**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 2, 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





Indicate
      by check mark whether the registrant is a shell company (as defined in Exchange
      Act Rule 12b-2). Yes: o No: x





As
      of
      November 11, 2005, there were 18,144,701 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 2, 2005**





**INDEX**


**Page****PART
                I FINANCIAL INFORMATION**
            **1****Item
                1.**
            **Consolidated
                Financial
                Statements.**
            **1**Consolidated
                Balance Sheets October 2, 2005
                (unaudited) and January 2, 2005Consolidated
                Statements of Operations Three months
                and nine months ended October 2, 2005 and September 26, 2004
                (unaudited)Consolidated
                Statements of Cash Flows Nine months ended
                October 2, 2005 and September 26, 2004 (unaudited)Notes
                to Consolidated Financial Statements
                (unaudited)**Item
                2.**
            **Management’s
                Discussion and Analysis of Financial Condition
                and Results of Operations.**
            **15****Item
                3.**
            **Quantitative
                and Qualitative Disclosures About Market
                Risk.**
            **28****Item
                4.**
            **Controls
                and Procedures.**
            **28****PART
                II OTHER INFORMATION**
            **30****Item
                1.**
            **Legal
                Proceedings.**
            **30****Item
                2.**
            **Unregistered
                Sales of Equity Securities and Use of
                Proceeds.**
            **28****Item
                3.**
            **Defaults
                Upon Senior Securities.**
            **28****Item
                4.**
            **Submission
                of Matters to a Vote of Securities
                Holders.**
            **28****Item
                5.**
            **Other
                Information.**
            **29****Item
                6.**
            **Exhibits.**
            **29****SIGNATURES**
            **30**


(i)
 *Index*


**PART
      I**


**FINANCIAL
      INFORMATION**





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





**NEW
      RIVER PHARMACEUTICALS INC. AND SUBSIDIARY**





**CONSOLIDATED
      BALANCE SHEETS**








**Assets**
            
            **October
                2, 2005**
            
            **January
                2, 2005**Current
                assets:
            
            (Unaudited)Cash
                and cash equivalents
            
            $
            1,723,592
            
            $
            4,018,556Short-term
                investments
            
            
            54,843,804
            
            
            21,174,747Prepaid
                expenses
            
            
            1,180,610
            
            
            315,644Total
                current assets
            
            
            57,748,006
            
            
            25,508,947Property
                and equipment:Leasehold
                improvements
            
            
            94,609
            
            
            76,860Machinery
                and equipment
            
            
            811,545
            
            
            686,895906,154
            
            
            763,755Less
                accumulated depreciation and amortization
            
            
            617,169
            
            
            502,890Property
                and equipment, net
            
            
            288,985
            
            
            260,865Total
                assets
            
            $
            58,036,991
            
            $
            25,769,812**Liabilities
                and Shareholders’ Equity**Current
                liabilities:Capital
                lease obligation - current
            
            $
            21,681
            
            $
            —Accounts
                payable
            
            
            1,218,377
            
            
            701,175Unpaid
                and accrued research and development expenses
            
            
            1,968,323
            
            
            2,100,421Accrued
                compensation
            
            
            1,825,533
            
            
            1,506,413Due
                to affiliates
            
            
            111,838
            
            
            76,920Total
                current liabilities
            
            
            5,145,752
            
            
            4,384,929Capital
                lease obligation - noncurrent
            
            
            32,959
            
            
            —Accrued
                stock-based compensation
            
            
            2,071,558
            
            
            —Deferred
                revenue
            
            
            50,000,000
            
            
            —Total
                liabilities
            
            
            57,250,269
            
            
            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 18,127,201 shares at October
                2,
                2005 and 17,774,554 shares at January 2, 2005
            
            
            18,127
            
            
            17,775Additional
                paid-in capital
            
            
            62,875,645
            
            
            61,346,030Accumulated
                deficit
            
            
            (62,107,050
            )
            
            (39,978,922
            )Total
                shareholders’ equity
            
            
            786,722
            
            
            21,384,883Commitments
                and contingenciesTotal
                liabilities and shareholders’ equity
            
            $
            58,036,991
            
            $
            25,769,812





See
      accompanying notes to consolidated financial statements.


*Index*


**NEW
      RIVER PHARMACEUTICALS INC. AND
      SUBSIDIARY**





**CONSOLIDATED
      STATEMENTS OF OPERATIONS**





**Three
                months ended**
            
            **Nine
                months ended****October
                2,**
              **2005**
            
            **September
                26,**
              **2004**
            
            **October
                2,**
              **2005**
            
            **September
                26,**
              **2004****(Unaudited)**
            
            **(Unaudited)**Sales,
                net
            
            $
            —
            
            $
            —
            
            $
            —
            
            $
            —Operating
                costs and expenses:Selling,
                general, and administrative
            
            
            4,327,045
            
            
            1,374,455
            
            
            9,272,568
            
            
            3,609,265Research
                and development
            
            
            5,247,036
            
            
            3,072,912
            
            
            14,072,247
            
            
            5,493,858Depreciation
                and amortization of property and equipment
            
            
            41,562
            
            
            30,254
            
            
            116,378
            
            
            89,966Total
                operating expenses
            
            
            9,615,643
            
            
            4,477,621
            
            
            23,461,193
            
            
            9,193,089Operating
                loss
            
            
            (9,615,643
            )
            
            (4,477,621
            )
            
            (23,461,193
            )
            
            (9,193,089
            )Other
                income (expense):Gain
                on settlement of litigation
            
            
            —
            
            
            —
            
            
            —
            
            
            1,764,043Interest
                expense
            
            
            (1,633
            )
            
            —
            
            
            (3,487
            )
            
            (11,422
            )Interest
                income
            
            
            515,814
            
            
            61,357
            
            
            1,336,552
            
            
            63,600Total
                other income, net
            
            
            514,181
            
            
            61,357
            
            
            1,333,065
            
            
            1,816,221Net
                loss
            
            $
            (9,101,462
            )
            $
            (4,416,264
            )
            $
            (22,128,128
            )
            $
            (7,376,868
            )Net
                loss per share:Basic
                and diluted
            
            $
            (0.50
            )
            $
            (0.28
            )
            $
            (1.24
            )
            $
            (0.53
            )





See
      accompanying notes to consolidated financial statements


2
 *Index*


**NEW
      RIVER PHARMACEUTICALS INC. AND
      SUBSIDIARY**





**CONSOLIDATED
      STATEMENTS OF CASH FLOWS**





**Nine
                months ended****October
                2,**
              **2005**
            
            **September
                26,**
              **2004****(Unaudited)**Cash
                flows from operating activities:Net
                loss
            
            $
            (22,128,128
            )
            $
            (7,376,868
            )Adjustments
                to reconcile net loss to net cash provided by (used in) operating
                activities:Depreciation
                and amortization of property and equipment
            
            
            116,378
            
            
            89,966Stock-based
                compensation
            
            
            2,485,869
            
            
            1,386,000Contribution
                of services by related party
            
            
            —
            
            
            576,229Changes
                in operating assets and liabilities:Prepaid
                expenses
            
            
            (864,966
            )
            
            (347,343
            )Due
                from affiliates
            
            
            —
            
            
            88,381Accounts
                payable
            
            
            517,202
            
            
            668,244Unpaid
                and accrued research and development expenses
            
            
            (132,098
            )
            
            (192,918
            )Accrued
                compensation
            
            
            319,120
            
            
            (8,062
            )Due
                to affiliates
            
            
            34,918
            
            
            69,191Deferred
                revenue
            
            
            50,000,000
            
            
            —Net
                cash provided by (used in) operating activities
            
            
            30,348,295
            
            
            (5,047,180
            )Cash
                flows from investing activities:Proceeds
                from sale of short-term investments
            
            
            53,075,000
            
            
            —Purchases
                of short-term investments
            
            
            (86,744,057
            )
            
            —Proceeds
                from sale of property and equipment
            
            
            91
            
            
            7,545Purchases
                of property and equipment
            
            
            (75,611
            )
            
            (73,663
            )Net
                cash used in investing activities
            
            
            (33,744,577
            )
            
            (66,118
            )Cash
                flows from financing activities:Proceeds
                from notes payable to shareholder
            
            
            —
            
            
            1,450,000Repayment
                of notes payable to shareholder
            
            
            —
            
            
            (1,800,000
            )Principal
                payments on capital lease obligation
            
            
            (14,338
            )
            
            —Net
                proceeds from issuances of common stock
            
            
            1,115,656
            
            
            34,827,436Net
                cash provided by financing activities
            
            
            1,101,318
            
            
            34,477,436Net
                increase (decrease) in cash and cash equivalents
            
            
            (2,294,964
            )
            
            29,364,138Cash
                and cash equivalents at beginning of period
            
            
            4,018,556
            
            
            264,393Cash
                and cash equivalents at end of period
            
            $
            1,723,592
            
            $
            29,628,531


Noncash
          investing and financing activities:
 In
        fiscal
        2005, the Company financed the purchase of equipment totaling $68,978 with
        a
        capital lease.


See
      accompanying notes to consolidated financial statements.


3
 *Index*


**NEW
      RIVER PHARMACEUTICALS INC.**


**AND
      SUBSIDIARY**





**NOTES
      TO CONSOLIDATED FINANCIAL STATEMENTS**





**Three
      and nine months ended October 2, 2005 and September 26,
      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
      October 2, 2005, 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.





*(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 new molecular entities that are
      derivatives of public domain actives and attempt to address certain deficiencies
      associated with currently marketed drugs. The products in the Company’s pipeline
      that are the most advanced in their development are NRP104 and NRP290, which
      are
      conditionally bioreversible derivatives (CBDs) of amphetamine and hydrocodone
      that are designed to provide overdose protection, abuse resistance 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 2, 2005 and
      for
      the three and nine months ended October 2, 2005 and September 26, 2004 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 2, 2005, included in the Company’s Annual Report on Form 10-K
      filed with the SEC on April 1, 2005.


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 13 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. Cash equivalents consisted of money
      market accounts of $1,420,248 and $22,759 at October 2, 2005 and January 2,
      2005, respectively.





*(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 2, 2005 and January 2, 2005, the Company’s short-term investments of
      $54,843,804 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 October 2, 2005 and January 2, 2005.
      All
      income generated from these investments is recorded as interest income.
      Short-term investments include accrued interest of $68,804 and $24,747 at
      October 2, 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. Because the Company does not currently have any products on the market,
      nor any products currently approved by the U.S. Food and Drug Administration
      (FDA) or other regulatory body for production, the Company did not have any
      inventory at October 2, 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 cannot sufficiently be assured
      that these deferred tax assets will be realized in accordance with the
      provisions of SFAS No. 109, *“Accounting
      for Income Taxes.”*


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 SEC 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 October 2, 2005, the Company had
      research and development commitments with third parties totaling approximately
      $18,339,000 of which approximately $7,168,000 had not yet been incurred. The
      commitments are cancelable by the Company at any time upon written notice.





*(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
      exceeds 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* .”


6
 *Index*


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. The Company will
      adopt this standard beginning with the first quarter of 2006 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**
            
            **Nine
                months ended****October
                2,**
              **2005**
            
            **September
                26,**
              **2004**
            
            **October
                2,**
              **2005**
            
            **September
                26,**
              **2004**Net
                loss:As
                reported
            
            $
            (9,101,462
            )
            $
            (4,416,264
            )
            $
            (22,128,128
            )
            $
            (7,376,868
            )Add
                stock-based employee compensation expense included in reported net
                loss,
                net of related tax effects
            
            
            —
            
            
            —
            
            
            —
            
            
            3,600Deduct
                total stock-based employee compensation expense determined under
                fair-value-based method for all awards, net of related tax
                effects
            
            
            (92,583
            )
            
            (123,236
            )
            
            (2,108,749
            )
            
            (192,328
            )Pro
                forma
            
            $
            (9,194,045
            )
            $
            (4,539,500
            )
            $
            (24,236,877
            )
            $
            (7,565,596
            )Net
                loss per share:Basic
                and diluted:As
                reported
            
            $
            (0.50
            )
            $
            (0.28
            )
            $
            (1.24
            )
            $
            (0.53
            )Pro
                forma
            
            $
            (0.51
            )
            $
            (0.29
            )
            $
            (1.35
            )
            $
            (0.55
            )


7
 *Index*





The
      per
      share weighted average fair value of stock options granted during the nine
      months ended October 2, 2005 of $18.31 and the three and nine months ended
      September 26, 2004 of $1.99 and $2.00, respectively, was determined on the
      date
      of grant utilizing the Black-Scholes option pricing model. The following
      weighted average assumptions were used in the Black-Scholes model:





**Nine
                months**
              **ended**
              **October
                2, 2005**
            
            **Three
                months**
              **ended**
              **September
                26, 2004**
            
            **Nine
                months**
              **ended**
              **September**
              **26, 2004**Expected
                dividend yield
            
            
            0%
            
            
            0%
            
            
            0%Risk-free
                interest rate
            
            
            4.61%
            
            
            4.18-4.32%
            
            
            4.53%Expected
                life of awards
            
            
            10
                years
            
            
            10
                years
            
            
            10
                yearsExpected
                volatility
            
            
            70%
            
            
            70%
            
            
            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 for
      the
      nine months ended October 2, 2005 and subsequent to the Company’s initial public
      offering that was completed on August 10, 2004 for the nine months ended
      September 26, 2004, 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 and nine months ended September 26, 2004 to place them on a basis
      comparable to the consolidated financial statements for the three and nine
      months ended October 2, 2005.


8
 *Index*


**(3)**
            **COLLABORATION
                ARRANGEMENT AND OTHER
                AGREEMENTS**





On
      January 31, 2005, the Company entered into a collaboration agreement with Shire
      Pharmaceuticals Group plc (Shire) relating to the global commercialization
      of
      NRP104 for treatment of attention deficit hyperactivity disorder (ADHD) and
      other potential indications. On March 31, 2005, the Company and Shire split
      this
      agreement into two agreements by entering into a United States Collaboration
      Agreement and 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 October 2, 2005.





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 new drug application (NDA) filing by the FDA,
      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
      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 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 Agreements 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.


9
 *Index*


On
      June
      29, 2005, we entered into a letter agreement with Optimer Pharmaceuticals,
      Inc.
      (Optimer) for the development of one or more proprietary pharmaceutical
      products comprising carbohydrate conjugates of iron for administration by
      injection using Optimer’s proprietary carbohydrate synthesis technology.
 Under the letter agreement, Optimer is responsible for synthesizing and
      characterizing compounds for testing.  Optimer commenced work on this
      project during the third quarter, and we are responsible for reimbursing Optimer
      for such work at a full time equivalent (FTE) consistent with current industry
      standards.  We will be responsible for conducting all preclinical and
      clinical testing on any such compounds.  The parties currently are
      negotiating a more formal and detailed agreement.  Upon execution of this
      more formal and detailed agreement, we will pay a licensing fee and potential
      milestones and royalty payments.





On
      July
      8, 2005, the Company entered into an exclusive licensing agreement with the
      Ernest Gallo Clinic Research Center at the University of California San
      Francisco to investigate a new approach toward improving the use of opioid
      analgesics in the treatment of pain by reducing the development of tolerance.
      Under the agreement, the Company paid a licensing fee and will pay an annual
      license maintenance fee, potential milestones and royalty payments in exchange
      for an exclusive license to pursue the commercial development of the technology
      for the treatment of pain. The Company refers to this as its NRP388
      program.








**(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.


10
 *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 million. 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. 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.


11
 *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 and nine months ended September 26, 2004, the Company recorded
      the
      estimated cost of these services of $131,000 and $576,000, respectively, 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
      and
      nine months ended September 26, 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 $38,000 and $10,000
      of expense under the administrative services agreement and lease agreement,
      respectively, from August 10, 2004 through September 26, 2004. The Company
      recognized approximately $108,000 and $358,000 of expense under the
      administrative services agreement and lease agreement for the three and nine
      months ended October 2, 2005. The unpaid portions of these amounts are included
      in due to affiliates in the accompanying consolidated balance sheet at October
      2, 2005.


12
 *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 September 26, 2004:Basic
                net loss per share
            
            $
            (4,416,264
            )
            
            15,707,393
            
            $
            (0.28
            )Effect
                of dilutive stock options
            
            
            —
            
            
            —Diluted
                net loss per share
            
            $
            (4,416,264
            )
            
            15,707,393
            
            $
            (0.28
            )Three-month
                period ended October 2, 2005:Basic
                net loss per share
            
            $
            (9,101,462
            )
            
            18,031,817
            
            $
            (0.50
            )Effect
                of dilutive stock options and stock appreciation rights
            
            
            —
            
            
            —Diluted
                net loss per share
            
            $
            (9,101,462
            )
            
            18,031,817
            
            $
            (0.50
            )Nine-month
                period ended September 26, 2004:Basic
                net loss per share
            
            $
            (7,376,868
            )
            
            13,800,617
            
            $
            (0.53
            )Effect
                of dilutive stock options
            
            
            —
            
            
            —Diluted
                net loss per share
            
            $
            (7,376,868
            )
            
            13,800,617
            
            $
            (0.53
            )Nine-month
                period ended October 2, 2005:Basic
                net loss per share
            
            $
            (22,128,128
            )
            
            17,910,205
            
            $
            (1.24
            )Effect
                of dilutive stock options and stock appreciation rights
            
            
            —
            
            
            —Diluted
                net loss per share
            
            $
            (22,128,128
            )
            
            17,910,205
            
            $
            (1.24
            )





All
      SARs
      to be settled by the issuance of restricted stock (see note 8) and stock options
      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.


13
 *Index*


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.





Stock
      option activity for the nine months ended October 2, 2005 was as follows:





**Number
                of**
              **shares**
            
            **Weighted**
              **average**
              **exercise
                price**Balance
                at January 2, 2005
            
            
            860,897
            
            $
            4.30Granted
            
            
            100,000
            
            
            23.20Exercised
            
            
            (352,647
            )
            
            (3.16
            )Expired
                or Forfeited
            
            
            (3,334
            )
            
            (14.22
            )Balance
                at October 2, 2005
            
            
            604,916
            
            $
            8.03Exercisable
                at October 2, 2005
            
            
            394,750
            
            $
            9.39





At
      October 2, 2005, the weighted average remaining contractual life of outstanding
      options was 7.7 years.





Effective
      March 29, 2005, the Compensation Committee of the Board 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, 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.
      The restricted stock issued upon the vesting of the stock-based SARs will vest
      upon the second anniversary following the exercise of the SARs. 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 approximately $2,113,000 and $2,486,000 of stock-based
      compensation expense related to these SARs during the three and nine months
      ended October 2, 2005, respectively.


14
 *Index*




**(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.





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.





**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 Securities and Exchange Commission
      (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;


15
 *Index*


·
            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)(1) and Section
                505(b)(2) under the Federal Food, Drug and Cosmetic Act;





·
            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 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 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 new molecular entities that are derivative 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 amphetamine and hydrocodone that are designed to provide
      overdose protection, abuse resistance and less potential for addiction while
      affording comparable efficacy. 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.


16
 *Index*


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.





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 October 2, 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 new drug application (NDA) filing by the U.S.
      Food and Drug Administration (FDA), 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 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. We are continuing
      to evaluate our accounting for the potential payments to be received pursuant
      to
      these agreements and expect to have our evaluation completed by the time we
      file
      our annual report on Form 10-K for the fiscal year ending January 1, 2006.
      Our
      preliminary evaluation is that certain of the milestone payments, such as the
      product labeling milestone of up to $300 million, will be recognized as revenue
      in the event that we achieve such milestone.





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 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 agreements under the laws of the United States
      or European Union.


17
 *Index*


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 United States 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 United States.





On
      June
      28, 2005, we announced the submission of an investigational new drug application
      (IND) to the FDA for NRP290, our second compound under development. NRP290,
      a
      novel opioid, is a conditionally bioreversible derivative of hydrocodone. We
      received approval of our IND for NRP290 in July 2005. On September 12, 2005,
      we
      announced results of a single dose pharmacokinetic study to assess oral
      bioavailability of hydrocodone from NRP290 and acetaminophen tablets, as
      compared to hydrocodone bitartrate and acetaminophen tablets in fasted state
      in
      healthy adult volunteers. Data presented indicate comparable bioavailability
      and
      the absence of intact NRP290 conjugates in the bloodstream. The dose of
      hydrocodone in NRP290 was 50% higher than that of Vicodin (7.5mg vs 5.0mg).
      Pharmacokinetic data indicate that "area under the curve," or AUC, for
      hydrocodone from NRP290 was proportionately higher for NRP290 than the positive
      control. AUC represents the total amount of a compound that is released into
      the
      blood. We believe this is positive because AUC for opioids is believed to be
      associated with analgesia, whereas "peak plasma concentration," or Cmax,
      may be associated with euphoria (i.e., abuse). That NRP290 demonstrated
      comparable Cmax and higher AUC at a 50% higher dose of hydrocodone than the
      positive control suggests that the drug may have comparable analgesic effect
      and
      lower abuse potential. We are currently conducting a second Phase 1 study
      to determine a dose range. We intend to initiate a Phase 2 study of the compound
      in the first half of 2006.





NRP369
      is
      our program that is focused on developing a conditionally bioreversible of
      oxycodone, an opioid widely used to treat chronic pain. We recently repositioned
      this program as a backup to NRP290 for the acute pain market, and will not
      advance an IND on NRP369 until we review sufficient clinical data on NRP290
      to
      determine that NRP369 could enjoy a differentiated market position relative
      to
      NRP290.





We
      recently decided to advance our development efforts in the area of hormone
      replacement therapy. We refer to this as our NRP409 program. Under this program,
      our Carrierwave triiodothyronine (T3) hormone is being developed as a
      replacement or supplemental therapy in patients with primary hypothyroidism
      and
      other indications. We expect to file an IND for NRP409 in the second quarter
      of
      2006.





On
      June
      6, 2005 we entered into a development and license agreement with Depomed, Inc.
      (Depomed) to create pharmaceutical products using Depomed’s patented oral drug
      delivery technology with our proprietary drug compounds. Under terms of the
      agreement, we may acquire worldwide rights to use Depomed's Gastric Retention
      oral drug delivery technology in up to three of our proprietary compounds.
      Once
      a compound is named and entered into development, Depomed will perform
      feasibility studies through an initial Phase I trial. In return, we will
      reimburse Depomed on a cost-plus basis for expenses as defined in each project
      budget. Once preclinical and Phase I testing is completed, we may exercise
      an
      option to license each product candidate and advance the product into additional
      clinical trials. At that time, we 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, we will pay Depomed royalties on net sales
      of
      each product.


18
 *Index*


On
      June
      29, 2005, we entered into a letter agreement with Optimer Pharmaceuticals,
      Inc.
      (Optimer) for the development of one or more proprietary pharmaceutical products
      comprising carbohydrate conjugates of iron for administration by injection
      using
      Optimer’s proprietary carbohydrate synthesis technology.  Under the letter
      agreement, Optimer is responsible for synthesizing and characterizing compounds
      for testing.  Optimer commenced work on this project during the third
      quarter, and we are responsible for reimbursing Optimer for such work at
      a  full
      time
      equivalent ( FTE ) consistent with current industry standards.  We will be responsible for
      conducting all preclinical and clinical testing on any such compounds.  The
      parties currently are negotiating a more formal and detailed agreement. 
Upon execution of this more formal and detailed agreement, we will pay a
      licensing fee and potential milestones and royalty payments.





On
      July
      8, 2005, 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. The subject of
      the
      agreement is a technology developed at the Gallo Center and at the University
      of
      California San Francisco by Dr. Jennifer L. Whistler and Dr. Mark von Zastrow.
      Preclinical work has suggested that doses of methadone administered with
      morphine at certain ratios could be used to increase analgesia and decrease
      the
      potential for opioid tolerance and dependence. Under the agreement, we paid
      a
      licensing fee and will pay an annual license maintenance fee, potential
      milestones and royalty payments in exchange for an exclusive license to pursue
      the commercial development of the technology for the treatment of pain. We
      refer
      to this as our NRP388 program.





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 October 2, 2005,
      we had an accumulated deficit of approximately $62.1 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 expect to submit an application for regulatory
      approval for NRP104 by the end of 2005. 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.





*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.


19
 *Index*


*Research
      and Development Expenses* .
      Our
      current research and development efforts are primarily focused on developing
      our
      lead product candidates. Our research and development expenses consist of direct
      and indirect costs. Our direct costs include salaries and related expenses
      for
      personnel, including stock-based compensation, costs of materials used in
      research and development, costs of facilities and external development costs
      that consist of fees paid to professional service providers for conducting
      various studies and trials. Indirect costs include various overhead costs.
      We
      believe that significant investment in product development is a competitive
      necessity, and we plan to continue these investments in order to be in a
      position to realize the potential of our product candidates and proprietary
      technologies.





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





The
      following table summarizes, from inception and for the three and nine months
      ended October 2, 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, (ii) each of our current
      lead product candidates and (iii) other preclinical development.





**Three**
              **Months**
              **ended**
              **October
                2,**
              **2005**
            
            **Nine**
              **Months**
              **ended**
              **October
                2,**
              **2005**
            
            **Inception**
              **to
                October**
              **2,
                2005****(in********thousands)**NRP104
            
            $
            3,259
            
            $
            9,287
            
            $
            17,020NRP290
            
            
            101
            
            
            985
            
            
            1,778NRP369
            
            
            21
            
            
            59
            
            
            212NRP409
            
            
            1
            
            
            60
            
            
            60Other
                preclinical development
            
            
            271
            
            
            347
            
            
            347Carrierwave/thyroid
            
            
            —
            
            
            —
            
            
            5,488Total
            
            $
            3,653
            
            $
            10,738
            
            $
            24,905





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.


20
 *Index*


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
      and capital lease obligations. 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 October 2, 2005 Compared to Three Months Ended September 26, 2004**





*Selling,
      General and Administrative Expenses.* Selling,
      general and administrative expenses increased by $2,953,000, or 215%, to
      $4,327,000 for the three months ended October 2, 2005 from $1,374,000 for the
      three months ended September 26, 2004. This increase was primarily attributed
      to
      an increase of approximately $915,000 of payroll and benefit costs, including
      estimated bonus accruals, associated with hiring executive management and
      accounting personnel, an increase in stock-based compensation expense of
      $1,296,000, and a general increase in general and administrative expenses
      associated with being a public company. Stock-based compensation for the three
      months ended September 26, 2004 was $450,000 and represented the excess of
      the
      estimated fair value of shares issued over the sales price of such shares.
      Stock-based compensation for the three months ended October 2, 2005 was
      $1,746,000 and represents cost being accrued over the vesting period of stock
      appreciation rights (SARs) granted to management.





*Research
      and Development Expenses.* Research
      and development expenses increased $2,174,000, or 71%, to $5,247,000 for the
      three months ended October 2, 2005 from $3,073,000 for the three months ended
      September 26, 2004. An increase in external development costs of $1,095,000
      and
      an increase in payroll and benefits costs of $735,000, including stock-based
      compensation, primarily accounted for this increase. The increase in external
      development costs was primarily related to Phase 3 clinical studies for our
      NRP104 compound, continued progress in our research and development of our
      NRP290 compound and commencement of other product development programs.
      Stock-based compensation for the three months ended October 2, 2005 was $367,000
      and represented cost being accrued over the vesting period of SARs granted
      to
      management. There was no stock-based compensation recognized for the three
      months ended September 26, 2004. The remaining increase in payroll and benefits
      costs was due to a combination of new hires, salary increases and bonus
      accruals.


21
 *Index*


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





**Three
                months ended****Research
                and development expenses**
            
            **October
                2,**
              **2005**
            
            **September
                26,**
              **2004****(in
                thousands)**Direct
                project costs:Personnel,
                benefits and related costs
            
            $
            1,017
            
            $
            282Consultants,
                supplies, materials and other direct costs
            
            
            486
            
            
            172External
                development costs
            
            
            3,653
            
            
            2,558Total
                direct costs
            
            
            5,156
            
            
            3,012Indirect
                costs
            
            
            91
            
            
            61Total
            
            $
            5,247
            
            $
            3,073





*Other
      Income:* Other
      income consists primarily of interest income and increased approximately
      $453,000, or 743%, to $514,000 for the three months ended October 2, 2005
      from $61,000 for the three months ended September 26, 2004. This increase was
      the result of investing the proceeds received from our initial public offering
      and the proceeds received pursuant to the collaboration agreements with
      Shire.





**Nine
      Months Ended October 2, 2005 Compared to Nine Months Ended September 26, 2004**





*Selling,
      General and Administrative Expenses.* Selling,
      general and administrative expenses increased by $5,664,000, or 157%, to
      $9,273,000 for the nine months ended October 2, 2005 from $3,609,000 for the
      nine months ended September 26, 2004. This increase was 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
      successful completion of our collaboration agreements with Shire, an increase
      of
      approximately $2,112,000 of payroll and benefit costs, including estimated
      bonus
      accruals, associated with hiring executive management and accounting personnel,
      an increase in stock-based compensation of $658,000 and a general increase
      in
      general and administrative expenses associated with being a public company,
      including increases in legal expenses of $563,000 and directors’ and officers’
insurance of $314,000. Stock-based compensation for the nine months ended
      September 26, 2004 was $1,386,000 and represented the excess of the estimated
      fair value of shares issued over the sales price of such shares. Stock-based
      compensation for the nine months ended October 2, 2005 was $2,044,000 and
      represents cost being accrued over the vesting period of SARs granted to
      management.


22
 *Index*


*Research
      and Development Expenses.* Research
      and development expenses increased $8,578,000, or 156%, to $14,072,000 for
      the
      nine months ended October 2, 2005 from $5,494,000 for the nine months ended
      September 26, 2004. An increase in external development costs of $6,585,000
      and
      an increase in payroll and benefits costs of $1,187,000, including estimated
      bonus accruals and stock-based compensation, primarily accounted for this
      increase. The increase in external development costs were primarily related
      to
      Phase 3 clinical studies for our NRP104 compound and continued progress in
      our
      research and development of our NRP290 compound. Stock-based compensation for
      the nine months ended October 2, 2005 was $442,000 and represents cost being
      accrued over the vesting period of SARs granted to management. There was no
      stock-based compensation recognized for the nine months ended September 26,
      2004. The remaining increase in payroll and benefits costs was due to a
      combination of new hires, salary increases and bonus accruals.





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





**Nine
                months ended****Research
                and development expenses**
            
            **October
                2,**
              **2005**
            
            **September
                26,**
              **2004****(in
                thousands)**Direct
                project costs:Personnel,
                benefits and related costs
            
            $
            2,020
            
            $
            833Consultants,
                supplies, materials and other direct costs
            
            
            962
            
            
            416External
                development costs
            
            
            10,738
            
            
            4,153Total
                direct costs
            
            
            13,720
            
            
            5,402Indirect
                costs
            
            
            352
            
            
            92Total
            
            $
            14,072
            
            $
            5,494


23
 *Index*





*Other
      Income:* Other
      income for the nine months ended September 26, 2004 included a gain of
      $1,764,000 on settlement of litigation, which is discussed further in the notes
      to the consolidated financial statements (see note 9). For the nine months
      ended
      October 2, 2005, other income included $1,337,000 of interest income earned
      primarily from investing the proceeds received from our initial public offering
      and the proceeds received pursuant to the collaboration agreements with
      Shire.





**Liquidity
      and Capital Resources**





Our
      operations from 2001 through October 2, 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.





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
      October 2, 2005, we had cash and cash equivalents of $1,724,000 compared to
      $4,019,000 at January 2, 2005. Our cash equivalents are highly liquid
      investments in money market funds. 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.


24
 *Index*


Cash
      provided by operations was $30,348,000 for the nine months ended October 2,
      2005
      compared to cash used in operations of $5,047,000 for the nine months ended
      September 26, 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 $33,745,000 for the nine months ended October 2, 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 $1,101,000 for the nine
      months ended October 2, 2005, which was primarily from proceeds received from
      exercises of stock options and $34,477,000 for the nine months ended September
      26, 2004, which was primarily from issuances of common stock, including
      approximately $30 million of net proceeds from the initial public offering
      of
      our common stock.





The
      following table summarizes our contractual obligations at October 2, 2005 and
      the effects such obligations are expected to have on our liquidity and cash
      flows in future periods.





**Total**
            
            **Due
                within 1 year**
            
            **Thereafter****(in
                thousands)**Operating
                lease obligations
            
            $
            104
            
            $
            104
            
            $
            —Capital
                lease obligations
            
            
            55
            
            
            22
            
            
            33Research
                and development contracts
            
            
            7,168
            
            
            7,168
            
            
            —Total
                contractual cash obligations
            
            $
            7,327
            
            $
            7,294
            
            $
            33





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.





As
      of
      October 2, 2005, our long-term contractual obligations consist of a capital
      lease for equipment used in our research operations. Our operating leases are
      for our research and development facilities and our administrative offices.
      The
      lease for the research and development facilities was renewed in August 2005
      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 October 2, 2005,
      we
      had commitments, which consist primarily of external development work, with
      third parties totaling approximately $18,339,000 of which approximately
      $7,168,000 had not yet been incurred.


25
 *Index*


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 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. 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.





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.


26
 *Index*


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 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 SEC 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.





*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 that
      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.


27
 *Index*


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. We will adopt this standard beginning
      with
      the first quarter of 2006 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 nine months ended October
      2,
      2005 and September 26, 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.





**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.**


28
 *Index*




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 2, 2005.
      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 significant change in our internal control over financial reporting
      during the quarter ended October 2, 2005 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
                2.**
            **Unregistered
                Sales of Equity Securities and Use of
                Proceeds.**





From
      August 5, 2004, the effective date of our Registration Statement on Form S-1
      (File No. 333-115207) to October 2, 2005, in accordance with the disclosure
      set
      forth in the prospectus related to our initial public offering, we have used
      approximately $27.9 million of the net offering proceeds from our initial public
      offering, as follows:





Funding
                for further development of NRP104
            
            $
            13.7
                millionFunding
                for further research and development of NRP290
            
            
            1.2
                millionFunding
                for other preclinical programs, working capital and general corporate
                purposes
            
            
            13.0 millionTotal
            
            $
            27.9
                million





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
      (i) because of our collaboration with Shire we have incurred and will incur
      additional general and administrative expenses and additional pre-clinical
      development expenses that were not originally included in our estimated use
      of
      proceeds from our initial public offering and (ii) based upon further
      discussions with the FDA we 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. Based on these discussions, we believe that we may also be
      required to do additional studies with respect to further development of NRP290,
      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.**




None





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




None.





**Item
                6.**
            **Exhibits**





(a)
            Exhibits.


30
 *Index*


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


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 16, 2005
            /s/
                Randal J. KirkRandal
                J. KirkChairman,
                President and Chief Executive Officer(Principal
                executive officer)Date:
                November 16, 2005
            /s/
                Krish S. KrishnanKrish
                S. KrishnanChief
                Operating Officer, Chief Financial Officer and Secretary(Principal
                financial and accounting officer)






32