SHEFFIELD PHARMACEUTICALS INC - 10-Q Quarterly Report

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SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549

FORM 10-Q

[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934

FOR THE QUARTER ENDED SEPTEMBER 30, 2002

Commission file number 1-12584

SHEFFIELD PHARMACEUTICALS, INC.
(Exact name of registrant as specified in its Charter)

DELAWARE 13-3808303
(State of Incorporation) (IRS Employer Identification Number)

14528 SOUTH OUTER FORTY ROAD 63017 (314) 579-9899
ST. LOUIS, MISSOURI (Zip Code) (Registrant's telephone,
(Address of principal executive offices) including area code)

SECURITIES REGISTERED PURSUANT TO SECTION 12(b) OF THE ACT:

Title of Class Name of each exchange on which registered
Common Stock. $.01 par value American Stock Exchange

SECURITIES REGISTERED PURSUANT TO SECTION 12(g) OF THE ACT:

None

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
during the preceding 12 months (or for such shorter period that the registrant
was required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days.
[X] Yes [ ] No

The number of shares outstanding of the Registrant's Common Stock is 29,563,712
shares as of November 14, 2002.

SHEFFIELD PHARMACEUTICALS, INC. AND SUBSIDIARIES
(a development stage enterprise)

FORM 10-Q
For the Quarter Ended September 30, 2002

Table of Contents

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PART I: FINANCIAL INFORMATION

Item 1. Financial Statements

SHEFFIELD PHARMACEUTICALS, INC. AND SUBSIDIARIES
(a development stage enterprise)
CONSOLIDATED BALANCE SHEETS

See notes to consolidated financial statements.

3

SHEFFIELD PHARMACEUTICALS, INC. AND SUBSIDIARIES
(a development stage enterprise)

CONSOLIDATED STATEMENTS OF OPERATIONS
For the Three and Nine Months Ended September 30, 2002
and 2001 and for the Period from October 17, 1986
(inception) to September 30, 2002
(Unaudited)

See notes to consolidated financial statements.

4

SHEFFIELD PHARMACEUTICALS, INC. AND SUBSIDIARIES
(a development stage enterprise)
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY (NET CAPITAL DEFICIENCY)
For the Period from October 17, 1986 (Inception) to September 30, 2002
(Unaudited)

See notes to consolidated financial statements.

5

SHEFFIELD PHARMACEUTICALS, INC. AND SUBSIDIARIES
(a development stage enterprise)

CONSOLIDATED STATEMENTS OF CASH FLOWS
For the Nine Months Ended September 30, 2002 and 2001 and for the Period
from October 17, 1986 (inception) to September 30, 2002
(Unaudited)

See notes to consolidated financial statements.

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SHEFFIELD PHARMACEUTICALS, INC. AND SUBSIDIARIES
(a development stage enterprise)

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
SEPTEMBER 30, 2002
(Unaudited)

1. BASIS OF PRESENTATION

The accompanying unaudited consolidated financial statements have been
prepared in accordance with the instructions to Form 10-Q of the
Securities and Exchange Commission and should be read in conjunction
with the financial statements and notes thereto included in the
Company's Annual Report on Form 10-K for the year ended December 31,
2001. In the opinion of management, all adjustments (consisting only of
normal recurring accruals) necessary to present fairly the financial
position, results of operations, stockholders' equity and cash flows at
September 30, 2002 and for all periods presented have been made.
Certain information and footnote disclosures normally included in
financial statements prepared in accordance with generally accepted
accounting principles have been condensed or omitted. The results of
operations for the three and nine months ended September 30, 2002 and
2001 are not necessarily indicative of the operating results for the
full years.

The consolidated financial statements include the accounts of Sheffield
Pharmaceuticals, Inc. and its wholly owned subsidiaries, Systemic
Pulmonary Delivery, Ltd., Ion Pharmaceuticals, Inc., and CP
Pharmaceuticals, Inc., and its 80.1% owned subsidiary, Respiratory
Steroid Delivery, Ltd., ("RSD") and are herein referred to as
"Sheffield" or the "Company." All significant intercompany transactions
are eliminated in consolidation.

The Company is focused on the development and commercialization of
later stage pharmaceutical products that utilize the Company's unique
proprietary pulmonary delivery technologies. The Company is in the
development stage and to date has been principally engaged in research,
development and licensing efforts.

The accompanying consolidated financial statements have been prepared
on a going concern basis that contemplates the realization of assets
and satisfaction of liabilities and commitments in the normal course of
business. The Company has generated minimal operating revenue,
sustained significant net operating losses, and requires additional
capital that the Company intends to obtain through out-licensing of
rights to its technology, as well as through equity and debt offerings,
to continue to operate its business. Unless the Company is able to
raise significant capital ($1 million to $2.5 million) within the next
30-60 days, management believes that it is unlikely that the Company
will be able to meet its obligations as they become due and to
continue as a going concern. To meet this capital requirement, the
Company is evaluating various financing alternatives including private
offerings of its securities, debt financings, collaboration and
licensing arrangements with other companies, and the sale of non-
strategic assets and/or technologies to third parties. Should the
Company be unable to meet its capital requirement through one or more
of the above-mentioned financing alternatives, the Company may file
for bankruptcy or similar protection under the 1978 Bankruptcy Code
and the basis of presentation of the Company's financial statements
will be adjusted to reflect a liquidation basis of accounting.

Additionally, the Company's ability to meet its obligations as they
become due and to continue as a going concern must be considered in
light of the expenses, difficulties and delays frequently encountered
in developing a new business, particularly since the Company will focus
on product development that may require a lengthy period of time and
substantial expenditures to complete. Even if the Company is able to
successfully develop new products, there can be no assurance that the
Company will generate sufficient revenues from the sale or licensing of
such products to be profitable.

2. BASIC LOSS PER COMMON SHARE

Basic net loss per share is calculated in accordance with Statement of
Financial Accounting Standards No. 128, Earnings Per Share. Basic net
loss per share is based upon the weighted average common stock
outstanding during each period. Potentially dilutive securities such as
stock options, warrants, convertible debt and preferred stock, have not
been included in any periods presented as their effect is antidilutive.

3. NOTES PAYABLE

On September 6, 2002, the Company entered into a $.5 million unsecured
debt financing with certain shareholders of the Company. The promissory
notes provide for interest at the rate of 7% per annum and mature on
January 1, 2003.

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Upon maturity, the Company will repay principal and accrued interest on
each note, and at the Company's discretion, either a premium of
approximately 14% of the principal amount, or a warrant to purchase the
number of shares of Sheffield common stock equal to the principal
amount each note. Any warrants to be issued under the notes would have
an exercise price equal to $.60 per share, the closing price of the
Company's common stock on the closing date of the notes. The
outstanding principal balance of the promissory notes at September 30,
2002 was $.5 million.

4. LONG-TERM DEBT

On August 14, 2001, the Company entered into a Note Purchase Agreement
("Agreement") with Elan Pharma International Ltd. ("Elan Pharma"),
pursuant to which Elan Pharma agreed to lend the Company up to $4
million. On April 4, 2002, the Company amended the Agreement. Under the
terms of the amended Agreement, Elan Pharma agreed to increase the
principal amount of the loan available from $4 million to $5 million
and extend the maturity date from November 14, 2002 to April 4, 2004.
On April 5, 2002, the Company received proceeds on the loan of $1
million, increasing the total borrowings to $5 million. All borrowings
under the Agreement are evidenced by a $5 million unsecured promissory
note of the Company that provides for interest on principal and
semi-annually compounded interest at a fixed rate of 10% per annum. The
outstanding principal balance of the Agreement at September 30, 2002,
and December 31, 2001, was $5 million and $4 million, respectively. Due
to the modification of the maturity date, the borrowings under the
Agreement, totaling $5 million at September 30, 2002, have been
classified in the Company's balance sheet as long-term debt.

In September 2001, in connection with the amendment of its 1998
agreement with Zambon Group SpA ("Zambon"), the Company entered into a
Loan and Security Agreement ("Loan Agreement") with Zambon, pursuant to
which Zambon agreed to lend the Company $2.5 million. The Company
received $1.0 million upon signing of the Loan Agreement, $1.0 million
on January 2, 2002 and $.5 million on April 5, 2002. The Loan Agreement
provides for interest on principal and annually compounded interest at
a fixed rate of 2% per annum and is secured by certain security
interests in respiratory products developed in the Premaire. One third
of the principal balance, together with interest, is payable by the
Company upon the Company's execution of an agreement with one or more
third parties to develop, co-promote and/or sell certain products in
North America, with all remaining unpaid principal and interest due on
December 31, 2005. The outstanding principal balance of the Loan
Agreement at September 30, 2002, and December 31, 2001, was $2.5
million and $1.0 million, respectively.

5. SUBSEQUENT EVENT

On November 8, 2002 the Company entered into an agreement with Elan
Pharma. Under the terms of the agreement, the Company received proceeds
of $.5 million evidenced by an unsecured demand promissory note of the
Company that provides for interest on principal and semi-annually
compounded interest at a fixed rate of 10% per annum. Also as part of
the agreement, the parties terminated the 1999 license agreement for
the Elan NanoCrystal technology made between Elan Pharma and RSD. As
provided in the 1999 license agreement, upon termination of this
license, all intellectual property of RSD was transferred to and
jointly owned by Elan and Sheffield.

6. RECLASSIFICATIONS

Certain amounts in the prior year financial statements and notes have
been reclassified to conform to the current year presentation.

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Item 2.
Management's Discussion and Analysis of Financial Condition and Results of
Operations

The following contains certain forward-looking statements within the meaning of
Section 27A of the Securities Act of 1933, as amended, and Section 21E of the
Securities Exchange Act of 1934, as amended, which are intended to be covered by
the safe harbors created thereby. All forward-looking statements involve risks
and uncertainty. Although the Company believes that the assumptions underlying
the forward-looking statements contained herein are reasonable, any of the
assumptions could be inaccurate, and therefore, there can be no assurance that
the forward-looking statements included in this report will prove to be
accurate. The Company's actual results may differ materially from the results
anticipated in the forward-looking statements. See "Management's Discussion and
Analysis of Financial Condition and Results of Operations - Important Factors
that May Affect Future Results" included herein for a discussion of factors that
could contribute to such material differences. In light of the significant
uncertainties inherent in the forward-looking statements included herein, the
inclusion of such information should not be regarded as a representation by the
Company or any other person that the objectives and plans of the Company will be
achieved. The Company disclaims any obligation to update or revise the
information provided in this report to reflect future events.

OVERVIEW

We provide innovative, cost-effective pharmaceutical therapies by combining
state-of-the-art pulmonary drug delivery technologies with existing and emerging
therapeutic agents. We are developing a range of products to treat respiratory
and systemic diseases in our proprietary Premaire(R) Delivery System
("Premaire") and Tempo(TM) Inhaler ("Tempo"). We are in the development stage
and, as such, have been principally engaged in the development of our pulmonary
delivery systems.

In 1997, we acquired the Premaire, a portable nebulizer-based pulmonary delivery
system, through a worldwide exclusive license and supply arrangement with
Siemens AG ("Siemens"). During the second half of 1998, we acquired the rights
to an additional pulmonary delivery technology, Tempo, from a subsidiary of
Aeroquip-Vickers, Inc. ("Aeroquip-Vickers"). The Tempo technology is a new
generation propellant-based pulmonary delivery system. Additionally, during
1998, we licensed from Elan Corporation, plc ("Elan") the Ultrasonic Pulmonary
Drug Absorption System ("UPDAS"), a novel disposable unit dose nebulizer system,
and Elan's Absorption Enhancing Technology ("Enhancing Technology"), a
therapeutic agent to increase the systemic absorption of drugs. In October 1999,
we licensed Elan's Nanocrystal(TM) technology to be used in developing certain
inhaled steroid products.

Our lead drug delivery technology, the Premaire, is a patented, multi-dose
nebulizer delivery system. The pocket-sized inhaled drug delivery system
features an ultrasonic nebulizer that emits high-frequency sound waves that turn
liquid medication into a fine cloud or soft mist. The Premaire combines the
therapeutic benefits of nebulization with the convenience of pressurized metered
dose inhalers, or pMDIs, in one patient-friendly device. The Premaire is
comprised of a hand-held ultrasonic nebulizer and drug-filled cartridges that
are inserted into the inhaler unit. The cartridges provide patients who must
take multiple respiratory medications with a single, easy-to-use system. We
believe the soft mist created by the Premaire provides multiple drug
administration advantages over the high-velocity pMDIs and dry powder inhalers.
Furthermore, the Premaire system is fast and portable as compared to
conventional tabletop nebulizers, which are large, cumbersome and more time
consuming to use. The Premaire system targets younger and older asthma patients,
as well as older chronic obstructive pulmonary disease patients who have
difficulty using pMDIs and currently depend on tabletop nebulizers for delivery
of their medications.

Our Tempo is a patented, new generation pMDI that we believe has significant
efficiency and performance advantages over standard pMDIs. The Tempo technology
utilizes a standard aerosol pMDI canister, encased in a compact device that
provides an aerosol flow-control chamber and a synchronized triggering
mechanism. The aerosol flow-control chamber allows the patient to inhale through
the device at a normal breathing rate, instead of a forced breath. The
inspiratory breath establishes flow fields within the device that mix and
uniformly disperse the drug in the breath. At the mouthpiece, nearly all the
propellant is evaporated leaving only drug particles to be inspired, allowing a
significant increase in the amount of drug delivered to the lungs. The Tempo
system, like the Premaire system, is designed to reduce patient coordination
problems and enhance compliance with the prescribed treatment.

In June 1998, we sublicensed to Zambon Group SpA ("Zambon") worldwide marketing
and development rights to respiratory products to be delivered by the Premaire
in return for an equity investment in the Company (approximately 10%). From June
1998 to September 2001, Zambon funded the development costs for the respiratory
compounds delivered by Premaire. In September 2001, we amended our 1998
agreement with Zambon whereby we regained the rights to the Premaire previously
granted to Zambon. As part of the amended agreement, Zambon provided a
low-interest, $2.5 million loan to us to progress the development

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of the Premaire respiratory program. Upon commercialization, Zambon will be
entitled to certain royalties on payments received by us for albuterol,
ipratropium and cromolyn sales for specified periods.

In 1998, the systemic applications of Premaire and Tempo were licensed to
Systemic Pulmonary Delivery, Ltd. ("SPD"), one of our wholly owned subsidiaries.
In addition, two Elan technologies, UPDAS(TM) and the Enhancing Technology, were
also licensed to SPD. We retained exclusive rights outside of the strategic
alliance to respiratory disease applications utilizing the Tempo technology and
the two Elan technologies. On August 21, 2002 we ended this strategic alliance
with Elan and regained all intellectual property rights to the systemic
applications of Premaire and Tempo that were licensed to SPD. In addition, as
part of the termination of this alliance, we will enter into a separate
agreement with Elan to license exclusively the UPDAS(TM) and the Enhancing
Technology. We have also granted to Elan an ongoing right to receive royalties
on commercialization of two products, morphine delivered by Premaire and
ergotamine tartrate delivered by Tempo.

In addition to the above alliance with Elan, in 1999, we and Elan formed a joint
venture, Respiratory Steroid Delivery, Ltd. ("RSD"), to develop certain inhaled
steroid products to treat respiratory diseases using Elan's NanoCrystal
technology. Currently, RSD is developing a solution-based unit-dose-packaged
steroid formulation for delivery using a conventional tabletop nebulizer, and a
solution-based steroid formulation for delivery using the Premaire. On November
8, 2002, as part of an agreement between Elan and RSD, the parties terminated
the license for the Elan NanoCrystal technology to RSD. As provided in the 1999
license agreement, upon termination of this license, all intellectual property
of RSD was transferred to and jointly owned by Elan and Sheffield.

RESULTS OF OPERATIONS

Revenue

Contract research revenues primarily represent revenues earned from a
collaborative research agreement with Zambon relating to the development of
respiratory applications of Premaire. There were no contract research revenues
for the third quarter of 2002 and 2001. For the first nine months of 2002 and
2001, contract research revenues were $5,000 and $869,095, respectively. The
decrease for the first nine months of 2002 was due to the Company no longer
performing development work for Zambon as a result of our regaining the Premaire
respiratory rights in the third quarter of 2001. Costs of contract research
revenue approximated such revenues in 2001 and were included in research and
development expenses. Future contract research revenues and expenses are
anticipated to fluctuate depending, in part, on obtaining additional
collaborative agreements and upon the success of current clinical studies.

Our ability to generate material revenues is contingent on the successful
commercialization of our technologies and other technologies and products that
we may acquire, followed by the successful marketing and commercialization of
such technologies through licenses, joint ventures and other arrangements.

Research and Development

Research and development ("R&D") expenses were $.5 million and $1.7 million for
the third quarter of 2002 and 2001, respectively. The decrease of $1.2 million
for the third quarter of 2002 was primarily due to lower Premaire development
costs associated with finalizing the to-be-marketed device in December 2001 as
well as reduced formulation work on the Premaire budesonide product ($.4
million), higher development expenses in the third quarter of 2001 related to
the anticipation of a Phase I trial of RSD's unit dose product ($.4 million),
lower Tempo development costs resulting from finalizing the industrialization of
the device in the first half of 2002 for Phase I and II trials and reduced
formulation work on certain respiratory products ($.2 million), lower new
product development in the area of polypeptides ($.1 million) and reduced R&D
administrative costs ($.1 million). For the nine months ended September 30, 2002
and 2001, R&D costs were $3.3 million and $4.7 million, respectively. The
decrease of $1.4 million was primarily due to lower design and development costs
associated with finalizing the to-be-marketed Premaire device in December 2001
($.8 million), lower Tempo development costs resulting from finalizing the
industrialization of the device in the first half of 2002 for Phase I and II
trials and reduced formulation work on certain respiratory products ($.6
million), higher development expenses in the third quarter of 2001 related to
the anticipation of a Phase I trial of RSD's unit dose product ($.5 million),
and lower new product development work in the area of polypeptides ($.3
million). These decreases were partially offset by higher expenses related to
formulation work on the Tempo dihydroergotamine ("DHE") product ($.8 million).

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The following details the status of each of our development programs as
of September 30, 2002:

Premaire Respiratory Program:

As a result of our regaining from Zambon the rights to the respiratory
applications to the Premaire in September 2001, the sponsorship of the
Premaire respiratory development programs was transferred to us from
Zambon with the Food and Drug Administration ("FDA") being notified
accordingly. In the fourth quarter of 2001, we reviewed all of the
development work completed-to-date, identifying a number of
deficiencies in the Zambon development program. To address these
issues, we made a number of internal management changes and moved the
program to a group of highly experienced pulmonary clinical and
regulatory experts. The Premaire device is currently in a
to-be-marketed form and fully industrialized. As of September 30, 2002,
we had spent $3.8 million on developing the respiratory products
discussed below.

Our strategy is to out license the U.S. rights to the Premaire
respiratory products to a third party which we anticipate concluding in
2003. As a result, we estimate a U.S. commercial launch of our first
products in Premaire to occur in the last half of 2005 or first half of
2006. Subject to obtaining additional financing from debt and/or equity
placements, we intend to fund the continued development work for the
Premaire respiratory products up through the period of outlicensing,
currently estimated at approximately $10 million, after which time it
is anticipated that the licensee would assume funding responsibility
for further development work.

Albuterol Sulfate. Zambon initiated a Phase II clinical trial
in December 1999 that compared the Premaire-albuterol sulfate to a
conventional albuterol-pMDI. Findings from Phase II studies indicated
that Premaire-albuterol and pMDI-albuterol were comparable in improving
lung function in the 24 adult patients. An end of Phase II meeting was
held in February 2002 with the FDA where the results of the development
activities-to-date, specifically the results of the Phase II trial,
were reviewed. We are currently reviewing the FDA's comments and
recommendations, integrating the information into the plans for the
Phase III trial and NDA submission. Subject to obtaining additional
funding by the end of 2002, we anticipate to begin pivotal clinical
trials for the albuterol sulfate program at the beginning of 2003.

Budesonide. Preclinical formulation development work is
currently underway. A formulation developed by Nanosystems has proven a
feasible candidate for delivery in the Premaire. The formulation is
dependent on a proprietary nanocrystaline dispersion of budesonide in
an aqueous carrier. Two other alternative formulation approaches are
also under evaluation. Upon scale-up and production of clinical batches
released under CMC protocol, an Investigational New Drug Application
("IND") will be prepared for filing with the FDA, which is currently
planned for the first half of 2003.

Ipratropium Bromide. Zambon initiated a Phase I/II clinical
trial in Europe in January 2000 assessing the safety and efficacy
compared to a commercially available ipratropium bromide product
delivered by a pMDI and placebo in patients with chronic obstructive
pulmonary disease ("COPD"). The results of the study indicated that
both Premaire-ipratropium bromide and pMDI-ipratropium were tolerated
and improved lung function in the COPD patients. An IND was filed by
Zambon with the FDA in May 2000. During 2001, the IND was transferred
to the us. We do not intend to further develop this product on our own
as the program has progressed to the point where a potential licensing
partner would be in a position to take the product into clinical
studies.

Sodium Cromoglycate. An IND was filed by Zambon with the FDA
in July 2000. No further development work is anticipated to be
completed on this product as the projected market opportunity for
sodium cromoglycate is currently deemed too small to justify further
progression.

Premaire Systemic Program:

Through our development alliance with Elan and SPD formed in 1998, we
evaluated certain drugs for systemic treatment by pulmonary delivery
through Premaire. By identifying a market opportunity for a
rapid-acting, non-invasive treatment for breakthrough pain, the first
drug to be tested for delivery in Premaire was morphine. In July 1999,
we completed a gamma scintigraphy/pharmacokinetic trial comparing
morphine delivered using the Premaire to subcutaneous injection. The
Premaire demonstrated good pulmonary deposition and very rapid
absorption, more rapid peak blood levels vs. subcutaneous injection and
low oral and throat deposition. As part of the development alliance
with Elan, Elan had the first right of refusal on the development of
any product developed by the joint venture. Elan chose not to license
this product from the joint venture. In August 2002, we regained all
intellectual property rights to the systemic applications of Premaire
from SPD and ended the joint venture relationship with Elan. As such,
we now continue to seek to attract a partner for the continued
development and commercialization of this product. Upon

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commercialization, Elan will be entitled to certain royalties on
payments received. We have spent $.4 million to date to develop this
product and do not anticipate incurring any future costs for further
development until such time as a licensing partner is secured.

Tempo Respiratory Program:

In September 2000, we completed a pilot study using the Tempo to
deliver an undisclosed, patented respiratory drug used to treat asthma.
The study measured the distribution of this respiratory drug delivered
by Tempo compared to the distribution of this same drug delivered
through a commercially available pMDI in 12 healthy volunteers. Results
of this study demonstrated that Tempo significantly increased drug
deposition in all regions of the lung. Tempo delivered approximately
200% more drug to the lungs, deposited approximately 75% less drug in
the mouth, and increased dosing consistency by approximately 55%
compared to the currently marketed form of this same drug. As of
September 30, 2002, we had incurred approximately $.9 million to-date
on this study. We are using the results of this study as a basis for
conducting discussions for feasibility work and/or clinical studies
with potential collaboration partners.

Tempo Systemic Program:

The development of systemic drugs using Tempo was being conducted as
part of our alliance with Elan. The initial product developed was
targeted to address migraine headaches. We utilized ergotamine tartrate
as a proof-of-principle product. In December 1999, we completed a gamma
scintigraphy/pharmacokinetic trial comparing the Tempo to a
conventional pMDI. The trial showed successful delivery of the drug to
all regions of lung with significantly reduced mouth and throat
deposition, and rapid drug absorption. As part of the development
alliance with Elan, Elan had the first right of refusal on the
development of any product developed by the joint venture. Elan chose
not to license this product from the joint venture. In August 2002, we
regained all intellectual property rights to the systemic applications
of Tempo from SPD and ended the joint venture relationship with Elan.
As such, we now continue to seek to attract a partner for the continued
development and commercialization of this product. Upon
commercialization, Elan will be entitled to certain royalties on
payments received. As of September 30, 2002, we had spent $1.0 million
to date to develop this product and do not anticipate incurring any
future costs for further development until such time as a licensing
partner is secured.

As a result of the work performed on the ergotamine product noted
above, in April 2002, we announced the initiation of a pulmonary
migraine therapy program with Inhale Therapeutic Systems ("Inhale"), a
world-renowned expert in particle design. We will combine Inhale's
supercritical fluid technology with our proprietary drug delivery
technologies to develop a systemically acting DHE administered through
the pulmonary route. We plan to study DHE in sub-categories of migraine
where DHE administered by injection is often used to relieve migraine
symptoms. These sub-categories are the more serious forms of migraine
and often require either hospitalization or treatment in pain or
headache clinics. Under the terms of the agreement, Inhale will supply
the particle engineering technology and receive R&D funding, milestone
payments, and royalties upon commercialization. We are responsible for
all other aspects of clinical development and marketing of the product.
As part of this agreement, Inhale will produce DHE particles using Good
Manufacturing Practices ("GMP") for clinical development and commercial
sale. The treatment of migraine represents a worldwide prescription
market estimated at approximately $2.4 billion. As of September 30,
2002, we had incurred-to-date approximately $1.0 million related to
this project. Future costs related to this project are dependent upon,
among other factors, the timing of securing a development partner.
Subject to obtaining additional financing from debt and/or equity
placements in 2002, we do not estimate incurring any costs related to
the development of the DHE project until the beginning of 2003.

Unit Dose Nebulizer Program:

As part of an alliance with Elan, RSD is developing a product for
inhalation delivery in a standard commercial tabletop device using the
steroid budesonide, formulated using the NanoCrystal technology. A
Phase I, double-blind safety and pharmacokinetic study of nebulized
nanobudesonide in 16 healthy volunteers was satisfactorily completed at
Thomas Jefferson University Hospital in February 2002. This study
compared single doses of Pulmicort Respules ("Pulmicort"), our
proprietary nanobudesonide in two different single dose strengths and
placebo. The study resulted in no significant adverse events with
either of our dosage strengths or the Pulmicort reference drug. Data
from the study is currently undergoing final data and statistical
analysis. After such data has been analyzed, we plan on initiating
discussions with potential partners regarding the outlicensing of this
opportunity. As of September 30, 2002, we incurred-to-date
approximately $2.9 million on this project. On November 8, 2002, as
part of an agreement between Elan and RSD, we and Elan terminated the
license for the Elan NanoCrystal technology to RSD. As provided in the
1999 license agreement,

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upon termination of this license, all intellectual property of RSD was
transferred to and jointly owned by Elan and Sheffield. Subject to
disposition of the property rights, we do not intend to incur any
additional development costs related to this product.

General and Administrative

General and administrative expenses were $.6 million for the third quarter of
2002 as compared to $1.0 million for the third quarter of 2001. The decrease of
$.4 million from 2001 was primarily due to cost reduction efforts to conserve
cash while various financing alternatives are evaluated, including lower legal
and consulting fees ($.2 million), reduced administrative headcount ($.1
million), and lower public relations expenditures ($.1 million). For the nine
months ended September 30, 2002 and 2001, general and administrative expenses
were $4.0 million and $2.9 million, respectively. The increase of $1.1 million
from 2001 was primarily due to higher consulting costs, legal fees and
severance-related costs in the first six months of 2002. The higher consulting
costs and legal fees were associated with expanded business development, and
merger and acquisition activities in the area of licensing and partnering of our
delivery systems, as well as potential acquisitions of complementary pulmonary
delivery technologies and companies ($.7 million). The severance costs were
associated with the resignation of three executive officers in 2002 and include
costs incurred pursuant to their respective separation agreements for severance
payments and ongoing benefit coverage ($.6 million) and modification of the
terms of certain stock options ($.2 million). These increases were partially
offset by the above-noted cost reduction efforts during third quarter of 2002
($.4 million).

Interest

Interest income was $883 and $4,362 for the third quarter of 2002 and 2001,
respectively, and $7,901 and $55,127 for the first nine months of 2002 and 2001,
respectively. The decrease in interest income for both the third quarter and
first nine months of 2002 was primarily due to less cash available for
investment and lower yields on those investments.

Interest expense was $195,949 and $95,039 for the third quarter of 2002 and
2001, respectively, and $526,706 and $204,286 for the first nine months of 2002
and 2001, respectively. The increase for both the third quarter and first nine
months of 2002 resulted primarily from interest associated with the borrowings
on the August 2001 Note Purchase Agreement with Elan Pharma. The borrowings
totaled $5 million as of September 30, 2002, compared to total borrowings of $2
million as of September 30, 2001.

LIQUIDITY AND CAPITAL RESOURCES

At September 30, 2002, we had $.3 million in cash and cash equivalents compared
to $.9 million at December 31, 2001. The decrease of $.6 million reflects cash
disbursements of $5.6 million used primarily to fund operating activities,
partially offset by the receipt of $1.0 million from the issuance of 1,000
shares of our Series E Cumulative Convertible Preferred Stock, $1.5 million from
the proceeds of a secured loan from Zambon, $1.0 million from the proceeds of an
unsecured promissory note from Elan Pharma, $.5 million from the proceeds of
unsecured promissory notes from certain shareholders and $1.0 million in
proceeds from the exercise of a portion of a common stock warrant by Elan
International Services, Ltd.

Cash available for funding our operations as of September 30, 2002 was $.3
million. As of such date, we had trade payables and accrued liabilities of $2.8
million, and current research obligations of $.2 million. In addition, committed
and/or anticipated funding of research and development after September 30, 2002
is estimated at approximately $.2 million, of which $.1 million has been
committed to be funded by Elan through the issuance of our Series E cumulative
convertible preferred stock, which funds are required to be used by us to fund
our portion of RSD's operating and development costs. As of November 14, 2002,
we had cash and equivalents of approximately $.7 million, of which $.1 million
is committed to fund our portion of RSD's expenditures. As of such date, we had
trade payables and accrued liabilities of approximately $2.9 million. Unless the
Company is able to raise significant capital ($1 million to $2.5 million) within
the next 30-60 days, management believes that it is unlikely that the Company
will be able to meet its obligations as they become due and to continue as a
going concern. To meet this capital requirement, we are evaluating various
financing alternatives including private offerings of our securities, debt
financings, collaboration and licensing arrangements with other companies, and
the sale of non-strategic assets and/or technologies to third parties. Should
the Company be unable to meets it capital requirement through one or more of
the above-mentioned financing alternatives, we may file for bankruptcy or
similar protection under the 1978 Bankruptcy Code.

13

Because we do not expect to generate significant cash flows from operations for
at least the next few years, we will require additional funds to meet our
current obligations and future costs. In an effort to meet both our short- and
long-term capital requirements, we are currently evaluating various financing
alternatives including private offerings of our securities, debt financings, and
collaboration and licensing arrangements with other companies. There can be no
assurance that we will be able to obtain such additional funds or enter into
such collaborative and licensing arrangements on terms favorable to us, if at
all. Our development programs will be stopped if future financings are not
completed.

On November 8, 2002 the Company entered into an agreement with Elan Pharma,
whereby among other items, the Company received proceeds of $.5 million
evidenced by an unsecured demand promissory note. The promissory note provides
for interest on principal and semi-annually compounded interest at a fixed rate
of 10% per annum.

On September 6, 2002, we entered into a $.5 million unsecured debt financing
with certain of our shareholders. The promissory notes provide for interest at
the rate of 7% per annum and mature on January 1, 2003. Upon maturity, we will
repay principal and accrued interest on each note, and at our discretion, either
a premium of approximately 14% of the principal amount, or a warrant to purchase
the number of shares of Sheffield common stock equal to the principal amount
each note. Any warrants to be issued under the notes would have an exercise
price equal to $.60 per share, the closing price of our common stock on the
closing date of the notes. The outstanding principal balance of the promissory
notes at September 30, 2002 was $.5 million.

On April 5, 2002, Elan International Services, Ltd. exercised a portion of a
warrant that it had received in June 1998 as part of a strategic alliance with
us and purchased 495,000 shares of our common stock at $2.00 per share. We
received approximately $1.0 million in proceeds as a result of the exercise of a
portion of this warrant.

On August 14, 2001, we entered into a Note Purchase Agreement ("Agreement") with
Elan Pharma, pursuant to which Elan Pharma agreed to lend us up to $4 million.
On April 4, 2002, we amended the Agreement. Under the terms of the amended
Agreement, Elan Pharma agreed to increase the principal amount of the loan
available from $4 million to $5 million and extend the maturity date from
November 14, 2002 to April 4, 2004. On April 5, 2002, we received proceeds on
the loan of $1 million, increasing the total borrowings to $5 million. All
borrowings under the Agreement are evidenced by our $5 million unsecured
promissory note that provides for interest on principal and semi-annually
compounded interest at a fixed rate of 10% per annum. Due to the modification of
the maturity date, the borrowings under the Agreement, totaling $5 million at
September 30, 2002, have been classified in our balance sheet as long-term debt.

In September 2001, in connection with the amendment of our 1998 agreement with
Zambon, we entered into a Loan and Security Agreement ("Loan Agreement") with
Zambon, pursuant to which Zambon agreed to lend us $2.5 million. We received
$1.0 million upon signing of the Loan Agreement, $1.0 million on January 2, 2002
and $.5 million on April 5, 2002. The Loan Agreement provides for interest on
principal and annually compounded interest at a fixed rate of 2% per annum and
is secured by certain security interests in respiratory products developed in
the Premaire. One third of the principal balance, together with interest, is
payable by us upon our execution of an agreement with one or more third parties
to develop, co-promote and/or sell certain products in North America, with all
remaining unpaid principal and interest due on December 31, 2005. On October 17,
2001, as part of the amendment of our 1998 agreement with Zambon, we repurchased
from Zambon, 214,997 shares of common stock for $3.0233 per share ("Repurchase
Price"). In addition, we received an option, expiring December 31, 2002, to
repurchase the remaining shares of our common stock held by Zambon at the
Repurchase Price. In the event we complete a sublicense for the North American
rights or a sublicense for the non-North American rights to certain Premaire
respiratory products prior to December 31, 2002, we will repurchase from Zambon
882,051 shares of our common stock on each of the events.

In October 1999, as part of a licensing agreement with Elan, we received gross
proceeds of $17,015,000 related to the issuance to Elan of 12,015 shares of
Series D Cumulative Convertible Exchangeable Preferred Stock and 5,000 shares of
Series F Convertible Non-Exchangeable Preferred Stock. In turn, we made an
equity investment of $12,015,000 in a joint venture, RSD, representing an
initial 80.1% ownership. The remaining proceeds from this preferred stock
issuance will be utilized for general operating purposes. As part of the
agreement, Elan also committed to purchase, on a drawdown basis, up to an
additional $4.0 million of our Series E Preferred Stock. Although only $3
million has been drawndown under the Series E Preferred Stock, as part of the
November 8, 2002 Note Agreement with Elan, Elan is no longer obligated to
provide us with the remaining $1 million in funding.

In May 1999, in conjunction with the completion of its Phase I/II
Premaire-albuterol trial, Zambon provided us with a $1.0 million interest-free
advance against future milestone payments. In January 2001, we received an
additional $1.0 million interest-free milestone advance resulting from the
demonstration of the technical feasibility of delivering an inhaled steroid
formulation in Premaire. The proceeds from these advances are not restricted as
to their use by us. As part of the amendment of its 1998 agreement with Zambon,
the terms of the milestone advances were modified in that we shall repay $1.0
million of the advance milestone payments upon the earlier of December 31, 2003,
or upon the first regulatory approval for either albuterol or an inhaled steroid
delivered in the Premaire. The remaining $1.0 million advance shall be repaid by
us on the earlier of

14

December 31, 2005, or the regulatory approval of the second product (albuterol
or an inhaled steroid) delivered in the Premaire. Due to the modification in the
repayment terms, the advances have been reclassified in our balance sheet as
long-term debt.

CERTAIN RISK FACTOR THAT MAY AFFECT FUTURE RESULTS, FINANCIAL CONDITION AND
MARKET PRICE OF SECURITIES

The following are some of the factors that could affect the Company's future
results. They should be considered in connection with evaluating forward-looking
statements contained in this report and otherwise made by us or on our behalf,
because these factors could cause actual results and conditions to differ
materially from those projected in forward-looking statements.

We will need additional financing, which if not available, could prevent us from
funding or expanding our operations.

Unless the Company is able to raise significant capital ($1 million to $2.5
million) within the next 30-60 days, management believes that it is unlikely
that the Company will be able to meet its obligations as they become due and to
continue as a going concern. To meet this immediate capital requirement, we are
evaluating various financing alternatives including private offerings of our
securities, debt financings, collaboration and licensing arrangements with other
companies, and the sale of non-strategic assets and/or technologies to third
parties. Should the Company be unable to meet its capital requirement through
one or more of the above-mentioned financing alternatives, we may file for
bankruptcy or similar protection under the 1978 Bankruptcy Code.

Provided immediate funding is secured, we will still need to raise substantial
additional capital in the very near-term to fund our operations in an effort to
continue to meet our obligations as they become due and to continue as a going
concern. The development of our technologies and proposed products will require
a commitment of substantial funds to conduct costly and time-consuming research,
preclinical and clinical testing, and to bring any such products to market. Our
future capital requirements will depend on many factors, including continued
progress in developing and out-licensing our pulmonary delivery technologies,
our ability to establish and maintain collaborative arrangements with others and
to comply with the terms thereof, receipt of payments due from partners under
research and development agreements, progress with preclinical and clinical
trials, the time and costs involved in obtaining regulatory approvals, the cost
involved in preparing, filing, prosecuting, maintaining and enforcing patent
claims, the need to acquire licenses to new technology and the status of
competitive products. We are currently seeking such additional funding through
collaborative or partnering arrangements, the extension of existing
arrangements, or through public or private equity or debt financings. Additional
financing may not be available on acceptable terms or at all. If we raise
additional funds by issuing equity securities, stockholders may be further
diluted and such equity securities might have rights, preferences and privileges
senior to those of our current stockholders. If adequate funds are not available
over the longer-term, we may be required to delay, reduce the scope of, or
eliminate one or more of our research or development programs or obtain funds
through arrangements with collaborative partners or others that may require us
to relinquish rights to certain of our technologies, product candidates or
products that we would otherwise seek to develop or commercialize. If adequate
funds are not available from operations or additional sources of funding, our
business will suffer a material adverse effect.

We have experienced significant operating losses throughout our history and
expect these losses to continue for the foreseeable future.

Our operations to date have consumed substantial amounts of cash and we have
generated to date only limited revenues from contract research and licensing
activities. We have incurred approximately $97.8 million of operating losses
since our inception, including $7.3 million during the nine months ended
September 30, 2002. Our operating losses and negative cash flow from operations
are expected to continue in the foreseeable future. The Company expects that it
will continue to have a high level of operating expenses, negative cash flow
from operations and will be required to make significant up-front expenditures
in connection with its product development activities. As a result, we
anticipate additional operating losses for the remainder of 2002 and that such
losses will continue thereafter until such time, if ever, as we are able to
generate sufficient revenues to sustain our operations. The independent
auditors' report dated February 12, 2002, on our consolidated financial
statements for the year ended December 31, 2001 stated that we have incurred
recurring operating losses and have a working capital deficiency and that these
conditions raise substantial doubt about our ability to continue as a going
concern.

If our common stock is delisted from the American Stock Exchange, the price of
our common stock and its liquidity could decline.

Our common stock is listed for trading on the American Stock Exchange, or AMEX,
under the symbol "SHM". We do not satisfy AMEX standards for continued listing,
including a standard that a listed company that has sustained losses from
continuing operations and/or net losses in its five most recent fiscal years,
have stockholders' equity of at least $6,000,000. We

15

had a net capital deficiency of $14.4 million at September 30, 2002. We
submitted a plan advising the AMEX of the action we will take that will bring us
into compliance with continued listing standards. On September 11, 2002, the
AMEX notified us that it had accepted our plan of compliance and granted us an
extension through the 2002 year-end reporting period to regain compliance with
the continued listing standards. We will be subject to periodic review by the
AMEX staff during the extension period. Failure to make progress consistent with
the plan or to regain compliance with the continued listing standards by the end
of the extension period could result in our being delisted from the AMEX. There
can be no assurance that we will be able to meet the objectives outlined in the
plan, which may result in the AMEX initiating delisting procedures. If our
common stock were delisted from AMEX, trading of our common stock, if any, would
thereafter likely be conducted in the over-the-counter market, unless we were
able to list our common stock on The Nasdaq Stock Market or another national
securities exchange, which cannot be assured. If our common stock were to trade
in the over-the-counter market it may be more difficult for investors to dispose
of, or to obtain accurate quotations as to the market value of our common stock.
In addition, it may become more difficult for us to raise funds through the sale
of our securities.

In the event of the delisting of our common stock from the AMEX and our
inability to list our common stock on The Nasdaq Stock Market or another
national securities exchange, the regulations of the SEC under the Securities
Exchange Act of 1934, as amended, require additional disclosure relating to the
market for penny stocks. SEC regulations generally define a penny stock to be an
equity security that has a market price of less than $5.00 per share, subject to
certain exceptions. A disclosure schedule explaining the penny stock market and
the risks associated therewith is required to be delivered to a purchaser and
various sales practice requirements are imposed on broker-dealers who sell penny
stocks to persons other than established customers and accredited investors
(generally institutions). In addition, the broker-dealer must provide the
customer with current bid and offer quotations for the penny stock, the
compensation of the broker-dealer and its salesperson in the transaction and
monthly account statements showing the market value of each penny stock held in
the customer's account. If our securities become subject to the regulations
applicable to penny stocks, the market liquidity for our securities could be
severely affected. In such an event, the regulations on penny stocks could limit
the ability of broker-dealers to sell our securities.

Our products are still in development and we may be unable to bring our products
to market.

We have not yet begun to generate revenues from the sale of products. Our
products will require significant additional development, clinical testing and
investment prior to their commercialization. We do not expect regulatory
approval for commercial sales of any of our products in the immediate future.
Potential products that appear to be promising at early stages of development
may not reach the market for a number of reasons. Such reasons include the
possibility that products will not be proven to be safe and efficacious in
clinical trials, that they will not be able to meet applicable regulatory
standards or obtain required regulatory approvals, that they cannot be produced
in commercial quantities at reasonable costs or that they fail to be
successfully commercialized or fail to achieve market acceptance.

If our products are not accepted by the medical community, our business will
suffer.

Commercial sales of our products will substantially depend upon the products'
efficacy and on their acceptance by the medical community. Widespread acceptance
of our products will require educating the medical community as to the benefits
and reliability of the products. Our products may not be accepted and, even if
accepted, we are unable to estimate the length of time it would take to gain
such acceptance.

We will be required to make royalty payments on products we may develop,
reducing the amount of revenues with which we could fund ongoing operations.

The owners and licensors of the technology rights acquired by us are entitled to
receive a certain percentage of all revenues received by us from
commercialization, if any, of products in respect of which we hold licenses.
Accordingly, in addition to our substantial investment in product development,
we will be required to make substantial payments to others in connection with
revenues derived from commercialization of products, if any, developed under
licenses we hold. Consequently, we will not receive the full amount of any
revenues that may be derived from commercialization of products to fund ongoing
operations.

Our dependence on third parties for rights to technology and the development of
our products could harm our business.

Under the terms of existing license agreements, we are obligated to make certain
payments to our licensors. In the event that we default on the payment of an
installment under the terms of an existing licensing agreement, our rights there
under could be forfeited. As a consequence, we could lose all rights under a
license agreement to the related licensed technology, notwithstanding the total
investment made through the date of the default. Unforeseen obligations or
contingencies may deplete our financial resources and, accordingly, sufficient
resources may not be available to fulfill our commitments. If we were to lose
our rights to technology, we may be unable to replace the licensed technology or
be unable to do so on commercially

16

reasonable terms, which would materially adversely affect our ability to bring
products based on that technology to market. In addition, we depend on our
licensors for assistance in developing products from licensed technology. If
these licensors fail to perform or their performance is not satisfactory, our
ability to successfully bring products to market may be delayed or impeded.

We face intense competition and rapid technological changes and our failure to
successfully compete or adapt to changing technology could make it difficult to
successfully bring products to market.

The medical field is subject to rapid technological change and innovation.
Pharmaceutical and biomedical research and product development are rapidly
evolving fields in which developments are expected to continue at a rapid pace.
Reports of progress and potential breakthroughs are occurring with increasing
frequency. Our success will depend upon our ability to develop and maintain a
competitive position in the research, development and commercialization of
products and technologies in our areas of focus. Competition from
pharmaceutical, chemical, biomedical and medical companies, universities,
research and other institutions is intense and is expected to increase. All, or
substantially all, of these competitors have substantially greater research and
development capabilities, experience, and manufacturing, marketing, financial
and managerial resources. Further, acquisitions of competing companies by large
pharmaceutical or other companies could enhance such competitors' financial,
marketing and other capabilities. Developments by others may render our products
or technologies obsolete or not commercially viable and we may not be able to
keep pace with technological developments.

We are subject to significant government regulation and failure to achieve
regulatory approval for our products would severely harm our business.

Our ongoing research and development projects are subject to rigorous FDA
approval procedures. The preclinical and clinical testing requirements to
demonstrate safety and efficacy in each clinical indication (the specific
condition intended to be treated) and regulatory approval processes of the FDA
can take a number of years and will require us to expend substantial resources.
We may be unable to obtain FDA approval for our products, and even if we do
obtain approval, delays in such approval would adversely affect the marketing of
products to which we have rights and our ability to receive product revenues or
royalties. Moreover, even if FDA approval is obtained, a marketed product, its
manufacturer and its manufacturing facilities are subject to continual review
and periodic inspections by the FDA, and a later discovery of previously unknown
problems with a product, manufacturer or facility may result in restrictions on
such product or manufacturer. Failure to comply with the applicable regulatory
requirements can, among other things, result in fines, suspensions of regulatory
approvals, product recalls, operating restrictions and criminal prosecution.
Additional government regulation may be established which could prevent or delay
regulatory approval of our products. Sales of pharmaceutical products outside
the United States are subject to foreign regulatory requirements that vary
widely from country to country. Even if FDA approval has been obtained, approval
of a product by comparable regulatory authorities of foreign countries must be
obtained prior to the commencement of marketing the product in those countries.
The time required to obtain such approval may be longer or shorter than that
required for FDA approval. We have no experience in manufacturing or marketing
in foreign countries nor in matters such as currency regulations, import-export
controls or other trade laws. To date, we have not received final regulatory
approval from the FDA or any other comparable foreign regulatory authority for
any of our products or technologies.

Our failure to meet product release schedules would make it difficult to predict
our quarterly results and may cause our operating results to vary significantly.

Delays in the planned release of our products may adversely affect forecasted
revenues and create operational inefficiencies resulting from staffing levels
designed to support the forecasted revenues. Our failure to introduce new
products on a timely basis could delay or hinder market acceptance and allow
competitors to gain greater market share.

If our intellectual property and proprietary rights are infringed, or infringe
upon the rights of others, our business will suffer.

Our success will depend in part on our ability to obtain patent protection for
our technologies, products and processes and to maintain trade secret protection
and operate without infringing the proprietary rights of others. The degree of
patent protection to be afforded to pharmaceutical, biomedical or medical
inventions is an uncertain area of the law. In addition, the laws of foreign
countries do not protect our proprietary rights to the same extent as do the
laws of the United States. We may not develop or receive sublicenses or other
rights related to proprietary technology that are patentable, patents that are
pending may be not issued, and any issued patents may not provide us with any
competitive advantages and may be challenged by third parties. Furthermore,
others may independently duplicate or develop similar products or technologies
to those developed by or licensed to us. If we are required to defend against
charges of patent infringement or to protect our own proprietary rights against
third parties, substantial costs will be incurred and we could lose rights to
certain products and technologies or be required to enter into costly royalty or
licensing agreements.

17

We do not have any marketing or manufacturing capabilities and will likely rely
on third parties for these capabilities in order to bring products to market.

We do not currently have our own sales force or an agreement with another
pharmaceutical company to market all of our products that are in development.
When appropriate, we may build or otherwise acquire the necessary marketing
capabilities to promote our products. However, we may not have the resources
available to build or otherwise acquire our own marketing capabilities, and we
may be unable to reach agreements with other pharmaceutical companies to market
our products on terms acceptable to us, if at all.

In addition, we do not intend to manufacture our own products. While we have
already entered into two manufacturing and supply agreements related to the
Premaire system and one related to the Tempo, these manufacturing and supply
agreements may not be adequate and we may not be able to enter into future
manufacturing and supply agreements on acceptable terms, if at all. Our reliance
on independent manufacturers involves a number of risks, including the absence
of adequate capacity, the unavailability of, or interruptions in, access to
necessary manufacturing processes and reduced control over product quality and
delivery schedules. If our manufacturers are unable or unwilling to continue
manufacturing our products in required volumes, we will have to identify
acceptable alternative manufacturers. The use of a new manufacturer may cause
significant interruptions in supply if the new manufacturer has difficulty
manufacturing products to our specifications. Further, the introduction of a new
manufacturer may increase the variation in the quality of our products.

Healthcare reimbursement policies are uncertain and may adversely impact the
sale of our products.

Our ability to commercialize human therapeutic and diagnostic products may
depend in part on the extent to which costs for such products and technologies
are reimbursed by private health insurance or government health programs. The
uncertainty regarding reimbursement may be especially significant in the case of
newly approved products. Reimbursement price levels may be insufficient to
provide a return to us on our investment in new products and technologies. In
the United States, government and other third-party payers have sought to
contain healthcare costs by limiting both coverage and the level of
reimbursement for new pharmaceutical products approved for marketing by the FDA,
including some cases of refusal to cover such approved products. Healthcare
reform may increase these cost containment efforts. We believe that managed care
organizations may seek to restrict the use of new products, delay authorization
to use new products or limit coverage and the level of reimbursement for new
products. Internationally, where national healthcare systems are prevalent,
little if any funding may be available for new products, and cost containment
and cost reduction efforts can be more pronounced than in the United States.

We may become subject to product liability claims and our product liability
insurance may be inadequate.

The use of our proposed products and processes during testing, and after
approval, may entail inherent risks of adverse effects that could expose us to
product liability claims and associated adverse publicity. Although we currently
maintain general liability insurance, the coverage limits of our insurance
policies may not be adequate. We currently maintain clinical trial product
liability insurance of $2.0 million per event for certain clinical trials and
intend to obtain insurance for future clinical trials of products under
development. However, we may be unable to obtain or maintain insurance for any
future clinical trials. Such insurance is expensive, difficult to obtain and may
not be available in the future on acceptable terms, or at all. A successful
claim brought against us in excess of our insurance coverage would have a
material adverse effect upon us and our financial condition. We intend to
require our licensees to obtain adequate product liability insurance. However,
licensees may be unable to maintain or obtain adequate product liability
insurance on acceptable terms and such insurance may not provide adequate
coverage against all potential claims.

The price of biotechnology/pharmaceutical company stocks has been volatile which
could result in substantial losses to our stockholders.

The market price of securities of companies in the biotechnology/pharmaceutical
industries has tended to be volatile. Announcements of technological innovations
by us or our competitors, developments concerning proprietary rights and
concerns about safety and other factors may have a material effect on our
business or financial condition. The market price of our common stock may be
significantly affected by announcements of developments in the medical field
generally or our research areas specifically. The stock market has experienced
volatility in market prices of companies similar to us that has been unrelated
to the operating results of such companies. This volatility may have a material
adverse effect on the market price of our common stock.

Our ability to issue "blank check" preferred stock may make it more difficult
for a change in our control.

18

Our certificate of incorporation authorizes the issuance of "blank check"
preferred stock with such designations, rights and preferences as may be
determined from time to time by the Board of Directors, without shareholder
approval. In the event of issuance, such preferred stock could be utilized,
under certain circumstances, as a method of discouraging, delaying or preventing
a change in our control and preventing shareholders from receiving a premium for
their shares in connection with a change of control. We issued Series A and
Series B cumulative convertible redeemable preferred stock in connection with
private placements in February 1997 and April 1998, respectively. All of the
Series A preferred stock was converted into common stock during 1998. On July
31, 1998, all of the Series B Preferred stock was redeemed for cash. We also
issued shares of our Series C cumulative convertible preferred stock in
connection with the consummation of an agreement with Elan International
Services, Ltd. ("Elan International") in June 1998. In October 1999, in
conjunction with a licensing agreement with Elan International, we issued shares
of our Series D cumulative convertible exchangeable preferred stock and Series F
cumulative convertible preferred stock. Except for the additional shares of
Series C, D and E preferred stock that may be payable as dividends to Elan
International, as holder of the outstanding Series C, D and E preferred stock,
we have no present intention to issue any additional shares of our preferred
stock. As we are currently investigating raising additional equity financing, we
may issue additional shares of our preferred stock in the near future.

We are obligated to issue additional securities in the future diluting our
stockholders.

As of September 30, 2002, we had reserved approximately 4,236,667 shares of our
common stock for issuance upon exercise of outstanding options and warrants
convertible into shares of our common stock, including by our officers and
directors. In addition, as of September 30, 2002, we had $2,000,000 principal
amount of a convertible promissory note, 15,501 shares of our Series C preferred
stock, 14,287 shares of our Series D preferred stock, 3,231 shares of our Series
E preferred stock and 5,000 shares of our Series F preferred stock outstanding.
Our Series C, D, E and F preferred stock are convertible into 10,993,617 shares,
2,939,712 shares, 830,591 shares and 1,470,588 shares, respectively, of common
stock. The convertible promissory note, including accrued interest is
convertible into 1,555,975 shares of common stock. The exercise of options and
outstanding warrants, the conversion of such other securities and sales of
common stock issuable thereunder could have a significant dilutive effect on the
market price of our common stock and could materially impair our ability to
raise capital through the future sale of our equity securities.

Item 3. Quantitative and Qualitative Disclosure About Market Risk

The Company has no material market risk exposure.

Item 4. Controls and Procedures

Our Chief Executive Officer and Chief Financial Officer have
concluded, based on their evaluation within 90 days of the
filing date of this report, that our disclosure controls and
procedures are effective for gathering, analyzing and
disclosing the information we are required to disclose in our
reports filed under the Securities Exchange Act of 1934. There
have been no significant changes in our internal controls or
in other factors that could significantly affect these
controls subsequent to the date of the previously mentioned
evaluation.

PART II: OTHER INFORMATION

Item 1. Legal Proceedings

The Company has been named as a defendant in Jeffrey Leston v.
Sheffield Pharmaceuticals, Inc., filed on October 16, 2002 in
the United States District Court, Southern District of New
York. The plaintiff in this action seeks damages of $100,000
for the breach of a contract under which Leston was retained
to introduce and facilitate a business alliance between
Sheffield and Zambon Corporation. Plaintiff claims that under
this contract, Sheffield was obligated, among other things, to
pay Leston a fee equal to 4% of any equity by Zambon in
Sheffield or other financing by Zambon, including loans. In
January 1999, an agreement was entered into amending the
original contract in a manner that the Company believes
relieved the Company for any of the obligations claimed in the
Complaint. In September 2001, Zambon loaned $2.5 million to
Sheffield as part of a restructuring of their alliance. This
action seeks consideration of $100,000, or 4% of the

19

$2.5 million loaned to Sheffield under this restructuring with
Zambon. The Company expects to deny the plaintiff's
allegations and plans to counter-claim for the return of
monies previously paid to the plaintiff and vigorously defend
the action and prosecute its counter-claims. The Company's
response to the Complaint is due by December 18, 2002.

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

(a) Exhibits

10.41 Form of promissory notes dated September 6, 2002 with
certain Shareholders.

(b) Reports on Form 8-K

A current Report on Form 8-K filed with the Securities and
Exchange Commission on August 14, 2002 under Item 9, relating
to the certification signed by the Company's Chief Executive
Officer and Chief Financial Officer as required pursuant to 18
U.S.C. Section 1350 as adopted pursuant to Section 906 of the
Sarbanes-Oxley Act of 2002, in connection with the Quarterly
Report on Form 10-Q for the period ending June 30, 2002.

A current Report on Form 8-K filed with the Securities and
Exchange Commission on September 6, 2002 to announce the
filing of a press release under Item 5.

20

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.

SHEFFIELD PHARMACEUTICALS, INC.

Dated: November 14, 2002 /s/ Thomas M. Fitzgerald
------------------------
Thomas M. Fitzgerald
President & Chief Executive Officer

Dated: November 14, 2002 /s/ Scott A. Hoffmann
---------------------
Scott A. Hoffmann
Vice President & Chief Financial Officer
(Principal Financial and Accounting Officer)

21

CERTIFICATIONS

I, Thomas M. Fitzgerald, certify that:

1. I have reviewed this quarterly report on Form 10-Q of Sheffield
Pharmaceuticals, Inc.;

2. Based on my knowledge, this quarterly report does not contain any untrue
statement of a material fact or omit to state a material fact necessary to make
the statements made, in light of the circumstances under which such statements
were made, not misleading with respect to the period covered by this quarterly
report;

3. Based on my knowledge, the financial statements, and other financial
information included in this quarterly report, fairly present in all material
respects the financial condition, results of operations and cash flows of the
registrant as of, and for, the periods presented in this quarterly report;

4. The registrant's other certifying officers and I are responsible for
establishing and maintaining disclosure controls and procedures (as defined in
Exchange Act Rules 13a-14 and 15d-14) for the registrant and have:

a) designed such disclosure controls and procedures to ensure that material
information relating to the registrant, including its consolidated subsidiaries,
is made known to us by others within those entities, particularly during the
period in which this quarterly report is being prepared;

b) evaluated the effectiveness of the registrant's disclosure controls and
procedures as of a date within 90 days prior to the filing date of this
quarterly report (the "Evaluation Date"); and

c) presented in this quarterly report our conclusions about the effectiveness of
the disclosure controls and procedures based on our evaluation as of the
Evaluation Date;

5. The registrant's other certifying officers and I have disclosed, based on our
most recent evaluation, to the registrant's auditors and the audit committee of
registrant's board of directors (or persons performing the equivalent
functions):

a) all significant deficiencies in the design or operation of internal controls
which could adversely affect the registrant's ability to record, process,
summarize and report financial data and have identified for the registrant's
auditors any material weaknesses in internal controls; and

b) any fraud, whether or not material, that involves management or other
employees who have a significant role in the registrant's internal controls; and

6. The registrant's other certifying officers and I have indicated in this
quarterly report whether there were significant changes in internal controls or
in other factors that could significantly affect internal controls subsequent to
the date of our most recent evaluation, including any corrective actions with
regard to significant deficiencies and material weaknesses.

Date: November 14, 2002
/s/ Thomas M. Fitzgerald
-----------------------------------
Thomas M. Fitzgerald
President & Chief Executive Officer

22

I, Scott A. Hoffmann, certify that:

1. I have reviewed this quarterly report on Form 10-Q of Sheffield
Pharmaceuticals, Inc.;

2. Based on my knowledge, this quarterly report does not contain any untrue
statement of a material fact or omit to state a material fact necessary to make
the statements made, in light of the circumstances under which such statements
were made, not misleading with respect to the period covered by this quarterly
report;

3. Based on my knowledge, the financial statements, and other financial
information included in this quarterly report, fairly present in all material
respects the financial condition, results of operations and cash flows of the
registrant as of, and for, the periods presented in this quarterly report;

4. The registrant's other certifying officers and I are responsible for
establishing and maintaining disclosure controls and procedures (as defined in
Exchange Act Rules 13a-14 and 15d-14) for the registrant and have:

a) designed such disclosure controls and procedures to ensure that material
information relating to the registrant, including its consolidated subsidiaries,
is made known to us by others within those entities, particularly during the
period in which this quarterly report is being prepared;

b) evaluated the effectiveness of the registrant's disclosure controls and
procedures as of a date within 90 days prior to the filing date of this
quarterly report (the "Evaluation Date"); and

c) presented in this quarterly report our conclusions about the effectiveness of
the disclosure controls and procedures based on our evaluation as of the
Evaluation Date;

5. The registrant's other certifying officers and I have disclosed, based on our
most recent evaluation, to the registrant's auditors and the audit committee of
registrant's board of directors (or persons performing the equivalent
functions):

a) all significant deficiencies in the design or operation of internal controls
which could adversely affect the registrant's ability to record, process,
summarize and report financial data and have identified for the registrant's
auditors any material weaknesses in internal controls; and

b) any fraud, whether or not material, that involves management or other
employees who have a significant role in the registrant's internal controls; and

6. The registrant's other certifying officers and I have indicated in this
quarterly report whether there were significant changes in internal controls or
in other factors that could significantly affect internal controls subsequent to
the date of our most recent evaluation, including any corrective actions with
regard to significant deficiencies and material weaknesses.

Date: November 14, 2002
/s/ Scott A. Hoffmann
--------------------------------------------
Scott A. Hoffmann
Vice President & Chief Financial Officer
(Principal Financial and Accounting Officer)

23