,000 fee incurred and paid to
        an
        investment banking firm during the nine months ended October 2, 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 $10,318,000, or 73%, to $24,390,000 for
        the
        nine months ended October 1, 2006 from $14,072,000 for the nine months ended
        October 2, 2005. Increases in external development expenses and stock-based
        compensation primarily accounted for this increase. External development
        increased $4,709,000. This increase is due to manufacturing costs of validation
        batches of NRP104 as such costs are not capitalized prior to receipt of
        regulatory approval and an increase in external development work associated
        with
        NRP409. Stock-based compensation increased approximately $4,763,000 and is
        associated with the adoption of SFAS 123(R). Stock-based compensation expense
        for the nine months ended October 1, 2006 was $5,205,000 and represents the
        cost
        related to SARs and options granted to research and development personnel
        that
        is being recognized in accordance with SFAS 123(R) over the vesting period
        of
        such SARs and options. Stock-based compensation expense for the nine months
        ended October 2, 2005 was $442,000 and related to SARs prior to the adoption
        of
        SFAS 123(R).
  23
 *Index*
  The
        following table shows the aggregate changes in our research and development
        expenses.
  **Nine
                  Months Ended****Research
                  and development expenses**
              
              **October
                  1, 2006**
              
              **October
                  2, 2005****(in
                  thousands)**Direct
                  project costs:Personnel,
                  benefits and related costs
              
              $
              7,933
              
              $
              2,020Consultants,
                  supplies, materials and other direct costs
              
              
              636
              
              
              962External
                  development costs
              
              
              15,447
              
              
              10,738Total
                  direct costs
              
              
              24,016
              
              
              13,720Indirect
                  costs
              
              
              374
              
              
              352Total
              
              $
              24,390
              
              $
              14,072
 
 *Other
        Income.* For
        the
        nine months ended October 1, 2006, other income included approximately
        $3,945,000 of interest income earned primarily from investing the proceeds
        received pursuant to the collaboration agreement with Shire and the proceeds
        received from our Notes, net of interest expense on the Notes subsequent
        to
        issuance. Other income for the nine months ended October 2, 2005 included
        approximately $1,337,000 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 agreement.
  **Liquidity
        and Capital Resources**
  Our
        operations from 2001 through October 1, 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, $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, and $137,750,000 of gross proceeds from our Notes
        offering in July 2006 (including the overallotment option that was exercised
        on
        August 7, 2006), 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
                
                
                —
                
                
                —
                
                
                50,000,0002006
                    - Convertible notes
                
                
                —
                
                
                —
                
                
                137,750,00019,785,920
                
                
                
                
                $
                288,632,401
 __________________
  (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
        October 1, 2006, we had cash and cash equivalents of $73,975,000 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 $88,825,000 and $49,250,000 at October
        1,
        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.
  24
 *Index*
 
 Cash
        provided by operations was $31,049,000 for the nine months ended October
        1, 2006
        compared to $30,304,000 for the nine months ended October 2, 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
        $39,804,000 for the nine months ended October 1, 2006 compared to $33,701,000
        for the nine months ended October 2, 2005. The increase is due to the net
        change
        in activity in short-term investments. Net proceeds provided by financing
        activities was $79,215,000 for the nine months ended October 1, 2006 compared
        to
        $1,101,000 for the nine months ended October 2, 2005. This increase is due
        to
        proceeds of approximately $133,218,000, net of issuance costs, received from
        our
        Notes offering and proceeds of approximately $29,478,000 received from the
        issuance of warrants to purchase our common stock. These receipts were offset
        by
        proceeds used to purchase convertible note hedges for $43,529,000 and proceeds
        used to purchase the Company’s common stock under a prepaid forward purchase
        contract for $41,000,000.
  The
        following table summarizes our contractual obligations at October 1, 2006
        and
        the effects such obligations are expected to have on our liquidity and cash
        flows in future periods.
  **Total**
              
              **Due
                  within 1 year**
              
              **Due
                  1 to 5 years**
              
              **Thereafter****(in
                  thousands)**Operating
                  lease obligations
              
              $
              319
              
              $
              319
              
              $
              —
              
              $
              —Capital
                  lease obligations
              
              
              33
              
              
              24
              
              
              9
              
              
              —Research
                  and development contracts
              
              
              21,380
              
              
              21,380
              
              
              —
              
              
              —Inventory
                  purchase commitments
              
              
              3,156
              
              
              3,156
              
              
              —
              
              
              —Interest
                  payments on convertible notes
              
              
              33,825
              
              
              5,684
              
              
              24,106
              
              
              4,035Convertible
                  notes
              
              
              137,750
              
              
              —
              
              
              —
              
              
              137,750Total
                  contractual cash obligations
              
              $
              196,463
              
              $
              30,563
              
              $
              24,115
              
              $
              141,785
 
 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.
  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.
        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
        October 1, 2006, our long-term contractual obligations consisted of our Notes
        and 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
        until construction for the final up-fit of the facilities begins. At such
        time,
        rent will be charged on a pro-rated basis, based on the specific area of
        the
        facilities for which construction has begun. During August 2006, construction
        began on certain areas of the facilities for which the pro-rated rent was
        approximately $7,000 per month. **** Rent for
        the new facilities will require monthly payments of approximately $23,668
        month
        once construction commences on all areas. We maintain an operating lease
        agreement with Third Security for offices occupied by certain of our executive
        and administrative staff. The lease was initially for 24 months and expired
        in
        August 2006. We renewed this lease for the first of three one-year periods
        in
        August 2006 under terms similar to the initial terms. The currently monthly
        rental is $6,210. We also have in-progress research and development contracts
        performed by third parties. As of October 1, 2006, we had commitments, which
        consist primarily of external development work, with third parties totaling
        approximately $33,905,000 of which approximately $8,406,000 was accrued at
        October 1, 2006 and $12,974,000 had not yet been incurred.
  25
 *Index*
  Effective
        May 18, 2006, we entered into an Active Pharmaceutical Ingredient Supply
        Agreement with Organichem Corporation (Organichem) for the non-exclusive
        manufacture and supply of NRP104 by Organichem for us. Under the terms of
        this
        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,
        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 $3,156,000.
  Effective
        August 18, 2006, the Company entered into a Drug Product Supply Agreement
        with
        Patheon Pharmaceuticals Inc. (Patheon) for the non-exclusive manufacture
        and
        supply of NRP104 capsules by Patheon for the Company.   Under the
        terms of this agreement, Patheon 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 October 2006, purchase orders in the total amount
        of approximately $906,000 were issued to Patheon under this agreement. The
        Company issued a purchase order in the amount of approximately $370,000 for
        manufacture of the validation batches and a purchase order in the amount
        of
        approximately $536,000 for commercial batches for commercial launch.  Since
        these purchase orders were issued in October 2006, they are excluded from
        the
        table above.
 
 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 agreement 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.
  26
 *Index*
  **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.
  **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.
  27
 *Index*
  *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.
  *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 nine months ended
        October 1, 2006 and October 2, 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
        October 1, 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 4 - Convertible Notes) 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 in connection
        with
        our issuance of $137,750,000 of Notes.
  28
 *Index*
  **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 October 1, 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 October 1, 2006 that has materially affected, or is reasonably
        likely to materially affect, our internal control over financial
        reporting.
  29
 *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**
 
 While
        we
        attempt to identify, manage and mitigate risks and uncertainties associated
        with
        our business to the extent practical under the circumstances, some level
        of risk
        and uncertainty will always be present. Item 1A of Quarterly Report on Form
        10-Q
        for the quarter ended July 2, 2006 describes some of the risks and uncertainties
        associated with our business. These risks and uncertainties have the potential
        to materially affect our operating results of our business and our financial
        condition. We do not believe that there have been any material changes to
        the
        risk factors previously disclosed in our Quarterly Report on Form 10-Q for
        the
        quarter ended July 2, 2006.
  **Item
                  2.**
              **Unregistered
                  Sales of Equity Securities and Use of
                  Proceeds**
  (c)
        Issuer purchases of equity securities (1)
  **Period**
              **Total
                  Number of Shares Purchased**
              **Average
                  Price Paid per Share**
              **Total
                  Number of Shares Purchased as Part of Publicly Announced Plans
                  or
                  Programs**
              **Approximate
                  Dollar Value that May Yet Be Purchased Under the Plans or
                  Programs**July
                  3, 2006 through August 1, 2006
              1,490,367
                  (1)
              $27.51
              1,490,367
              $10,000,000August
                  2, 2006 through September 1, 2006
              **_**
              **_**
              **_**
              $10,000,000September
                  2, 2006 through October 1, 2006
              **_**
              **_**
              **_**
              $10,000,000(1)In
                  connection with the sale of the Notes in July 2006, 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.
 
  **Item
                  3.**
              **Defaults
                  Upon Senior
                  Securities.**
  None.
 
 **Item
                  4.**
              **Submission
                  of Matters to a Vote of Securities
                  Holders.**
  None.
  **Item
                  5.**
              **Other
                  Information.**
  30
 *Index*
  The
        following disclosure would otherwise have been filed on Form 8-K under the heading
        “Item 1.01 - Entry into a Material Definitive Agreement”.
 
 Effective
        August 18, 2006, the Company entered into a Manufacturing Services Agreement
        (the Manufacturing Agreement) with Patheon Pharmaceuticals Inc. (Patheon)
        for
        the non-exclusive manufacture and supply of NRP104 capsules by Patheon for
        the
        Company.   Under the terms of the Manufacturing Agreement, Patheon 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 October 2006, purchase
        orders in the total amount of approximately $906,000 were issued to Patheon
        under the Manufacturing Agreement . The Company issued a purchase order in
        the
        amount of approximately $370,000 for manufacture of the validation batches
        and a
        purchase order in the amount of approximately $536,000 for commercial batches
        for commercial launch. A copy of the Manufacturing Agreement is attached
        hereto
        as Exhibit 10.23, and is incorporated herein by reference.
 
 
 **Item
                  6.**
              **Exhibits**
  (a)
              Exhibits.
  Exhibit
                  10.23* - Manufacturing Services Agreement
                  between Patheon Pharmaceuticals, Inc and New River Pharmaceuticals
                  Inc.,
                  dated as of August 18, 2006.
  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
  ____________________
  *
        Certain
        portions of this exhibit have been omitted intentionally, subject to a
        confidential treatment request. A complete version of this exhibit has been
        filed separately with the Securities and Exchange Commission.
  31
 *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:
                  November 9, 2006
              /s/
                  Randal J. KirkRandal
                  J. KirkChairman,
                  President and Chief Executive Officer(Principal
                  executive officer)
  
 Date:
                  November 9, 2006
              /s/
                  Krish S. KrishnanKrish
                  S. KrishnanChief
                  Operating Officer, Chief Financial Officer and
                  Secretary(Principal
                  financial and accounting
                  officer)




32