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SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

FORM 10-Q

(Mark One)

CIMA LABS INC.
(Exact name of registrant as specified in its charter)

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, and (2) has been subject to such filing requirements for the past 90 days.

                   Yes    [X]       No       [  ]

Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of the latest practical date.

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INDEX
CIMA LABS INC.

All other trademarks used in this report are the property of their respective owners. We have registered “CIMA®,” “CIMA LABS INC.®,” “OraSolv®,” “OraVescent®,” “DuraSolv®” and “PakSolv®” as trademarks with the U.S. Patent and Trademark Office. We also use the trademarks “OraSolv®SR/CR,” “OraVescent®SL/BL” and “OraVescent®SS.” “Triaminic®” and “Softchews®” are trademarks of Novartis. “Zomig®,” “Zomig-ZMT™” and “Rapimelt™” are trademarks of AstraZeneca. “Remeron®” and “SolTab™” are trademarks of Organon. “Tempra®” is a registered trademark of a Canadian affiliate of Bristol-Myers Squibb. “FirsTabs™” is a trademark of Bristol-Myers Squibb. “NuLev™” is a trademark of Schwarz P harma. “Actiq®” is a registered trademark of Anesta Corporation. “Claritin®” and “Reditabs®” are registered trademarks of Schering Corporation. “Maxalt-MLT®” is a registered trademark of Merck & Co., Inc. “Zydis®” is a registered trademark of Cardinal Health, Inc. “FlashDose®” is a registered trademark of Biovail Corporation. “WOWTab®” is a registered trademark of Yamanouchi Pharma Technologies, Inc. “Flashtab®” is a registered trademark of Ethypharm.

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PART I - FINANCIAL INFORMATION

Item 1. Financial Statements

Balance Sheets CIMA LABS INC.

	June 30,				December 31,
	2002				2001
	(Unaudited)				(See note)
Assets
Current assets:
Cash and cash equivalents	$	7,417,959			$	1,879,647
Available-for-sale securities		48,358,111				20,085,284
Trade accounts receivable, net		8,870,329				8,963,105
Interest receivable		1,551,303				2,127,151
Inventories, net		3,991,295				3,770,807
Deferred taxes		700,000				700,000
Prepaid expenses		428,967				170,516
Total current assets		71,317,964				37,696,510
Other assets:
Available-for-sale securities		88,280,875				127,539,806
All other, net		8,384,568				5,933,652
Total other assets		96,665,443				133,473,458
Property and equipment:
Property, plant and equipment		55,056,501				37,490,871
Accumulated depreciation		(11,187,782	)			(9,729,963	)
		43,868,719				27,760,908
Total assets	$	211,852,126			$	198,930,876
Liabilities and stockholders’ equity
Current liabilities:
Accounts payable	$	7,979,819			$	1,607,378
Accrued expenses		2,260,853				1,771,849
Deferred revenue		543,334				775,000
Total current liabilities		10,784,006				4,154,227
Stockholders’ equity:
Convertible preferred stock, $.01 par value; 5,000,000 shares
authorized; none outstanding		-				-
Common stock, $.01 par value; 60,000,000 shares authorized;
14,810,995 and 14,739,116 shares issued and outstanding
(including 619,425 and 533,700 treasury shares), respectively		148,110				147,391
Additional paid-in capital		239,343,563				237,271,364
Accumulated deficit		(19,431,118	)			(27,003,219	)
Accumulated other comprehensive income		1,007,457				2,217,364
Treasury stock		(19,999,892	)			(17,856,251	)
Total stockholders’ equity		201,068,120				194,776,649
Total liabilities and stockholders’ equity	$	211,852,126			$	198,930,876

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Note: The balance sheet at December 31, 2001 has been derived from the audited financial statements at that date but does not include all of the information and footnotes required by generally accepted accounting principles for complete financial statements.

See accompanying notes.

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Statements of Operations
CIMA LABS INC.
(Unaudited)

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Statements of Cash Flows
CIMA LABS INC.

(Unaudited)

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CIMA LABS INC.
Notes to Financial Statements
(Unaudited)

1. Basis of Presentation
CIMA LABS INC. (the “Company”), a Delaware corporation, develops and manufactures fast-dissolve and enhanced-absorption oral drug delivery systems. OraSolv and DuraSolv, the Company’s leading proprietary fast-dissolve technologies, are oral dosage forms incorporating taste-masked active drug ingredients into tablets, which dissolve quickly in the mouth without chewing or the need for water. The Company develops applications for technologies that are licensed to pharmaceutical company partners. The Company currently manufactures and packages five pharmaceutical brands incorporating its proprietary fast-dissolve technologies. Revenues are comprised of three components: net sales of products it manufactures; product development fees and licensing revenues for development activities conducted through collaborative agreements with pharmaceutical companies; and royalties on the sales of products sold by pharmaceutical companies under license from the Company.

The accompanying unaudited financ ial statements have been prepared in accordance with generally accepted accounting principles for interim financial information and with the instructions to Form 10-Q and Article 10 of Regulation S-X. These financial statements do not include all of the information and footnotes required by generally accepted accounting principles for complete financial statements. In the opinion of management, all adjustments, consisting of normal recurring accruals, which are considered necessary for fair presentation have been included. Operating results for the three and six month periods ended June 30, 2002, are not necessarily indicative of the results that may be expected for the year ended December 31, 2002. For further information, you should refer to the audited financial statements and accompanying notes contained in our Annual Report on Form 10-K for the year ended December 31, 2001.

2. Use of Estimates
The preparation of financial statements in conformity with generally accepted accounting principles requires us to make estimates and assumptions that may affect the amounts we report in our financial statements and accompanying notes. Actual results could differ from those estimates.

3. Cash Equivalents and Investments
The Company’s investments in available-for-sale securities are carried at fair value, with unrealized gains and losses included in accumulated other comprehensive income as a separate component of stockholders’ equity. As of June 30, 2002, the amortized cost and estimated market value of available-for-sale securities, all of which have contractual maturities of three years or less, are as follows:

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	Amortized Cost			Gross Unrealized Gains			Gross Unrealized Losses			Estimated Market Value
As of June 30, 2002:
Asset backed securities	$	28,595,681		$	265,062		$	8,201		$	28,852,542
Commercial paper		3,733,506			-			190			3,733,316
Corporate bonds and notes		70,225,247			568,436			90,514			70,703,169
Euro notes		14,075,663			322,874			23,653			14,374,884
Floating rate notes		15,641,940			5,298			47,413			15,599,825
U.S. government securities		3,359,492			15,758			-			3,375,250
Totals – June 30, 2002	$	135,631,529		$	1,177,428		$	169,971		$	136,638,986
As of December 31, 2001:
Asset backed securities	$	30,476,440		$	377,781		$	14,235		$	30,839,986
Corporate bonds and notes		85,770,912			1,371,649			52,536			87,090,025
Euro notes		14,392,231			537,290			-			14,929,521
Floating rate notes		12,696,395			17,283			-			12,713,678
U.S. government securities		2,071,748			-			19,868			2,051,880
Totals – December 31, 2001	$	145,407,726		$	2,304,003		$	86,639		$	147,625,090

4. Income Per Share
Income per share for the three and six months ended June 30, 2002, and 2001 are summarized in the following table:

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5. Comprehensive Income
Comprehensive income consists of net income and net unrealized gains (losses) on available-for-sale securities.

6. Inventories
Inventories are stated at the lower of cost (first in, first out) or fair market value.

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Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations
Forward-Looking Statements

We make many statements in this Quarterly Report on Form 10-Q under the captions Management’s Discussion and Analysis of Financial Condition and Results of Operations, and Factors That Could Affect Future Results and elsewhere, which are forward-looking and are not based on historical facts. These statements relate to our future plans, objectives, expectations and intentions. We may identify these statements by the use of words such as believe, expect, will, anticipate, intend, plan and other similar expressions. These forward-looking statements involve a number of risks and uncertainties. Our actual results could differ materially from those anticipated in these forward-looking statements as a result of various factors, including those we discuss in Factors That Could Affect Future Results and elsewhere in this report. These forward-looking statements speak only as of the date of this report, and we caution you not to rely on these statements wit hout considering the risks and uncertainties associated with these statements and our business that are addressed in this report.

These forward-looking statements include statements relating to the expected growth in operating revenues in the second half of 2002; the timing of expected improvements to our Eden Prairie manufacturing facility; the timing for completion of improvements to our Brooklyn Park R&D center, including the construction of a second site for manufacturing; future expense levels; the timing of availability of products; expected demand for products using our technologies; the adequacy of our production capacity; and future research and development activities relating to our current or new technologies. We are not under any duty to update any of the forward-looking statements after the date of this report to conform these statements to actual results, except as required by law.

Overview

We develop and manufacture pharmaceutical products based on our proprietary OraSolv and DuraSolv fast dissolve technologies. We currently manufacture five pharmaceutical brands utilizing our fast dissolve technologies: three prescription and two over-the-counter brands. These products include Triaminic Softchews for Novartis, Tempra FirsTabs for a Canadian affiliate of Bristol-Myers Squibb, AstraZeneca’s Zomig-ZMT and its equivalent for non-U.S. markets, Remeron SolTab for Organon and NuLev for Schwarz Pharma. The FDA is currently reviewing Wyeth’s (formerly known as American Home Products) regulatory submission for an orally disintegrating dosage form of loratadine that we developed. We are also currently developing other oral drug delivery technologies for ourselves and for others. We operate within a single business segment, the development and manufacture of fast dissolve and enhanced-absorption oral drug delivery systems. Our revenues ar e comprised of three components, including net sales of products we manufacture for pharmaceutical companies using our proprietary fast dissolve technologies, product development fees and licensing revenues for development activities we conduct through collaborative agreements with pharmaceutical companies, and royalties on the sales of our products which are sold by pharmaceutical companies under licenses from us.

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Revenues from product sales and from royalties will fluctuate from quarter to quarter and from year to year depending on, among other factors, demand by consumers for the products we produce, new product introductions, the seasonal nature of some of the products we produce to treat seasonal ailments, pharmaceutical company ordering patterns and our production schedules. Revenues from product development fees and licensing revenue will fluctuate depending on, among other factors, the number of new collaborative agreements that we enter into, the number and timing of product development milestones that we achieve under our collaborative agreements and the level of our development activity conducted for pharmaceutical companies.

Critical Accounting Policies and Estimates

General
The following discussion and analysis of our financial condition and results of operations are based upon our financial statements, which have been prepared in accordance with accounting principles generally accepted in the United States. The preparation of our financial statements requires us to make estimates and judgments that affect the reported amounts of assets, liabilities, revenues and expenses, and related disclosure of contingent assets and liabilities. On an on-going basis, we evaluate our estimates, including those related to bad debts, inventories, income taxes, and contingencies and litigation. 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 thes e estimates under different assumptions or conditions.

We believe the following critical accounting policies affect our more significant judgments and estimates used in the preparation of our financial statements.

Revenue Recognition

We recognize revenue in accordance with the Securities and Exchange Commission’s Staff Accounting Bulletin No. 101, or SAB 101, “Revenue Recognition in Financial Statements.” SAB 101 requires that four basic criteria must be met before revenue can be recognized: (1) persuasive evidence of an agreement exists; (2) delivery has occurred or services rendered; (3) the fee is fixed and determinable; and (4) collectibility is reasonably assured. Revenues from our business activities are recognized from net sales of manufactured products upon shipment; from product development fees as the contracted services are rendered; from product development milestones upon completion and acceptance; from up-front product development license fees as they are amortized over the expected development term of the proposed products; and from royalties on the sales of products sold by pharmaceutical companies under license from us. The determination of SAB 101 c riteria (3) and (4) for each source of revenue is based on our judgments regarding the fixed nature and collectibility of each source of revenue. Revenue recognized for any reporting period could be adversely affected should changes in conditions cause us to determine that these criteria are not met for certain future transactions.

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Deferred Taxes

The carrying value of our net deferred tax assets assumes that we will be able to generate sufficient taxable income in the United States, based on management’s current estimates and assumptions. We record a valuation allowance to reduce the carrying value of our net deferred tax assets to the amount that is more likely than not to be realized. While we have considered future taxable income and ongoing prudent and feasible tax planning strategies in assessing the requirements for the valuation allowance, in the event we were to determine that we would be able to realize our deferred tax assets in the future in excess of our net recorded amount, an adjustment to the deferred tax asset would increase net income in the period such determination is made. Likewise, should we determine that we would not be able to realize all or part of our net deferred tax asset in the future, an adjustment to the net deferred tax asset would decrease net income in the period such determination is made. On a quarterly basis, we evaluate the realizability of our deferred tax assets and assess the requirements for a valuation allowance. For the six months ended June 30, 2002, we have recorded an $11.5 million valuation allowance related to our net deferred tax assets of $20.1 million, compared to a valuation allowance of $16.2 million related to our net deferred tax assets of $22.4 million for the year ended December 31, 2001.

Results of Operations

Three and Six Month Periods Ended June 30, 2002 and 2001

Components of revenue, expenses, and net income as a percentage of total operating revenue for the three and six month periods ended June 30 were as follows:

Operating Revenues. Total operating revenues for the second quarter ended June 30, 2002 were $10.2 million, an increase of $2.1 million, or 27%, over the same period in 2001, and for the first half of 2002, total operating revenues were $18.6 million, an increase of $4.6 million, or 33%, over same period in 2001. The second quarter and first half increases in total operating revenue resulted from increases in all three of our revenue components: (1) royalties on the sales of our products which are sold by pharmaceutical companies under licenses from us, (2) product development fees and licensing revenue, and (3) revenues from the sales of products we manufacture.

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Revenues from net sales of products we manufacture in the second quarter of 2002 were $4.6 million, an increase of $38,000, or 1%, over the same period of 2001, and for the first half of 2002, revenues from net sales of products we manufacture were $8.9 million, an increase of $1.0 million, or 12%, over the same period of 2001. The second quarter and first half increases were primarily due to higher manufacturing volumes of Remeron SolTab for Organon that were partially offset by lower sales of Triaminic Softchews for Novartis. As a category, sales of branded prescription products increased; representing 81% and 77% of our total product sales in the second quarter and first half of 2002, respectively, compared with 50% and 60% in last year’s second quarter and first half, respectively. Triaminic Softchews are expected to account for a higher proportion of manufacturing volumes in the third quarter, which is typically the peak quarter for this over - -the-counter product due to its seasonal nature.

Revenues from product development fees and licensing were $3.1 million in the second quarter of 2002, an increase of $1.0 million, or 50%, from the same period of 2001, and for the first half of 2002, revenues from product development fees and licensing were $5.4 million, an increase of $1.5 million, or 37%, from the same period of 2001. These increases resulted from agreements for proposed new products, our achievement of certain milestones under existing agreements, and an overall increase in development activity. Revenues from product development fees and licensing included amortization of deferred revenue of $206,000 and $282,000 in the second quarter and first half of 2002, respectively, compared to $13,000 and $92,000 in the same periods of 2001, respectively. For full-year 2002, we expect combined revenues attributable to product development fees and licensing revenues to increase by approximately 20 to 25% from 2001 levels.

Revenues from royalties were $2.5 million in the second quarter of 2002, an increase of $1.1 million or 77% over the same period of 2001, and for the first half of 2002, revenues from royalties were $4.3 million, an increase of $2.1 million, or 97%, over the same period of 2001. The increases were due primarily to increased end-customer sales by Organon of Remeron SolTab and increased end-customer sales by AstraZeneca of Zomig Rapimelt (the non-U.S. equivalent of Zomig-ZMT) in Europe and Zomig-ZMT in the United States. For full-year 2002, we expect royalties to increase by approximately 100% from 2001 levels.

Cost of goods sold. Cost of goods sold was $3.8 million in the second quarter of 2002, a decrease of $305,000 from $4.1 million in the second quarter of 2001, and cost of goods sold in the first half of 2002 increased to $7.2 million from $6.7 million for the same period of 2001. The second quarter decrease of $305,000 was principally due to an improved mix in the products we manufactured and shipped compared to the same period last year. The first half of 2002 cost of goods sold increase of $450,000 was due mainly to higher production volumes and higher levels of depreciation expense over the same period in 2001. For 2002, we expect cost of goods sold to increase from 2001 in terms of dollar amounts, but decrease as a percentage of net sales of products we manufacture.

Gross profits on product sales were $827,000 and $1.7 million in the second quarter and first half of 2002, respectively, compared to $484,000 and $1.2 million in the same periods of 2001, respectively. The second quarter and first half improvements were principally due

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to increased production volumes of higher margin branded prescription products. Gross profits on product sales were 18% and 19% of total product sales in the second quarter and first half of 2002, respectively, compared to 11% and 15% for the same periods in 2001, respectively, reflecting the increased mix of branded prescription products. For full-year 2002, we expect gross profits on product sales to increase from 2001 levels in terms of dollar amounts and as a percentage of product sales.

Research and product development expenses. Research and product development expenses were $2.5 million in the second quarter of 2002, an increase of $1.1 million, or 82%, over the same period of 2001, and for the first half of 2002, these expenses were $4.5 million, an increase of $1.7 million, or 59%, over the same period of 2001. These increases were due primarily to additional staffing, development activity for our proprietary products, including OraVescent fentanyl, and infrastructure investments. For full-year 2002, we expect research and product development expenses to increase by approximately 50% from 2001 levels due to a significant increase in development work for our collaborative pharmaceutical company partners, as well as development efforts related to our proprietary products

Selling, general and administrative expenses. Selling, general and administrative expenses were $1.9 million in the second quarter of 2002, an increase of $633,000, or 48%, over the same period of 2001. Selling, general and administrative expenses of $3.4 million for the first half of 2002 increased $1.0 million, or 41%, over the same period of 2001. These increases were due primarily to costs associated with increased professional staffing. In the second quarter of 2002, selling, general and administrative expenses included approximately $200,000 of one-time executive recruitment and relocation costs. For full-year 2002, we expect selling, general and administrative expenses to increase approximately 40% from 2001 levels as we continue to make investments in people and systems to support our anticipated growth.

Other income (expense). Other income was $1.9 million in the second quarter of 2002, a decrease of $446,000, over the same period of 2001. For the first half of 2002 other income of $3.7 million decreased $1.2 million from the same period of 2001. Other income consists primarily of investment income comprised of interest earned on securities and gains realized on the sale of securities. The decreases from 2001 were due primarily to lower levels of cash available for investment and from lower interest rates on our investments. For full-year 2002, we expect other income to decrease in the range of 35 to 40% from 2001 levels due to lower interest rates and expected capital expenditures, which will reduce the level of cash available for investment.

Liquidity and Capital Resources

We have financed our operations to date primarily through private and public sales of equity securities, other income, and from operating revenues consisting of product sales, product development fees and licensing revenues, and royalties.

Working capital increased from $33.5 million at December 31, 2001, to $60.5 million at June 30, 2002. The increase of $27.0 million resulted primarily from the reclassification of $28.3 million of non-current available-for-sale securities to current available-for-sale

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securities when the maturities of those securities became less than one year. Cash and available-for-sale securities, including both current and non-current securities, were $144.1 million at June 30, 2002, compared to $149.5 million at December 31, 2001. This decrease of $5.4 million resulted from $17.6 million of capital expenditures made by the Company (including $5.7 million used to purchase our Eden Prairie corporate headquarters and manufacturing facility), and common stock repurchases of $2.1 million, partially offset by $14.7 million of cash generated from our operating activities. We invest excess cash in interest-bearing money market accounts and investment grade securities.

During the next six months, we plan to spend approximately $15.0 to $20.0 million to add granulation capabilities and expand taste-masking capacity to our Eden Prairie manufacturing facility, expand and renovate our Brooklyn Park R&D center, and to initiate work on a second manufacturing site, which will be located at our Brooklyn Park R&D center. We expect this second manufacturing site, which will include a bottling production line, to be operational in the second half of 2003. In addition, we expect to fund additional product development activities related to our OraVescent technology and to develop proprietary products using our OraSolv and DuraSolv technologies. We may also acquire technologies that complement our current portfolio of oral drug delivery technologies. We believe that our cash and cash equivalents and available-for-sale securities, together with expected revenues from operations, will be sufficient to meet our anticipated capital requirements for the foreseeable future. However, we may require additional funds to support our working capital requirements or for other purposes and may seek to raise such additional funds through public or private equity financings or from other sources. We cannot be certain that additional financing will be available on terms favorable to us, or at all, or that any additional financing will not be dilutive.

Factors That Could Affect Future Results

Certain statements made in this Quarterly Report on Form 10-Q are forward-looking statements based on our current expectations, assumptions, estimates and projections about our business and our industry. These forward-looking statements involve risks and uncertainties. Our business, financial condition and results of operations could differ materially from those anticipated in these forward-looking statements as a result of certain factors, as more fully described below and elsewhere in this Form 10-Q. You should consider carefully the risks and uncertainties described below, which are not the only ones facing our company. Additional risks and uncertainties also may impair our business operations.

The Loss Of One Of Our Major Customers Could Reduce Our Revenues Significantly.
Revenues from AstraZeneca, Organon and Novartis together represented approximately 70% of our total operating revenues for both the quarter ended June 30, 2002, and for the six months ended June 30, 2002, compared to 85% and 84% for the corresponding periods in 2001. The loss of any one of these customers could cause our revenues to decrease significantly, resulting in losses from our operations. If we cannot broaden our customer base, we will continue to depend on a few customers for the majority of our revenues. We may be unable to negotiate favorable business terms with customers that represent a significant portion of our revenues. If we cannot, our revenues and

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gross profits may not grow as expected and may be insufficient to allow us to achieve sustained profitability.

We Rely On Third Parties To Market, Distribute And Sell The Products Incorporating Our Drug Delivery Technologies And Those Third Parties May Not Perform.
Our pharmaceutical company partners market and sell the products we develop and manufacture. If one or more of our pharmaceutical company partners fails to pursue the marketing of our products as planned, our revenues and gross profits may not reach our expectations, or may decline. We often cannot control the timing and other aspects of the development of products incorporating our technologies because our pharmaceutical company partners may have priorities that differ from ours. Therefore, our commercialization of products under development may be delayed unexpectedly. Because we incorporate our drug delivery technologies into the oral dosage forms of products marketed and sold by our pharmaceutical company partners, we do not have a direct marketing channel to consumers for our drug deli very technologies. The marketing organizations of our pharmaceutical company partners may be unsuccessful, or they may assign a low level of priority to the marketing of our products that is different from our priorities. Further, they may discontinue marketing the products that incorporate our drug delivery technologies. If marketing efforts for our products are not successful, our revenues may fail to grow as expected or may decline.

If We Do Not Enter Into Additional Collaborative Agreements with Pharmaceutical Companies, We May Not Be Able To Achieve Sustained Profitability.
We depend upon collaborative agreements with pharmaceutical companies to develop, test and obtain regulatory approval for, and commercialize oral dosage forms of, active pharmaceutical ingredients using our drug delivery technologies. The number of products that we successfully develop under these collaborative agreements will affect our revenues. If we do not enter into additional agreements in the future, or if our current or future agreements do not result in successful marketing of our products, our revenues and gross profits may be insufficient to allow us to achieve sustained profitability.

      We face additional risks related to our collaborative agreements, including the risks that:

If We Cannot Increase Our Production Capacity, We May Be Unable To Meet Expected Demand For Our Products And We May Lose Revenues.
We must increase our production capacity to meet expected demand for our products. We currently have two production lines and are planning to add a bottling line and other manufacturing equipment in 2003. If we are unable to increase our production capacity as

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scheduled, we may be unable to meet expected demand for our products, we may lose revenues and we may not be able to maintain our relationships with our pharmaceutical company partners. Production lines in the pharmaceutical industry generally take 16 to 24 months to complete due to the long lead times required for precision production equipment to be manufactured and installed, as well as the required testing and validation process that must be completed once the equipment is installed. We may not be able to increase our production capacity quickly enough to meet the requirements of our pharmaceutical company partners.

If We Do Not Properly Manage Our Growth, We May Be Unable To Sustain The Level Of Revenues We Have Attained Or Effectively Pursue Additional Business Opportunities.
Compared to the corresponding periods a year earlier, our operating revenues increased 34% and 33% for the year ended December 31, 2001, and for the six month period ended June 30, 2002, respectively, placing significant strain on our management, administrative and operational resources. If we do not properly manage the growth we have recently experienced and expect in the future, our revenues may decline or we may be unable to pursue sources of additional revenues. To properly manage our growth, we must, among other things, implement additional (and improve existing) administrative, financial and operational systems, procedures and controls on a timely basis. We will also need to expand our finance, administrative and operations staff. We may not be able to complete the improveme nts to our systems, procedures and controls necessary to support our future operations in a timely manner. We may not be able to hire, train, integrate, retain, motivate and manage required personnel and may not be able to successfully identify, manage and pursue existing and potential market opportunities. Improving our systems and increasing our staff will increase our operating expenses. If we fail to generate additional revenue in excess of increased operating expenses in any fiscal period we may incur losses, or our losses may increase in that period.

We May Be Unable To Achieve Our Anticipated Revenues and Profits Because The Markets For The Products We Develop And Manufacture For Our Pharmaceutical Company Partners Are Subject To Market Risks From The Introduction of Generic Prescription Products, The Pricing Strategies Of Generic Competitors And From Regulatory Strategies That Could Switch A Prescription Product To An Over-The-Counter Product.
In January 2002, Mylan Laboratories and Teva Pharmaceutical Industries announced that they received tentative approval from the FDA for mirtazapine tablets, which are expected to be generic substitutes for Organon’s Remeron standard tablets. In March 2002, Akzo Nobel NV, Organon’s parent company, reported that Organon sued seven generic pharmaceutical companies, including Teva and Mylan, for the infringement of Organon’s U.S. patent for Remeron (mirtazapine standard tablets). In May 2002, Organon announced that it sued Barr Laborato ries, Inc. for infringing on its U.S. patent for Remeron SolTab (mirtazapine orally disintegrating tablets). The U.S. market launch of generic mirtazapine standard tablets by Mylan Laboratories, Teva Pharmaceutical Industries, and five other unnamed generic pharmaceutical companies, as well as the U.S. market launch of generic orally disintegrating mirtazapine tablets by Barr Laboratories, is subject to final FDA approval, which could occur after the resolution of all legal issues related to Organon’s patent rights. Organon is vigorously defending its patent rights, which it believes apply through June 2017. There can be no assurance that Organon’s market for Remeron SolTab would not be negatively affected by generic mirtazapine competition due to the potential impact of lower product pricing

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resulting from generic competition from either or both standard and orally disintegrating tablets. Due to the large number of variables and high degree of uncertainty, we are unable to predict the timing for the market introduction of a generic mirtazapine standard tablet or a generic mirtazapine orally disintegrating tablet, or the effect of such generic product introductions on our business.

Another pharmaceutical active that involves a high degree of uncertainty is loratadine, which is currently a prescription product. We have developed for Wyeth (formerly known as American Home Products) a fast dissolve formulation of loratadine for both the prescription pharmaceutical and the over-the-counter markets, which Wyeth expects to market as a competitive product to Claritin Reditabs in 2003, unless Schering Corporation, the loratadine patent holder, is successful in its efforts to secure extended exclusive rights to market Claritin. In August 2002, Schering Corporation received a summary judgement from a United States District Court that invalidates their patent. Schering Corporation is expected to appeal this Court’s decision.

In May 2001, a joint committee of the FDA’s Nonprescription Drugs Advisory Committee and Pulmonary-Allergy Drugs Advisory Committee made a non-binding recommendation that loratadine, the active drug ingredient in Claritin, has a safety profile acceptable for over-the-counter marketing. In March 2002, Schering Corporation announced that the FDA has accepted for filing its application to switch all formulations of Claritin to over-the-counter products. In April 2002, the FDA’s Nonprescription Advisory Committee endorsed Claritin (loratadine) for over-the-counter treatment in chronic idiopathic urticaria, or chronic hives of unknown cause. We have developed for Wyeth a fast dissolve formulation of loratadine for the over-the-counter market, which Wyeth is expected to launch in the U.S. market, subject to the FDA’s approval to switch loratadine to the over-the-counter market and the resolution of certain legal and patent issues brought by Sc hering Corporation in their efforts to secure extended exclusive rights to market loratadine.

The ongoing litigation against Wyeth and others by Schering Corporation to prevent or delay the market entry of a loratadine product, as well as Schering Corporation’s application to switch loratadine to the over-the-counter market, could affect our anticipated revenues and profits. The potential switch of loratadine from the prescription market to the over-the-counter market affects pricing, distribution channels, advertising, insurance reimbursement and a variety of other marketing and regulatory factors. The effects of a delayed market entry of Wyeth’s generic alternative to Claritin Reditabs and the potential switch from the prescription market to the over-the-counter market involve a high degree of uncertainty and we are unable to predict the effect of such changes on our business.

We May Experience Significant Delays In Expected Product Releases While Our Pharmaceutical Company Partners Seek Regulatory Approvals For The Products We Develop And, If They Are Not Successful In Obtaining The Approvals, We May Be Unable To Achieve Our Anticipated Revenues And Profits.
The federal government, principally the U.S. Food and Drug Administration, and state and local government agencies regulate all new pharmaceutical products, including our existing products and those under development. Our pharmaceutical company partners may experience significant delays in expected product releases while attempting to obtain regulatory approval for the products we develop. If

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they are not successful, our revenues and profitability may decline. We cannot control, and our pharmaceutical company partners cannot control, the timing of regulatory approval for the products we develop.

Applicants for FDA approval often must submit extensive clinical data and supporting information to the FDA. Varying interpretations of the data obtained from pre-clinical and clinical testing could delay, limit or prevent regulatory approval of a drug product. Changes in FDA approval policy during the development period, or changes in regulatory review for each submitted new drug application, also may cause delays or rejection of an approval. Even if the FDA approves a product, the approval may limit the uses or “indications” for which a product may be marketed, or may require further studies. The FDA also can withdraw product clearances and approvals for failure to comply with regulatory requirements or if unforeseen problems follow initial marketing.

Manufacturers of drugs also must comply with applicable good manufacturing practices requirements. If we cannot comply with applicable good manufacturing practices, we may be required to suspend the production and sale of our products, which would reduce our revenues and gross profits. We may not be able to comply with the applicable good manufacturing practices and other FDA regulatory requirements for manufacturing as we expand our manufacturing operations.

If our products are marketed in foreign jurisdictions, we, and the pharmaceutical company partners with which we are developing our technologies, must obtain required regulatory approvals from foreign regulatory agencies and comply with extensive regulations regarding safety and quality. If approvals to market our products are delayed, if we fail to receive these approvals, or if we lose previously received approvals, our revenues would be reduced. We may be required to incur significant costs in obtaining or maintaining foreign regulatory approvals.

Our Commercial Products Are Subject To Continuing Regulations And We May Be Subject To Adverse Consequences If We Fail To Comply With Applicable Regulations.
Even if our products receive regulatory approval, either in the U.S. or internationally, we will continue to be subject to extensive regulatory requirements. These regulations are wide-ranging and govern, among other things:

If we fail to comply or maintain compliance with these laws and regulations, we may be fined or barred from selling our products. If the FDA determines that we are not complying with the law, it can:

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•	refuse to permit products to be imported into, or exported out of, the U.S.;
•	totally or partially suspend our production;
•	withdraw previously approved marketing applications; and
•	initiate criminal prosecutions.

We Have A Single Manufacturing Facility And We May Lose Revenues And Be Unable To Maintain Our Relationships With Our Pharmaceutical Company Partners If We Lose Its Production Capacity.
We manufacture all our products on our existing production lines in our Eden Prairie facility. If our existing production lines or facility becomes incapable of manufacturing products for any reason, we may be unable to meet production requirements, we may lose revenues and we may not be able to maintain our relationships with our pharmaceutical company partners. Without our existing production lines, we would have no other means of manufacturing products incorporating our drug delivery technologies until we were able to restore the manufacturing capability at our facility or develop an alternative manufacturing facility. Although we carry business interruption insurance to cover lost revenues and profits in an amount we consider adequate, this insurance does not cover all possible situations. In addition, our business interruption insurance would not compensate us for the loss of opportunity and potential adverse impact on relations with our existing pharmaceutical company partners resulting from our inability to produce products for them. Although we currently plan to add a second manufacturing site at our Brooklyn Park, Minnesota facility to reduce this risk, we may encounter unforeseen difficulties or delays in doing so.

We Rely On Single Sources For Some Of Our Raw Materials And We May Lose Revenues And Be Unable To Maintain Our Relationships With Our Pharmaceutical Company Partners If Those Materials Were Not Available.
We rely on single suppliers for some of our raw materials and packaging supplies. If these raw materials or packaging supplies were no longer available we may be unable to meet production requirements, we may lose revenues and we may not be able to maintain our relationships with our pharmaceutical company partners. Without adequate supplies of raw materials or packaging supplies, our manufacturing operations may be interrupted until another supplier could be identified, its products validated and trading terms with it negotiated. We may not be able to identify an alternative supplier in a timely manner, or at all. Furthermore, we may not be able to negotiate favorable terms with an alternative supplier. Any disruptions in our manufacturing operations from the loss of a supplier could potentially damage our relations with our pharmaceutical company partners.

If We Cannot Develop Additional Products, Our Ability To Increase Our Revenues Would Be Limited.
We intend to continue to enhance our current technologies and pursue additional proprietary drug delivery technologies. If we are unable to do so, we may be unable to achieve our objectives of revenue growth and sustained profitability. Even if enhanced or additional technologies appear promising during various stages of development, we may not be able to develop commercial applications for them because:

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•	we may not find a pharmaceutical company willing to adopt the technologies;
•	it may be difficult to apply the technologies on a commercial scale; or
•	the technologies may be uneconomical to market.

If We Cannot Keep Pace With The Rapid Technological Change And Meet The Intense Competition In Our Industry, We May Lose Business.
Our success depends, in part, on maintaining a competitive position in the development of products and technologies in a rapidly evolving field. If we cannot maintain competitive products and technologies, our current and potential pharmaceutical company partners may choose to adopt the drug delivery technologies of our competitors. Fast dissolve tablet technologies that compete with our OraSolv and DuraSolv technologies include the Zydis technology developed by R.P. Scherer Corporation, a wholly-owned subsidiary of Cardinal Health, Inc., the WOWTab technology developed by Yamanouchi Pharma Technologies, the Flashtab technology developed by Ethypharm and the FlashDose technology developed by Fuisz Technologies Ltd., a wholly-owned subsidiary of Biovail Corporation. We also compete generally with other drug deliver y, biotechnology and pharmaceutical companies engaged in the development of alternative drug delivery technologies or new drug research and testing. Many of these competitors have substantially greater financial, technological, manufacturing, marketing, managerial and research and development resources and experience than we do and represent significant competition for us.

Our competitors may succeed in developing competing technologies or obtaining governmental approval for products before us. The products of our competitors may gain market acceptance more rapidly than our products. Developments by competitors may render our products, or potential products, noncompetitive or obsolete.

If We Cannot Adequately Protect Our Technology And Proprietary Information, We May Be Unable To Sustain A Competitive Advantage.
Our success depends, in part, on our ability to obtain and enforce patents for our products, processes and technologies and to preserve our trade secrets and other proprietary information. If we cannot do so, our competitors may exploit our innovations and deprive us of the ability to realize revenues and profits from our developments. We have been granted more than fourteen patents on our drug delivery and packaging systems in the U.S., which will expire beginning in 2010.

Any patent applications we may have made or may make relating to our potential products, processes and technologies may not result in patents being issued. Our current patents may not be valid or enforceable. They may not protect us against competitors that challenge our patents, obtain patents that may have an adverse effect on our ability to conduct business or are able to circumvent our patents. Further, we may not have the necessary financial resources to enforce our patents.

To protect our trade secrets and proprietary technologies and processes, we rely, in part, on confidentiality agreements with our employees, consultants and advisors. These agreements may not provide adequate protection for our trade secrets and other proprietary information in the event of any unauthorized use or disclosure, or if others lawfully develop the information.

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Third Parties May Claim That Our Technologies, Or The Products In Which They Are Used, Infringe On Their Rights And We May Incur Significant Costs Resolving These Claims.
Third parties may claim that the manufacture, use or the sale of our drug delivery technologies infringe on their patent rights. If such claims are asserted, we may have to seek licenses, defend infringement actions or challenge the validity of those patents in court. If we cannot obtain required licenses, are found liable for infringement or are not able to have these patents declared invalid, we may be liable for significant monetary damages, encounter significant delays in bringing products to market or be precluded from participating in the manufacture, use or sale of products or methods of drug delivery covered by the patents of others. We may not have identified, or be able to identify in the future, U.S. and foreign patents that pose a risk of potential infringement c laims.

We enter into collaborative agreements with pharmaceutical companies to apply our drug delivery technologies to drugs developed by others. Ultimately, we receive license revenues and product development fees, as well as revenues from, and royalties on, the sale of products incorporating our technology. The drugs to which our drug delivery technologies are applied are generally the property of the pharmaceutical companies. Those drugs may be the subject of patents or patent applications and other forms of protection owned by the pharmaceutical companies or third parties. If those patents or other forms of protection expire, are challenged or become ineffective, sales of the drugs by the collaborating pharmaceutical company may be restricted or may cease.

Because We Have A Limited Operating History, Potential Investors In Our Stock May Have Difficulty Evaluating Our Prospects.
We recorded the first commercial sales of products using our fast dissolve technologies in early 1997. Accordingly, we have only a limited operating history, which may make it difficult for you and other potential investors to evaluate our prospects. The difficulty investors may have in evaluating our prospects may cause volatile fluctuations, including decreases, in the market price of our common stock as investors react to information about our prospects. Since 1997, we have generated revenues from product development fees and licensing arrangements, sales of products using our fast dissolve technologies and royalties. We are currently making the transition from research and product development operations with limited production to commercial operations with expanding production capabilities in addition to research and product development activities. Our business and prospects, therefore, must be evaluated in light of the risks and uncertainties of a company with a limited operating history and, in particular, one in the pharmaceutical industry.

If We Are Not Profitable In The Future, The Value Of Our Stock May Fall.
Although we were profitable for the year ended December 31, 2001, and the six months ended June 30, 2002, we have accumulated aggregate net losses from inception of approximately $19.4 million. If we are unable to sustain profitable operations in future periods, the market price of our stock may fall. The costs for research and product development of our drug delivery technologies and general and administrative expenses have been the principal causes of our losses. Our ability to achieve sustained profitable operations depends on a number of factors, many of which are beyond our direct control. These factors include:

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•	the demand for our products;
•	our ability to manufacture our products efficiently and with the required quality;
•	our ability to increase our manufacturing capacity;
•	the level of product and price competition;
•	our ability to develop additional commercial applications for our products;
•	our ability to control our costs; and
•	general economic conditions.

We May Require Additional Financing, Which May Not Be Available On Favorable Terms Or At All And Which May Result In Dilution Of The Equity Interest Of An Investor.
We may require additional financing to fund the development and possible acquisition of new drug delivery technologies and to increase our production capacity beyond what is currently anticipated. If we cannot obtain financing when needed, or obtain it on favorable terms, we may be required to curtail any plans to develop or acquire new drug delivery technologies or may be required to limit the expansion of our manufacturing capacity. We believe our cash and cash equivalents, and expected revenues from operations will be sufficient to meet our anticipated capital requirements for the foreseeable future. However, we may elect to pursue additional financing at any time to more aggressively pursue development of new drug delivery technologies and expand manufacturing capacity beyond that currently planned.

Other factors that will affect future capital requirements and may require us to seek additional financing include:

Demand For Some Of Our Products Is Seasonal, And Our Sales And Profits May Suffer During Periods When Demand Is Light.
Certain non-prescription products that we manufacture for our pharmaceutical company partners treat seasonal ailments such as colds, coughs and allergies. Our pharmaceutical company partners may choose to not market those products in off-seasons and our sales and profits may decline in those periods as a result. For full-year 2001 and for the first six months of 2002, operating revenues from Novartis, which included revenues related to Triaminic, a seasonal cold, cough and allergy product, represented 33% and 16%, respectively, of our total operating revenues for such periods. We may not be successful in developing a mix of products to reduce these seasonal variations.

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If The Marketing Claims Asserted About Our Products Are Not Approved, Our Revenues May Be Limited.
Once a drug product incorporating our technologies is approved by the FDA, the Division of Drug Marketing, Advertising and Communication, the FDA’s marketing surveillance department within the Center for Drug Evaluation and Research, must approve marketing claims asserted about it by our pharmaceutical company partners. If our pharmaceutical company partners fail to obtain from the Division of Drug Marketing acceptable marketing claims for a product incorporating our drug technology, our revenues from that product may be limited. Marketing claims are the basis for a product’s labeling, advertising and promotion. The claims our pharmaceutical company partners are asserting about our drug delivery technology, or the drug product itself, may not be approved by the Division of Drug Marketing.

We May Face Product Liability Claims Related To Participation In Clinical Trials Or The Use Or Misuse Of Our Products.
The testing, manufacturing and marketing of products using our drug delivery technologies may expose us to potential product liability and other claims resulting from their use. If any such claims against us are successful, we may be required to make significant compensation payments. Any indemnification that we have obtained, or may obtain, from contract research organizations or pharmaceutical companies conducting human clinical trials on our behalf may not protect us from product liability claims or from the costs of related litigation. Similarly, any indemnification we have obtained, or may obtain, from pharmaceutical companies with which we are developing our drug delivery technologies may not protect us from product liability claims from the consumers of those products or from the costs of related litigation. If we are subject to a product liability claim, our product liability insurance may not reimburse us, or be sufficient to reimburse us, for any expenses or losses we may suffer. A successful product liability claim against us, if not covered by, or if in excess of, our product liability insurance, may require us to make significant compensation payments, which would be reflected as expenses on our statement of operations and reduce our earnings.

Anti-Takeover Provisions Of Our Corporate Charter Documents, Delaware Law And Our Stockholders’ Rights Plan May Affect The Price Of Our Common Stock.
Our corporate charter documents, Delaware law and our stockholders’ rights plan include provisions that may discourage or prevent parties from attempting to acquire us. These provisions may have the effect of depriving our stockholders of the opportunity to sell their stock at a price in excess of prevailing market prices in an acquisition of us by another company. Our board of directors has the authority to issue up to 5,000,000 shares of preferred stock and to determine the rights, preferences and privileges of those shares without any further vote or action by our stockholders. The rights of holders of our common stock may be adversely affected by the rights of the holders of any preferred stock that may be issued in the future. Additional provisions of our certificate of incorporat ion and bylaws could have the effect of making it more difficult for a third party to acquire a majority of our outstanding voting common stock. These include provisions that limit the ability of stockholders to call special meetings or remove a director for cause.

We are subject to the provisions of Section 203 of the Delaware General Corporation Law, which prohibits a publicly-held Delaware corporation from engaging in a “business combination” with an “interested stockholder” for a period of three years after the date of the

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transaction in which the person became an interested stockholder, unless the business combination is approved in a prescribed manner. For purposes of Section 203, a “business combination” includes a merger, asset sale or other transaction resulting in a financial benefit to the interested stockholder, and an “interested stockholder” is a person who, either alone or together with affiliates and associates, owns (or within the past three years, did own) 15% or more of the corporation’s voting stock.

We also have a stockholders’ rights plan, commonly referred to as a poison pill, which makes it difficult, if not impossible, for a person to acquire control of us without the consent of our board of directors.

Our Stock Price Has Been Volatile And May Continue To Be Volatile.
The trading price of our common stock has been, and is likely to continue to be, highly volatile. The market value of your investment in our common stock may fall sharply at any time due to this volatility. In the year ended December 31, 2001, the closing sale price for our common stock ranged from $30.05 to $85.75. For the six months ended June 30, 2002, the closing sale price for our common stock ranged from $18.94 to $35.45. The market prices for securities of drug delivery, biotechnology and pharmaceutical companies historically have been highly volatile. Factors that could adversely affect our stock price include:

Our Operating Results May Fluctuate, Causing Our Stock Price To Fall.
Fluctuations in our operating results may lead to fluctuations, including declines, in our stock price. Our operating results may fluctuate from quarter to quarter and from year to year depending on:

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•	the number and timing of product development milestones that we achieve under collaborative agreements;
•	the level of our development activity conducted for, and at the direction of, pharmaceutical companies under collaborative agreements; and
•	the level of our spending on new drug delivery technology development and technology acquisition, and internal product development.

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Item 3. Quantitative and Qualitative Disclosures about Market Risks

The Company is subject to interest rate and foreign currency risks. Our investments in fixed-rate debt securities, which are classified as available-for-sale at June 30, 2002, have remaining maturities ranging from 3 to 36 months and thus are exposed to the risk of fluctuating interest rates. Available-for-sale securities had a market value of $136.6 million at June 30, 2002, and represented 64% of total assets. The primary objective of our investment activities is to preserve capital. We have not used derivative financial instruments in our investment portfolio.

We performed a sensitivity analysis assuming a hypothetical 10% adverse movement in interest rates applicable to fixed rate investments maturing during the next twelve months that are subject to reinvestment risk. As of June 30, 2002, the analysis indicated that these hypothetical market movements would not have a material effect on our financial position, results of operations or cash flow.

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PART II - OTHER INFORMATION

Item 4. Submission of Matters to Vote of Security Holders

The Annual Meeting of the Stockholders of the Company was held on Wednesday, June 5, 2002. There were 14,149,929 shares of the Company’s common stock entitled to vote and a total of 13,222,905 shares were represented at the Annual Meeting. Two matters were submitted to the stockholders for approval: (1) the election of six directors and (2) the ratification of the selection of Ernst & Young LLP as the independent public accountants for the Company.

Six nominees, namely John M. Siebert, Ph.D., Terrence W. Glarner, Steven B. Ratoff, Joseph R. Robinson, Ph.D., John F. Chappell, and Steven D. Cosler, were duly elected as directors of the Company until the next annual meeting of stockholders. Each nominee received at least ninety-eight percent of the votes cast in favor of his election. Further results of the voting were as follows:

There were no abstentions and no broker non-votes.

The proposal to approve the selection of Ernst & Young LLP as the independent public accountants for the Company was approved by the Company’s stockholders. A total of 12,890,503 shares of the Company’s common stock were voted in favor of the proposal, 427,161 shares of the Company’s common stock were voted against the proposal and holders of 5,241 shares of the Company’s common stock abstained from voting. There were no broker non-votes. The proposal to approve the selection of Ernst & Young LLP as the independent public accountants for the Company received approximately ninety-seven percent of the vote cast.

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Item 6. Exhibits and Reports on Form 8-K

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SIGNATURE

Pursuant to the requirements of the Securities Exchange Act of 1934, as amended, the Registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.

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