**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 April 3, 2005**





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 report), and (2) has been subject to such filing requirements for
the past 90 days. Yes: x No o





Indicate
by check mark whether the registrant is an accelerated filer (as defined in
Exchange Act Rule 12b-2).


Yes: o No: x





As of May
10, 2005, there were 17,890,204 shares of the registrant’s common stock, $.001
par value per share, outstanding.







**NEWRIVER PHARMACEUTICALS INC.**


**FORM
10-Q**


**FOR
THE QUARTERLY PERIOD ENDED APRIL 3, 2005**





**INDEX**


**Page****PART
      I FINANCIAL INFORMATION**
    **1****Item
      1.   Consolidated Financial
      Statements.**
    **1**Consolidated Balance Sheets April 3, 2005 (unaudited) and
      January 2, 2005Consolidated Statements of Operations Three months ended
      April 3, 2005 and March 28, 2004 (unaudited)Consolidated Statements of Cash Flows Three months ended
      April 3, 2005 and March 28, 2004 (unaudited)Notes to Consolidated Financial Statements
      (unaudited)**Item
      2.   Management’s Discussion and Analysis
      of Financial Condition and Results of
    Operations.**
    **14****Item
      3.   Quantitative and Qualitative Disclosures
      About Market Risk.**
    **24****Item
      4.   Controls and
      Procedures.**
    **24****PART
      II OTHER INFORMATION**
    **25****Item
      1.   Legal
      Proceedings.**
    **25****Item
      2.   Unregistered Sales of Equity Securities
      and Use of Proceeds.**
    **25****Item
      3.   Defaults Upon Senior
      Securities.**
    **25****Item
      4.   Submission of Matters to a Vote of
      Securities Holders.**
    **25****Item
      5.   Other
      Information.**
    **26****Item
      6.   Exhibits and Reports on Form
      8-K.**
    **26****SIGNATURES**
    **28**




(i)
 *Index*




**PART I**








**Item
      1.**
    **Consolidated
      Financial Statements.**





**NEW RIVER PHARMACEUTICALS INC. AND
      SUBSIDIARY**
      
      **CONSOLIDATED
      BALANCE SHEETS****Assets**
    
    **April
      3, 2005**
    
    **January
      2, 2005**Current
      assets:
    
    (Unaudited)Cash
      and cash equivalents
    
    $
    14,600,027
    
    $
    4,018,556Short-term
      investments
    
    
    52,479,724
    
    
    21,174,747Prepaid
      expenses
    
    
    220,718
    
    
    315,644Total
      current assets
    
    
    67,300,469
    
    
    25,508,947Property
      and equipment:Leasehold
      improvements
    
    
    94,609
    
    
    76,860Machinery
      and equipment
    
    
    723,766
    
    
    686,895818,375
    
    
    763,755Less
      accumulated depreciation and amortization
    
    
    538,070
    
    
    502,890Property
      and equipment, net
    
    
    280,305
    
    
    260,865Total
      assets
    
    $
    67,580,774
    
    $
    25,769,812**Liabilities
      and Shareholders’ Equity**Current
      liabilities:Accounts
      payable
    
    $
    665,348
    
    $
    701,175Unpaid
      and accrued research and development expenses
    
    
    1,408,294
    
    
    2,100,421Accrued
      compensation
    
    
    461,793
    
    
    1,506,413Due
      to affiliates
    
    
    141,922
    
    
    76,920Total
      current liabilities
    
    
    2,677,357
    
    
    4,384,929Accrued
      stock-based compensation
    
    
    14,311
    
    
    —Deferred
      revenue
    
    
    50,000,000
    
    
    —Total
      liabilities
    
    
    52,691,668
    
    
    4,384,929Shareholders’
      Equity: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 17,830,204 shares at April 3, 2005 and 17,774,554 shares
      at January 2, 2005
    
    
    17,831
    
    
    17,775Additional
      paid-in capital
    
    
    61,522,429
    
    
    61,346,030Accumulated
      deficit
    
    
    (46,651,154
    )
    
    (39,978,922
    )Total
      shareholders’ equity
    
    
    14,889,106
    
    
    21,384,883Commitments
      and contingenciesTotal
      liabilities and shareholders’ equity
    
    $
    67,580,774
    
    $
    25,769,812





See
      accompanying notes to consolidated financial
statements.




*Index*




**NEW RIVER PHARMACEUTICALS INC. AND
      SUBSIDIARY**
      
      **CONSOLIDATED
      STATEMENTS OF OPERATIONS****Three
      months ended****April
      3, 2005**
    
    **March
      28, 2004****(Unaudited)**Sales,
      net
    
    $
    —
    
    $
    —Operating
      costs and expenses:Selling,
      general, and administrative
    
    
    3,175,281
    
    
    686,658Research
      and development
    
    
    3,784,215
    
    
    1,108,258Depreciation
      and amortization of property and equipment
    
    
    35,180
    
    
    30,543Total
      operating expenses
    
    
    6,994,676
    
    
    1,825,459Operating
      loss
    
    
    (6,994,676
    )
    
    (1,825,459
    )Other
      income (expense):Interest
      expense
    
    
    —
    
    
    (8,455
    )Interest
      income
    
    
    322,444
    
    
    541Total
      other income (expense), net
    
    
    322,444
    
    
    (7,914
    )Net
      loss
    
    $
    (6,672,232
    )
    $
    (1,833,373
    )Net loss per
      share:Basic
      and diluted
    
    $
    (0.38
    )
    $
    (0.15
    )




2
 *Index*




**NEWRIVER PHARMACEUTICALS INC. AND
      SUBSIDIARY**
      
      **CONSOLIDATED
      STATEMENTS OF CASH FLOWS****Three
      months ended****April
      3,**
      **2005**
    
    **March
      28,**
      **2004****(Unaudited)**Cash
      flows from operating activities:Net
      loss
    
    $
    (6,672,232
    )
    $
    (1,833,373
    )Adjustments
      to reconcile net loss to net cash provided by (used in) operating
      activities:Depreciation
      and amortization of property and equipment
    
    
    35,180
    
    
    30,543Stock-based
      compensation
    
    
    19,081
    
    
    —Contribution
      of services by related party
    
    
    —
    
    
    182,077Changes
      in operating assets and liabilities:Prepaid
      expenses
    
    
    94,926
    
    
    (13,652
    )Due
      from affiliates
    
    
    —
    
    
    (2,221
    )Accounts
      payable
    
    
    (35,827
    )
    
    34,912Unpaid
      and accrued research and development expenses and other accrued
      expenses
    
    
    (692,127
    )
    
    2,549Accrued
      compensation
    
    
    (1,044,620
    )
    
    (13,879
    )Due
      to affiliates
    
    
    65,002
    
    
    8,455Deferred
      revenue
    
    
    50,000,000
    
    
    —Net
      cash provided by (used in) operating activities
    
    
    41,769,383
    
    
    (1,604,589
    )Cash
      flows from investing activities:Proceeds
      from sale of short-term investments
    
    
    14,200,000
    
    
    —Purchases
      of short-term investments
    
    
    (45,504,977
    )
    
    —Proceeds
      from sale of property and equipment
    
    
    —
    
    
    7,545Purchases
      of property and equipment
    
    
    (54,620
    )
    
    (4,200
    )Net
      cash provided by (used in) investing activities
    
    
    (31,359,597
    )
    
    3,345Cash
      flows from financing activities:Proceeds
      from notes payable to shareholder
    
    
    —
    
    
    1,400,000Net
      proceeds from issuances of common stock
    
    
    171,685
    
    
    —Net
      cash provided by financing activities
    
    
    171,685
    
    
    1,400,000Net
      increase (decrease) in cash and cash equivalents
    
    
    10,581,471
    
    
    (201,244
    )Cash
      and cash equivalents at beginning of period
    
    
    4,018,556
    
    
    264,393Cash
      and cash equivalents at end of period
    
    $
    14,600,027
    
    $
    63,149





See
      accompanying notes to consolidated financial
statements.




3
 *Index*


**NEW RIVER PHARMACEUTICALS INC.**


**AND
SUBSIDIARY**





**NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS**





**Three
months ended April 3, 2005 and March 28, 2004**


(Unaudited)





**(1)**
    **ORGANIZATION
      AND NATURE OF BUSINESS**





*(a)*
    *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
April 3, 2005, Lotus Bermuda no longer held any 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.





*(b)*
    *Nature
      of Business*





The
Company is a specialty pharmaceutical company focused on developing safer and
improved versions of widely-prescribed drugs in large and growing markets.
Utilizing its proprietary Carrierwave TM technology, the Company is developing versions of amphetamines and opioids that
are designed to provide overdose protection, abuse resistance and less potential
for addiction while providing efficacy comparable to the active pharmaceutical
ingredients on which they are based.





**(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 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 April 3, 2005 and for the three months
ended April 3, 2005 and March 28, 2004 is unaudited but includes all adjustments
(consisting only of normal recurring adjustments) which, 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 2, 2005, included in
the Company’s annual report on Form 10-K filed with the SEC.


4
 *Index*


*(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 thirteen
weeks except during years that include 53 weeks. In such years, the fourth
quarter will include 14 weeks. Fiscal year 2004 includes 53 weeks and ended on
January 2, 2005. Fiscal year 2005 includes 52 weeks and ends January 1,
2006.





*(c)*
    *Cash
      and Cash Equivalents*





For
purposes of the consolidated statements of cash flows, the Company considers all
highly liquid debt instruments purchased with an original maturity of three
months or less to be cash equivalents. At April 3, 2005, cash equivalents
consisted of commercial paper and money market accounts of $12,348,243 and
$2,348,982, respectively. At January 2, 2005 cash equivalents consisted of money
market accounts of $22,759.





*(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
April 3, 2005 and January 2, 2005, the Company’s short-term investments of
$52,479,724 and $21,174,747, respectively, consisted 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 their variable interest rates, which typically reset every 28 to 35 days, and
the fact that, despite the long-term nature of their stated contractual
maturities, the Company has the ability to liquidate readily these
securities. As a result, the Company had no cumulative gross unrealized gains
(losses) from its investments in these securities at April 3, 2005 and January
2, 2005. All income generated from these investments is recorded as interest
income. Short-term investments include accrued interest of $79,724 and $24,747
at April 3, 2005 and January 2, 2005, respectively.





*(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. Since the Company does not currently have any products on the market,
nor any products currently approved by the Food and Drug Administration or other
regulatory body for production, the Company does not have any inventory at April
3, 2005 or January 2, 2005.





*(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. Due to the Company’s history of losses,
no income tax benefit has been recorded and the corresponding deferred tax
assets have been fully reserved as the Company believes that it is more likely
than not that the deferred tax assets will not be realized.


5
 *Index*


*(g)*
    *Revenue
      Recognition*





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. Additionally,
pursuant to the guidance of Securities and Exchange Commission Staff Accounting
Bulletin 104 (“SAB 104”), unless evidence suggests otherwise, revenue from
consideration received is recognized on a straight-line basis over the expected
term of the arrangements. 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 considers 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 April 3, 2005, the Company had
research and development commitments with third parties totaling approximately
$16,944,000, of which approximately $9,662,000 had not yet been incurred. The
commitments are cancelable by the Company at any time upon written notice.


6
 *Index*


*(i)*
    *Stock-Based
      Compensation*





The
Company applies the intrinsic-value-based method of accounting prescribed by
Accounting Principles Board (APB) Opinion No. 25, *Accounting
for Stock Issued to Employees* , and
related interpretations, including Financial Accounting Standards Board (FASB)
Interpretation No. 44 (FIN 44), *Accounting
for Certain Transactions Involving Stock Compensation, an interpretation of APB
Opinion No. 25* , and FIN
28, *Accounting
for Stock Appreciation Rights and Other Variable Stock Option or Award Plans,* to
account for its fixed-plan stock options and stock appreciation rights (SARs),
including stock options granted to non-employee members of the Board of
Directors. Under this method, compensation expense is recorded for stock options
on the date of grant only if the current market price of the underlying stock
exceeded the exercise price. For SARs, compensation expense is recorded over the
vesting period based on the difference between the market value of the Company’s
common stock at the end of the current reporting period and the exercise price
of the SARs. SARs to be settled in cash are recorded as a liability and SARs to
be settled with common stock are recorded as additional paid in capital. SFAS
No. 123, *Accounting
for Stock-Based Compensation* ,
established accounting and disclosure requirements using a fair-value-based
method of accounting for stock-based employee compensation plans. As allowed by
SFAS No. 123, the Company has elected to continue to apply the
intrinsic-value-based method of accounting described above, and has adopted only
the disclosure requirements of SFAS No. 123, as amended by SFAS No. 148, *Accounting
for Stock-Based Compensation—Transition and Disclosure, an amendment of SFAS No.
123* .





In
December 2004, the FASB issued Statement of Financial Accounting
Standards (SFAS) No. 123 (revised 2004), “Share-Based Payment,” (SFAS
No. 123(R)). SFAS No. 123(R) requires companies to expense the grant-date
fair value of employee stock options over the vesting period. SFAS No. 123(R) is
effective for the first fiscal year beginning after June 15, 2005; however,
early adoption is encouraged. The Company has not yet adopted this standard and
is currently evaluating the expected impact of adoption on its consolidated
financial position, results of operations and cash flows, including the specific
transition method to be utilized upon adoption. It is anticipated that the
adoption of SFAS No. 123(R) will negatively impact the Company’s
earnings.





The
following table illustrates the effect on net loss if the fair-value-based
method had been applied to all outstanding and unvested awards in each
period.





**Three
      months ended****April
      3, 2005**
    
    **March
      28, 2004**Net
      loss:As
      reported
    
    $
    (6,672,232
    )
    $
    (1,833,373
    )Add
      stock-based employee compensation expense included in reported net loss,
      net of related tax effects
    
    
    —
    
    
    —Deduct
      total stock-based employee compensation expense determined under
      fair-value-based method for all awards, net of related tax
      effects
    
    
    (1,923,583
    )
    
    (44,981
    )Pro
      forma
    
    $
    (8,595,815
    )
    $
    (1,878,354
    )Net
      loss per share:Basic
      and diluted:As
      reported
    
    $
    (0.38
    )
    $
    (0.15
    )Pro
      forma
    
    $
    (0.48
    )
    $
    (0.15
    )





The per
share weighted average fair value of stock options granted during the three
months ended April 3, 2005 of $18.31 was determined on the date of grant
utilizing the Black-Scholes option pricing model. There were no stock options
granted during the three months ended March 28, 2004. The following weighted
average assumptions were used in the Black-Scholes model:


7
 *Index*




**Three
      months**
      **ended**
      **April
      3, 2005**Expected
      dividend yield
    0%Risk-free
      interest rate
    4.61%Expected
      life of awards
    10
      yearsExpected
      volatility
    70%





Because
the determination of the fair value of all options granted after the Company
became a publicly traded entity includes an expected volatility factor and
because additional option grants are expected in the future, the pro forma
disclosures above are not representative of the pro forma effects of option
grants on reported net operating results in future years.





*(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 reflects the potential dilution that would occur if
securities or other contracts to issue common stock were exercised or converted
into common stock or resulted in the issuance of common stock that then shared
in the net loss of the Company (see note 7).





*(k)*
    *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.





*(l)*
    *Reclassifications*





Certain
reclassifications have been made to the consolidated financial statements for
the three months ended March 28, 2004 to place them on a basis comparable to the
consolidated financial statements for the three months ended April 3, 2005.





**(3)**
    **COLLABORATION
      ARRANGEMENT**





On
January 31, 2005, the Company entered into a collaboration agreement with Shire
Pharmaceuticals Group plc (Shire) relating to the global commercialization of
NRP104 for treatment of attention deficit hyperactivity disorder (ADHD) and
other potential indications. On March 31, 2005, the Company and Shire split this
agreement into two agreements by entering into a United States Collaboration
Agreement and an ROW Territory License Agreement (the Shire Agreements) to
replace the initial collaboration agreement. The collaboration includes product
development, manufacturing, marketing and sales. Under the terms of the
collaboration, Shire paid the Company an upfront fee of $50 million on February
11, 2005, which could be refundable to Shire in certain circumstances. The
Company has recorded the $50 million upfront payment as deferred revenue in the
consolidated balance sheet at April 3, 2005.


8
 *Index*


The Shire
Agreements also provide for additional payments to the Company in the event that
certain milestones are achieved. These potential payments include an additional
$50 million on acceptance of the NDA filing by the FDA and an amount of up to
$300 million 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
collaboration is $505 million. In addition to the upfront and milestone
payments, the Shire Agreements provide for profit sharing on U.S. product sales
when and if the product is approved by the FDA. Shire will retain 75% of
profits, as defined, for the first two years following the launch of the product
and the parties will share the profits equally thereafter. For product sales in
the rest of the world, Shire will pay the Company a royalty. The Shire
Agreements provide for certain termination rights. Shire may for instance
terminate the Shire Agreements at any time prior to receiving regulatory
approval in the U.S., 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 Agreements under the laws of the U.S. or European
Union.





**(4)**
    **LIQUIDITY
      AND INITIAL PUBLIC OFFERING**





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).





In
February and March 2004, the Company received a total of $1,400,000 and in April
2004, the Company received $50,000 from Kirkfield, L.L.C., a related party, in
exchange for a series of promissory demand notes. These notes, along with an
additional promissory demand note issued in exchange for $350,000 received from
Kirkfield, L.L.C. in February 2003, were due, along with accrued interest at the
prime rate, upon demand of the holder or in the event of default (as defined) by
the Company. On March 26, 2004, the Company entered into a Subscription
Agreement with New River Management III, LP (the Fund), an affiliated private
equity fund, pursuant to which the Company agreed to sell, and the Fund agreed
to purchase 453,333 shares of the Company’s common stock on or before April 9,
2004, 156,667 shares on or before May 10, 2004, 150,000 shares on or before June
9, 2004, and 150,000 shares on or before July 12, 2004 at $5.00 per share. On
April 16, 2004, the Company repaid the outstanding balances of the notes payable
to Kirkfield, L.L.C., totaling $1,800,000 plus accrued interest, using a portion
of the $2,266,665 proceeds received from the sale of common stock to the Fund,
which was originally due on April 9, 2004 and which was received on April 14,
2004. The proceeds from the May 10, 2004, June 9, 2004 and July 12, 2004 stock
issuances totaled $783,335, $750,000 and $750,000, respectively, and were
received on May 14, 2004, June 10, 2004 and July 12, 2004, respectively. On May
3, 2004, the Company also issued 60,000 shares of common stock to a member of
the Board of Directors of the Company and received proceeds of $300,000 from
this sale. The Company also issued 5,000 stock options to the same member of the
Board of Directors on May 3, 2004. The stock options vested immediately
and had an exercise price of $5.00 per share.


9
 *Index*


In
connection with the sales of 970,000 shares of common stock and the issuance of
5,000 stock options at $5.00 per share described in the previous paragraph, the
Company recorded $1,386,000 of stock-based compensation expense during the
fiscal year ended January 2, 2005. This expense represents the difference
between the sales price of $5.00 per share and the estimated fair value of the
common stock on the various dates of issuance, which was $5.72 for the shares
and options issued on April 14, 2004, May 3, 2004 and May 14, 2004 and $8.00 for
shares issued on June 10, 2004 and July 12, 2004.





On April
23, 2004, the Company entered into a credit agreement with Randal J. Kirk (2000)
Limited Partnership (the Partnership), an entity controlled by the Company’s
current Chairman, President and Chief Executive Officer, Randal J. Kirk. Under
the terms of the credit agreement, the Partnership provided an irrevocable line
of credit to the Company for up to the principal amount of $5,000,000. The
proceeds from the credit line were to be used by the Company for general working
capital and operating expenses. Amounts advanced to the Company under this
credit agreement were to bear interest at 12% and payments made by the Company
were to be applied first to any accrued interest. This credit agreement expired
in accordance with its terms on August 10, 2004, which was the completion of the
initial public offering of the Company’s common stock. The Company made no
borrowings under this credit agreement during the time it was in
effect. ****





In April
2004, the Board of Directors (the Board) authorized the Company to file a
registration statement with the SEC covering the proposed sale by the Company of
its common stock to the public. On June 25, 2004, the Board approved, subject to
shareholder approval, the amendment and restatement of the Company’s Articles of
Incorporation to provide for, among other things, an increase in the number of
authorized shares of common stock and preferred stock to 150,000,000 shares and
25,000,000 shares, respectively, and a one-for-two reverse stock split of the
Company’s common stock. All references in the consolidated financial statements
to shares of common stock, common stock options, common stock prices and per
share of common stock amounts have been adjusted retroactively for all periods
presented to reflect this reverse stock split. On August 10, 2004, the Company
completed the initial public offering of its common stock in which the Company
sold 4,200,000 shares of common stock at $8.00 per share resulting in gross
proceeds of $33.6 million. In connection with this offering, the Company paid
approximately $2.4 million in underwriting discounts and commissions and
incurred estimated other offering expenses of approximately $1.2 million. The
net proceeds from the offering were approximately $30 million.


10
 *Index*


**(5)**
    **ROYALTY
      OBLIGATIONS**





Effective
June 30, 2004, the Company entered into an agreement (the  Innovative
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 Agreement provided 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
Agreement) for a period of 10 years for up to a total of $1 million, whichever
comes first.





**(6)**
    **RELATED
      PARTY TRANSACTIONS**





Through
August 10, 2004, the date of the completion of the Company’s initial public
offering, Third Security, LLC (Third Security), an entity controlled by the
Company’s current Chairman, President and Chief Executive Officer, Randal J.
Kirk, provided to the Company accounting, finance, information technology, human
resources, legal and executive management services at no charge to the Company.
For the three months ended March 28, 2004, the Company recorded the estimated
cost of these services of $182,000 as selling, general and administrative
expenses and as a contribution to additional paid-in capital. Management
estimated the cost of these services based on the actual compensation of the
individuals performing the work multiplied by an estimated percentage of the
individual’s time allocated to services performed for the Company. Management
believes that this method is a reasonable approximation of the cost of these
services. Management also believes that it is not practicable to estimate the
cost for these services that would have been incurred if the Company had
operated as an unaffiliated entity for the three months ended March 28, 2004.





Effective
upon the completion of the Company’s initial public offering on August 10, 2004,
the Company executed an administrative services agreement with Third Security,
pursuant to which Third Security has continued to provide certain services for a
monthly fee. The monthly fee varies and is based on an hourly billing rate for
each individual providing services multiplied by the number of hours of services
performed by such individual. The initial term of the agreement is for 24 months
and may be terminated with written notice at any time by the Company. The
Company also hired certain executive and administrative staff to perform
functions that were previously performed by Third Security.





Also upon
completion of the initial public offering, the Company entered into a lease
agreement with Third Security for certain executive and administrative office
space for an initial period of 24 months. The current monthly rental is
approximately $6,500. The Company recognized approximately $146,000 and $19,500
of expense under the administrative services agreement and lease agreement,
respectively, for the three months ended April 3, 2005. The unpaid portions of
these amounts are included in due to affiliates in the accompanying consolidated
balance sheet at April 3, 2005.


11
 *Index*


**(7)**
    **NET
      LOSS PER SHARE**





The
following is a reconciliation of the numerators and denominators of the net loss
per share computations for the periods presented:





**Net
      loss**
      **(numerator)**
    
    **Shares**
      **(denominator)**
    
    **Per
      share**
      **amount**Three-month
      period ended March 28, 2004:Basic
      net loss per share
    
    $
    (1,833,373
    )
    
    12,592,888
    
    $
    (0.15
    )Effect
      of dilutive stock options
    
    
    —
    
    
    —Diluted
      net loss per share
    
    $
    (1,833,373
    )
    
    12,592,888
    
    $
    (0.15
    )Three-month
      period ended April 3, 2005:Basic
      net loss per share
    
    $
    (6,672,232
    )
    
    17,788,941
    
    $
    (0.38
    )Effect
      of dilutive stock options and stock appreciation rights
    
    
    —
    
    
    —Diluted
      net loss per share
    
    $
    (6,672,232
    )
    
    17,788,941
    
    $
    (0.38
    )





All stock
options and SARs to be settled by the issuance of restricted stock (see note 8)
could potentially dilute net loss per share and therefore, they were not
included in the computation of diluted net loss per share because to do so would
have been anti-dilutive.





**(8)**
    **STOCK-BASED
      COMPENSATION**





Effective
June 25, 2004 the Board approved the 2004 Incentive Compensation Plan (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 SARs, 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 1,620,000 shares, but no
more than 810,000 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.





Effective
March 23, 2005, the Compensation Committee approved the grant of 25,000 stock
options to each of the Company’s four non-employee directors under the
Plan. **** These
100,000 stock options have a per share exercise price of $23.20, which was the
closing price of the Company’s common stock on the date of grant, were vested
upon the date of grant and expire 10 years from the date of grant.


12
 *Index*


Stock
option activity for the three months ended April 3, 2005 was as follows:





**Number
      of shares**
    
    **Weighted
      average exercise price**Balance
      at January 2, 2005
    
    
    860,897
    
    $
    4.30Granted
    
    
    100,000
    
    
    23.20Exercised
    
    
    (55,650
    )
    
    (3.09
    )Balance
      at April 3, 2005
    
    
    905,247
    
    $
    6.46Exercisable
      at April 3, 2005
    
    
    636,747
    
    $
    6.59





At April
3, 2005, the weighted average remaining contractual life of outstanding options
was 7.7 years.





Effective
March 29, 2005, the Compensation Committee of the Board of Directors granted a
total of 639,000 SARs to the Company’s three executive officers under the Plan.
These SARs, of which 479,250 are payable in cash and 159,750 are payable in
restricted stock, have an exercise price of $24.00, 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, which is the measurement date for determining
their value. Upon vesting, the SARs will not be exercisable for two additional
years. In the event that the Board of Directors believes that payment of the
SARs will have an adverse impact to the Company, it has the right to defer
payment of the awards until such time that it believes that payment will not
have an adverse impact. The Company recognized $19,081 of stock-based
compensation expense related to these SARs during the three months ended April
3, 2005.





**(9)**
    **CONTINGENCIES**





In May
2002, the Company filed suit against DSM Pharmaceuticals, Inc. (DSM), alleging
breach of contract and misrepresentations by DSM and failure of consideration by
DSM. The parties reached an agreement for the settlement of all claims and
counterclaims associated with the litigation, mutual releases between the
parties and their affiliates, and the payment of $1.3 million to the Company by
DSM. An Agreed Order of Dismissal with Prejudice evidencing the dismissal of all
claims associated with the litigation was signed by counsel for both parties and
submitted to the court for entry upon the Company’s receipt of the settlement
amount of $1.3 million from DSM on May 4, 2004. As a result of this settlement,
the Company recognized a gain of $1,764,043 in April 2004, including reversing
outstanding invoices payable of $464,043.





From time
to time, the Company may become involved in other litigation in the normal
course of business. Management believes that any costs resulting from such
litigation will not have a significant adverse effect on the Company’s
consolidated financial condition, results of operations or liquidity.


13
 *Index*


In the
normal course of business, the Company may enter into agreements which
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 which 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.







**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 and the
consolidated financial statements and notes thereto in the annual report on Form
10-K filed on April 1, 2005, with the SEC.*





***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
      progress of our product development programs;





·
    the
      status of our preclinical and clinical development of potential drugs,
      clinical trials and the regulatory approval process;





·
    our
      estimates for future revenues and profitability;





·
    our
      estimates regarding our capital requirements and our needs for additional
      financing;





·
    the
      likely scheduling of product candidates;





·
    our
      ability to attract partners with acceptable development, regulatory and
      commercialization expertise;





·
    the
      likelihood of regulatory approval under Section 505(b)(2) under the
      Federal Food, Drug and Cosmetic Act;


14
 *Index*


·
    the
      expected benefits of our Carrierwave technology such as abuse resistance
      and decreased toxicity; and





·
    our
      ability to obtain favorable patent claims.





In some
cases, you can identify forward-looking statements by terms such as “may,”
“will,” “should,” “could,” “would,” “intend,” “expect,” “plan,” “anticipate,”
“believe,” “estimate,” “project,” “predict,” “potential” and similar expressions
intended to identify forward-looking statements. These statements reflect our
current views with respect to future events and are based on assumptions and
subject to risks and uncertainties. Given these uncertainties, you should not
place undue reliance on these forward-looking statements. We discuss many of
these risks in greater detail under the heading “Risk Factors Related to Our
Business” in the annual report on Form 10-K for the fiscal year ended January 2,
2005 filed on April 1, 2005, with the SEC. The forward-looking statements made
in this 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 focused on developing novel pharmaceuticals
that are safer and improved versions of widely-prescribed drugs in large and
growing markets. Utilizing our proprietary Carrierwave technology, we are
currently developing versions of amphetamines and opioids that are designed to
provide overdose protection, abuse resistance and less potential for addiction
while providing efficacy comparable to the active pharmaceutical ingredients on
which they are based. We believe some of our drugs may prove highly resistant to
overdose. We believe that we are the first company with a viable product in the
pipeline attempting to address the potential overdose risk associated with
currently-marketed amphetamines and opioids.





We are
currently devoting our efforts to the development of our three lead product
candidates. NRP104, our most advanced product candidate, is a conditionally
bioreversible derivative (CBD) of amphetamine and is currently in Phase 3
trials. We anticipate filing a new drug application (NDA) on NRP104 by the end
of 2005. NRP290, our second product candidate, is a CBD of hydrocodone, an
opioid widely used to treat acute pain. We are currently conducting preclinical
animal studies on NRP290. We anticipate filing an investigational new drug
application (IND) for NRP290 by the end of the second quarter of 2005. NRP369 is
our third pipeline program. This program is focused on developing a CBD of
oxycodone, an opioid widely used to treat chronic pain. We are currently
evaluating several CBDs of oxycodone and anticipate filing an IND on NRP369 by
the fourth quarter of 2005.


15
 *Index*


On
January 31, 2005, we entered into a collaboration agreement with Shire
Pharmaceuticals Group plc (Shire) relating to the global commercialization of
NRP104 for treatment of attention deficit hyperactivity disorder (ADHD) and
other potential indications. On March 31, 2005, we and Shire split this
agreement into two agreements by entering into a United States Collaboration
Agreement and an ROW Territory License Agreement to replace the initial
collaboration agreement. The collaboration includes product development,
manufacturing, marketing and sales. Under the terms of the collaboration, Shire
paid us an upfront fee of $50 million on February 11, 2005, which could be
refundable to Shire in certain circumstances. We have recorded the $50 million
upfront payment as deferred revenue in the consolidated balance sheet at April
3, 2005.





The
collaboration also provides for additional payments to us in the event that
certain milestones are achieved. These potential payments include an additional
$50 million on acceptance of the NDA filing by the FDA and an amount of up to
$300 million 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
collaboration is $505 million. In addition to the upfront and milestone
payments, the collaboration provides for profit sharing on U.S. product sales
when and if the product is approved by the FDA. Shire will retain 75% of
profits, as defined, for the first two years following the launch of the product
and the parties will share the profits equally thereafter. For product sales in
the rest of the world, Shire will pay us a royalty.





Our
agreements with Shire provide for certain termination rights. Shire may for
instance terminate the agreements at any time prior to receiving regulatory
approval in the U.S., 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 agreements under the laws of the U.S. or European Union.





The
collaboration will be managed by committees that will have equal representation
of Shire and us, although ultimate responsibility for approval is allocated to
one party or the other in certain areas. We, at our own expense, will bear
primary responsibility for development and regulatory approval of the product in
the U.S. for ADHD, and Shire will bear primary responsibility for development
and regulatory approval in other countries, and in certain cases will share
those expenses with us. Shire will have primary responsibility for
commercialization in all countries, and we will have certain co-promotion rights
in the U.S.





Throughout
our history, we have incurred significant losses. We anticipate incurring
additional losses, which may increase, for our fiscal year ending January 1,
2006. We have not been and may never become profitable. As of April 3, 2005, we
had an accumulated deficit of approximately $46.7 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. We do not expect to submit an application for regulatory
approval for any of our product candidates before the end of 2005, and it could
be later. 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 or royalties from product sales.


16
 *Index*


*Selling,
General and Administrative Expenses.* Selling,
general and administrative expenses consist primarily of legal costs associated
with patent filings and litigation that was settled in May 2004, board of
director fees, insurance expense, personnel and benefits costs, stock-based
compensation costs, costs associated with completing the collaboration
agreements with Shire, and fees charged to us by an affiliate, Third Security,
LLC (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
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 focused on developing our three
lead product candidates. Our research and development expenses consist of direct
and indirect costs. Our direct costs include salaries and related expenses for
personnel, including stock-based compensation, costs of materials used in
research and development, costs of facilities and external development costs
that consist of fees paid to professional service providers for conducting
various studies and trials. Indirect costs include various overhead costs. We
believe that significant investment in product development is a competitive
necessity, and we plan to continue these investments in order to be in a
position to realize the potential of our product candidates and proprietary
technologies.





We use
our research and development employee and infrastructure resources across
several projects, and many of our costs are not attributable to an
individually-named project but are directed to broadly-applicable research
efforts. Accordingly, we do not account for internal research and development
costs on a project-by-project basis, and we cannot state precisely the total
costs incurred for each of our clinical and preclinical projects on a
project-by-project basis.





The
following table summarizes, from inception and for the three months ended April
3, 2005, 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, and (ii) each of our
current lead product candidates.





**Three
      months ended**
      **April
      3, 2005**
    
    **Inception
      to April 3, 2005****(in
      thousands)**NRP104
    
    $
    2,217
    
    $
    9,950NRP290
    
    
    655
    
    
    1,449NRP369
    
    
    38
    
    
    191Carrierwave/thyroid
    
    
    —
    
    
    5,488Total
    
    $
    2,910
    
    $
    17,078




17
 *Index*


We expect
that a larger percentage 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.





*Interest
Income (Expense)* .
Interest income consists of interest earned on cash and cash equivalents and
short-term investments. Interest expense consists of interest on long-term debt.
We currently have no long-term debt obligations.





**Results
of Operations**





We
anticipate that our results of operations will fluctuate for the foreseeable
future due to several factors, including, but not limited to, the progress of
our research and development efforts and the timing and outcome of regulatory
submissions. Due to these uncertainties, accurate predictions of future
operations are difficult or impossible.





**Three
Months Ended April 3, 2005 Compared to Three Months Ended March 28, 2004**





*Selling,
General and Administrative Expenses.* Selling,
general and administrative expenses increased by $2,488,000, or 362%, to
$3,175,000 for the three months ended April 3, 2005 from $687,000 for the three
months ended March 28, 2004. This increase is primarily attributed to a
$1,500,000 fee paid to an investment banking firm for managing the process
through which we were able to evaluate various partnering alternatives prior to
the successful completion of our collaboration agreements with Shire, an
increase of approximately $626,000 of payroll and benefit costs, including
estimated bonus accruals, associated with hiring executive management and
accounting personnel and a general increase in general and administrative
expenses associated with being a public company.


18
 *Index*


*Research
and Development Expenses.* Research
and development expenses increased $2,676,000, or 242%, to $3,784,000 for the
three months ended April 3, 2005 from $1,108,000 for the three months ended
March 28, 2004. An increase in external development costs of $2,194,000
accounted for most of this increase. This increase in external development costs
was primarily related to Phase 3 clinical studies for our NRP104 compound and
continued progress in our research and development of our NRP290
compound.





The
following table shows the aggregate changes in our research and development
expenses.





**Three
      months ended****Research
      and development expenses**
    
    **April
      3, 2005**
    
    **March
      28, 2004****(in
      thousands)**Direct
      project costs:Personnel,
      benefits and related costs
    
    $
    471
    
    $
    282Consultants,
      supplies, materials and other direct costs
    
    
    255
    
    
    98External
      development costs
    
    
    2,910
    
    
    716Total
      direct costs
    
    
    3,636
    
    
    1,096Indirect
      costs
    
    
    148
    
    
    12Total
    
    $
    3,784
    
    $
    1,108





**Liquidity
and Capital Resources**





Our
operations from 2001 through April 3, 2005, have been funded primarily from
proceeds of approximately $17.3 million raised from various private placements
of our common stock, $33.6 million of gross proceeds from the initial public
offering of our common stock on August 10, 2004, and $50 million received on
February 11, 2005 in accordance with the terms of our collaboration agreements
with Shire, as follows:




**Fiscal
      year**
    
    **Number
      of shares****(1)**
    
    **Price
      per share**
    
    **Gross
      Proceeds**2001
    
    
    150,000
    
    $
    6.66
    
    $
    1,000,0002002
    
    
    1,122,500
    
    
    2.50
    
    
    2,806,2502002
    
    
    2,038,860
    (2)
    
    2.50
    
    
    5,097,1512003
    
    
    1,411,600
    
    
    2.50
    
    
    3,529,0002004
    
    
    970,000
    
    
    5.00
    
    
    4,850,0002004
      - Initial public offering
    
    
    4,200,000
    
    
    8.00
    
    
    33,600,0002005
      - Shire collaboration
    
    
    —
    
    
    
    
    
    50,000,0009,892,960
    
    
    
    
    $
    100,882,401





(1)
    As
      adjusted for a one-for-two reverse stock split effective as of August 3,
      2004.


(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.


19
 *Index*


On August
10, 2004 we completed the initial public offering of our common stock whereby we
sold 4,200,000 shares at a price of $8.00 per share, resulting in gross proceeds
of $33.6 million. In connection with this offering, we paid approximately $2.4
million in underwriting discounts and commissions and incurred estimated other
offering expenses of approximately $1.2 million. After deducting the
underwriting discounts and commissions and offering expenses, we received net
proceeds from the offering of approximately $30 million.





At April
3, 2005, we had cash and cash equivalents of $14,600,000 compared to $4,019,000
at January 2, 2005. Our cash and 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 maintain short-term
investments in auction rate municipal bonds. We record these short-term
investments at cost, which approximates fair market value due to their variable
interest rates, which typically reset every 28 to 35 days, and the fact that,
despite the long-term nature of their stated contractual maturities, we have the
ability to liquidate readily these securities. We do not anticipate any losses
with respect to such cash and cash equivalents and short-term investment
balances.





Cash
provided by operations was $41,769,000 for the three months ended April 3, 2005
compared to cash used in operations of $1,605,000 for the three months ended
March 28, 2004. The upfront payment of $50,000,000 received in February 2005
under the terms of our collaboration agreements with Shire, offset by increased
operating expenses primarily accounted for this change. Cash used in investing
activities was $31,360,000 for the three months ended April 3, 2005 and was the
result of investing the proceeds from the $50,000,000 upfront payment received
from Shire. Cash provided by financing activities was $172,000 for the three
months ended April 3, 2005, which was from proceeds received from exercises of
stock options and $1,400,000 for the three months ended March 28, 2004, which
was from proceeds from demand loans from Kirkfield. These notes were repaid
during the second quarter of 2004.





The
following table summarizes our contractual obligations at April 3, 2005 and the
effects such obligations are expected to have on our liquidity and cash flows in
future periods.





**Total**
    
    **2005**
    
    **Thereafter****(in
      thousands)**Operating
      lease obligations
    
    $
    161
    
    $
    115
    
    
    46Research
      and development contracts
    
    
    9,662
    
    
    9,662
    
    
    —Total
      contractual cash obligations
    
    $
    9,823
    
    $
    9,777
    
    
    46





The
contractual commitments reflected in this table exclude royalty payments that we
may be obligated to pay to Innovative Technologies in the future. Such future
royalty payments are contingent on product sales and are based on 1% of net
sales (as defined in the agreement with Innovative Technologies dated June 30,
2004) for a period of 10 years or up to a total of $1 million, whichever occurs
first.


20
 *Index*


As of
April 3, 2005, we do not have any short-term debt or long-term contractual or
debt obligations. Our operating leases are for our research and development
facilities and our administrative offices. We renewed the research and
development facility lease, including additional space of 2,358 square feet, in
August 2004 for one year at a monthly rental of approximately $11,000. We may
renew this lease for successive one-year periods thereafter. Upon completion of
the initial public offering of our common stock on August 10, 2004, we entered
into an operating lease agreement with Third Security for offices occupied by
certain of our executive and administrative staff. The lease is for 24 months
with a current monthly rental of approximately $6,500. We may renew this lease
for three successive one-year periods thereafter. We also have in-progress
research and development contracts performed by third parties. As of April 3,
2005, we had commitments, which consist primarily of external development work,
with third parties totaling approximately $16,944,000, of which approximately
$9,662,000 had not yet been incurred. The commitments are cancelable by us at
any time upon written notice.





We expect
to incur losses from operations for fiscal year 2005. 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, legal and accounting staff, add
infrastructure and incur additional costs related to being a public company,
including directors’ and officers’ insurance, investor relations programs and
increased professional fees.





Our
future capital requirements will depend on a number of factors, including 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 24 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. Any future funding may
dilute the ownership of our equity investors.





**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.


21
 *Index*


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 product. In accordance with
SFAS No. 48, “ *Revenue
Recognition When the Right of Return Exists,* ” 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 its 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 the we have 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. Additionally, pursuant to the
guidance of Securities and Exchange Commission Staff Accounting Bulletin 104
(“SAB 104”), unless evidence suggests otherwise, revenue from consideration
received is recognized on a straight-line basis over the expected term of the
arrangements. 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.


22
 *Index*


*Stock-Based
Compensation* . We have
elected to follow APB Opinion No. 25, “ *Accounting
for Stock Issued to Employees,* ” and
related interpretations, in accounting for our stock-based compensation plans,
rather than the alternative fair value accounting method provided for under SFAS
No. 123, “ *Accounting
for Stock-Based Compensation* ”. In the
notes to our financial statements, we provide pro forma disclosures in
accordance with SFAS No. 123 and related pronouncements. The two factors which
are most likely to affect charges or credits to operations related to
stock-based compensation are the fair value of the common stock underlying stock
options for which stock-based compensation is recorded and the volatility of
such fair value. If our estimates of the fair value of these equity instruments
are too high or too low, our expenses will be overstated or understated. Because
shares of our common stock had not been publicly traded before our initial
public offering in August 2004, we valued our stock and stock option grants by
considering comparative values of stock of public companies discounted for the
risk and limited liquidity of our common stock, events that have occurred since
the date of grants, economic trends and transactions involving the sale of our
common stock to independent third parties.





In
December 2004, the Financial Accounting Standards Board (FASB) issued
Statement of Financial Accounting Standards (SFAS) No. 123 (revised
2004), “Share-Based Payment,” (SFAS No. 123(R)). SFAS No. 123(R) requires
companies to expense the grant-date fair value of employee stock options. SFAS
No. 123(R) is effective for the first fiscal year beginning after June 15, 2005;
however, early adoption is encouraged. We have not yet adopted this standard and
are currently evaluating the expected impact of adoption on our consolidated
financial position, results of operations and cash flows, including the specific
transition method to be utilized upon adoption. We anticipate that the adoption
of SFAS No. 123(R) will negatively impact our earnings.





*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 months ended April 3,
2005 and March 28, 2004. 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 2, 2005, we had federal net operating
loss carry forwards of approximately $33.5 million available to reduce future
taxable income, which will begin to expire in 2019.





23
 *Index*




**Item
      3.**
    **Quantitative and Qualitative Disclosures About Market
      Risk.**


Our
exposure to market risk is currently confined to our cash and cash equivalents
that have original 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 their
variable interest rates, which typically reset every 28 to 35 days, and the fact
that, despite the long-term nature of their stated contractual maturities, we
have the ability to liquidate readily these securities. We currently do not
hedge interest rate exposure. We have not used derivative financial instruments.
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.







**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 principal executive officer and
principal financial officer, of the effectiveness of our disclosure controls and
procedures (as defined under Rule 13a-15(e) under the Exchange Act), as of
April 3, 2005. Based upon that evaluation, our principal executive officer and
principal financial officer concluded that our 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 Securities and Exchange Commission
rules and forms. There has been no significant change in our internal control
over financial reporting during the quarter ended April 3, 2005 that has
materially affected, or is reasonably likely to materially affect, our internal
control over financial reporting.


24
 *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 2.**
    **Unregistered Sales of Equity Securities and Use of
      Proceeds.**





Effective
March 23, 2005, in consideration for their service on our Board of Directors, we
granted each of our four non-employee directors options to purchase 25,000
shares of our common stock. These options were granted at an exercise price of
$23.20 per share pursuant to our Incentive Compensation Plan. No underwriters
were involved in these option issuances. These option issuances were exempt from
registration under the Securities Act of 1933, as amended, either pursuant to
Rule 701 under the Securities Act, as transactions pursuant to a compensatory
benefit plan, or pursuant to Section 4(2) under the Securities Act, as a
transaction by an issuer not involving a public offering.





From
August 5, 2004, the effective date of our Registration Statement on Form S-1
(File No. 333-115207) to April 3, 2005, in accordance with the disclosure set
forth in the prospectus related to our initial public offering, we have used
approximately $15.5 million of the net offering proceeds from our initial public
offering, as follows:





Funding
      for further development of NRP104
    
    $
    7,126,000Funding
      for further research and development of NRP290
    
    
    619,000Working
      capital and general corporate purposes
    
    
    7,776,000Total
    
    $
    15,521,000





We intend
to use the remaining proceeds of the offering in accordance with the disclosure
set forth in the prospectus related to our initial public offering, except that
based upon further discussions with the FDA we have agreed to conduct additional
studies in support of the NDA filing for NRP104, the cost of which we estimate
to be approximately $5.5 million. As a result of these discussions, we may also
be required to do additional studies with respect to further development of
NRP290 and NRP369, which would result in additional cost. Pending application of
the remaining proceeds, we have invested the proceeds in short-term,
investment-grade, interest-bearing securities.





**Item 3.**
    **Defaults Upon Senior
  Securities.**





None.





**Item 4.**
    **Submission
      of Matters to a Vote of Securities
Holders.**





There
were no matters submitted to a vote of our shareholders during the quarter ended
April 3, 2005.


25
 *Index*


**Item 5.**
    **Other
      Information.**





None.





**Item 6.**
    **Exhibits
      and Reports on Form 8-K.**





(a)
    Exhibits.





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





(b)
    Reports
      on Form 8-K.





We filed
the following reports on Form 8-K during the quarter covered by this
report:





·
    On
      March 25, 2005, we filed a Current Report on Form 8-K under Item 1.01
      relating to bonus payments to executive officers and compensation of
      non-employee directors.





·
    On
      March 1, 2005, we filed a Current Report on Form 8-K under Item 8.01
      relating to a presentation by our management at the Wells Fargo Securities
      Healthcare Conference.





·
    On
      February 10, 2005 we filed a Current Report on Form 8-K under Item 8.01
      relating to a press release announcing an update on our clinical trials
      and pipeline.





·
    On
      January 31, 2005, we filed a Current Report on Form 8-K under Item 1.01
      relating to a collaboration agreement with Shire Pharmaceuticals Group plc
      for the commercialization of our NRP104 compound.





·
    On
      January 20, 2005, we filed a Current Report on Form 8-K under Item 5.02
      relating to the resignation of a member of our Board of Directors.


26
 *Index*


·
    On
      January 3, 2005, we filed a Current Report on Form 8-K under Item 8.01
      relating to a press release announcing a non-binding letter of intent with
      Shire Pharmaceuticals Group plc, with respect to commercialization of our
      NRP104 compound.




27
 *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:
      May 11, 2005
    /s/
      Randal J. KirkRandal
      J. KirkChairman,
      President and Chief Executive Officer(Principal
      executive officer)Date:
      May 11, 2005
    /s/
      Krish S. KrishnanKrish
      S. KrishnanChief
      Operating Officer, Chief Financial Officer and
Secretary(Principal
      financial and accounting officer)




28