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UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

FORM 10-Q

(Mark One)

Commission File Number 0-24424

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.

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

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.

     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.” All other trademarks used in this report are the property of their respective owners. “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 Pharma. “Alavert™” is a trademark of Wyeth. “Allegra®” is a registered trademark of Aventis Pharmaceuticals Inc. “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. “OraQuick™” is a trademark of KV Pharmaceutical Company. “Pharmaburst™” is a trademark of SPI Pharma, Inc.

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PART I — FINANCIAL INFORMATION

Item 1. Financial Statements

CIMA LABS INC.
Balance Sheets
(in thousands, except per share data)

Note: The balance sheet at December 31, 2002 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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CIMA LABS INC.
Income Statements
(Unaudited)
(in thousands, except per share data)

     See accompanying notes.

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CIMA LABS INC.

Statements of Cash Flows
(Unaudited)
(in thousands)

     See accompanying notes.

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CIMA LABS INC.
Notes to Financial Statements
(Unaudited)
(in thousands, except per share data)

1. Basis of Presentation
CIMA LABS INC. (the “Company”), a Delaware corporation, develops and manufactures orally disintegrating tablets and enhanced-absorption oral drug delivery systems. The Company operates within a single business segment, the development and manufacture of orally disintegrating tablets and enhanced-absorption oral drug delivery systems. OraSolv and DuraSolv, the Company’s leading proprietary orally disintegrating tablet technologies, allow an active drug ingredient, which is frequently taste-masked, to be formulated into a new, orally disintegrating dosage form that dissolves quickly in the mouth without chewing or the need for water. The Company is also developing enhanced oral drug delivery technologies and independently developing new products based on its oral drug delivery technologies. The Company enters into collaborative agreements with pharmaceutical companies to develop products based on its oral drug delivery technologies. The Company currently manufactures six pharmaceutical brands for its partners incorporating its proprietary orally disintegrating tablet technologies. Revenues are comprised of three components: net sales of products the Company manufactures for pharmaceutical partners; 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 financial 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 nine month periods ended September 30, 2003 are not necessarily indicative of the results that may be expected for the year ended December 31, 2003. 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, 2002.

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.

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3. 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 September 30, 2003 and December 31, 2002, the amortized cost and estimated market value of available-for-sale securities are as follows:

4. Stock Based Compensation
The Company accounts for its stock plans under the recognition and measurement principles of APB Opinion No. 25, Accounting for Stock Issued to Employees, and related Interpretations. No stock-based employee compensation cost is reflected in net income, as all options granted under those plans had an exercise price equal to the market value of the underlying common stock on the date of grant. Under the requirements of FASB Statement No. 148, Accounting for Stock Based Compensation — Transition and Disclosure, the following table illustrates the effect on net income and net income per share if the Company had applied the fair value recognition provisions of that statement to stock based compensation:

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5. Income Per Share
Income per share for the three and nine months ended September 30, 2003 and 2002 are summarized in the following table:

6. Comprehensive Income
Comprehensive income consists of net income, fair value of forward contracts and net unrealized gains (losses) on available-for-sale securities.

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

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8. Tax Expense
Provisions for income taxes for the three- and nine-month periods ended September 30, 2003 reflect provisions for U.S. federal and state income taxes. At December 31, 2002, the Company had a valuation reserve of $6,408 resulting in a net deferred tax asset of $11,414. As of September 30, 2003, the Company had a valuation reserve of $4,320 resulting in a net deferred tax asset of $9,399.

9. Segment Information — Major Customers
The Company operates within a single segment: the development and manufacture of orally disintegrating tablets and enhanced-absorption oral drug delivery systems. Revenues are comprised of three components: net sales of products the Company manufactures for pharmaceutical partners; 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.

Revenues from major customers are as follows:

Trade accounts receivable at September 30, 2003 of approximately $14,900 were comprised primarily of the following customers: Organon (35%), Wyeth (26%), and AstraZeneca (15%).

All of the Company’s assets and operations are located in the U.S. While the Company does not directly conduct its activities outside the U.S., it considers international revenues to be those arising from shipments ultimately destined for non-U.S. end-users and revenues from royalties generated by non-U.S. sales by partners.

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10. Reclassifications
Certain amounts presented in the 2002 financial statements have been reclassified in order to conform to the 2003 presentation. These reclassifications have no impact on the net income or stockholders’ equity as previously reported.

11. Merger with aaiPharma Inc.
The Company entered into an Agreement and Plan of Merger dated August 5, 2003, by and among the Company, aaiPharma Inc. (“aaiPharma”), Scarlet Holding Corporation, Scarlet MergerCo, Inc. and Crimson MergerCo, Inc. (the “CIMA/aaiPharma Agreement”). Under the terms of the CIMA/aaiPharma Agreement, a newly-formed holding company was formed to acquire all of the outstanding shares of each company and each company would become a wholly-owned subsidiary of the holding company. Under the CIMA/aaiPharma Agreement, each share of the Company’s common stock would have been exchanged for 1.3657 shares of the holding company’s common stock. See Note 12 below.

12. Subsequent Event

On November 3, 2003, the Company announced that it terminated the CIMA/aaiPharma Agreement and paid to aaiPharma a termination fee of $11,500 as required by the agreement.

Following the termination of the CIMA/aaiPharma Agreement, the Company, Cephalon, Inc., a Delaware corporation (“Cephalon”), and C MergerCo, Inc., a Delaware corporation and a direct, wholly-owned subsidiary of Cephalon (“C MergerCo”), entered into an Agreement and Plan of Merger, dated as of November 3, 2003 (the “CIMA/Cephalon Agreement”). Pursuant to the CIMA/Cephalon Agreement, Cephalon will acquire the Company through the merger of C MergerCo with and into the Company, with the Company surviving as a wholly-owned subsidiary of Cephalon (the “Merger”). In connection with the Merger, each outstanding share of the Company’s common stock will be converted into the right to receive $34.00 per share in cash. Each outstanding option to purchase the Company’s common stock, whether or not vested or exercisable, will be converted into the right to receive an amount of cash equal to $34.00 less the exercise price for each share underlying such option. If the CIMA/Cephalon Agreement is terminated under certain circumstances, the Company may be required to pay Cephalon a termination fee and expenses up to $16,250.

The Merger is subject to approval by the Company’s stockholders, as well as regulatory approvals and the satisfaction of other customary closing conditions.

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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 heading Management’s Discussion and Analysis of Financial Condition and Results of Operations and elsewhere, that 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 under the heading “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 without considering the risks and uncertainties associated with these statements and our business.

These forward-looking statements include statements relating to the expected growth in operating revenues for 2003 and changes in components of revenues for 2003; the expected increases of gross profits and gross profit margins; the expected decrease in other income; the timing for recognition of our remaining tax benefits; the timing for completion of improvements to our Brooklyn Park R&D center, including the construction and operation of a second site for manufacturing; future expense levels; the timing of availability and expected mix of products; expected demand for products using our technologies; the adequacy of our production capacity, including plans to expand our capacity; the adequacy of our cash and cash reserves; the timing of the closing of the merger transaction with Cephalon, Inc.; the expected amount of merger-related expenses; and future research and development activities and funding relating to our current or new technologies. We do not undertake any obligation 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 enter into collaborative agreements with pharmaceutical companies to develop and manufacture products based on our proprietary OraSolv and DuraSolv orally disintegrating tablet technologies. We currently manufacture six pharmaceutical brands utilizing our orally disintegrating tablet technologies: three prescription and three over-the-counter (“OTC”) brands. The three prescription products are AstraZeneca’s Zomig-ZMT and its equivalent for non-U.S. markets, Remeron SolTab for Organon, and NuLev for Schwarz Pharma. The OTC products are Triaminic Softchews for Novartis, Tempra FirsTabs for a Canadian affiliate of Bristol-Myers Squibb, and Alavert for Wyeth. 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 orally disintegrating tablets and enhanced-absorption oral drug delivery systems. Our revenues are comprised of three components, including net sales of products we manufacture for pharmaceutical companies using our proprietary orally disintegrating tablet technologies, product development fees and licensing revenues for development activities we conduct through collaborative agreements with pharmaceutical companies, and royalties on the sales of products we manufacture which are sold by pharmaceutical companies under license from us.

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 for our partners, 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.

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Recent Event

On November 3, 2003, the Company announced that it terminated that certain Agreement and Plan of Merger dated August 5, 2003, by and among the Company, aaiPharma Inc. (“aaiPharma”), Scarlet Holding Corporation, Scarlet MergerCo, Inc. and Crimson MergerCo, Inc. (the “CIMA/aaiPharma Agreement”). In connection with the termination of the CIMA/aaiPharma Agreement, the Company paid to aaiPharma a termination fee of $11.5 million as required by the agreement.

Following the termination of the CIMA/aaiPharma Agreement, the Company, Cephalon, Inc., a Delaware corporation (“Cephalon”), and C MergerCo, Inc., a Delaware corporation and a direct, wholly-owned subsidiary of Cephalon (“C MergerCo”), entered into an Agreement and Plan of Merger, dated as of November 3, 2003 (the “CIMA/Cephalon Agreement”). Pursuant to the CIMA/Cephalon Agreement, Cephalon will acquire the Company through the merger of C MergerCo with and into the Company, with the Company surviving as a wholly-owned subsidiary of Cephalon (the “Merger”). In connection with the Merger, each outstanding share of the Company’s common stock will be converted into the right to receive $34.00 per share in cash. Each outstanding option to purchase the Company’s common stock, whether or not vested or exercisable, will be converted into the right to receive an amount of cash equal to $34.00 less the exercise price for each share underlying such option. The completion of the Merger is subject to several customary closing conditions, including the approval of the CIMA/Cephalon Agreement by the Company’s stockholders and the expiration or termination of the applicable waiting periods under the Hart-Scott-Rodino Antitrust Improvements Act of 1976.

In connection with the CIMA/Cephalon Agreement, the Company entered into an amendment (the “Rights Agreement Amendment”) to its Amended and Restated Rights Agreement dated as of September 26, 2001, as amended on August 5, 2003 (the “Rights Agreement”). The Rights Agreement Amendment clarifies that the execution of the CIMA/Cephalon Agreement or the consummation of the transactions contemplated thereby will not trigger the Rights Agreement by providing, among other matters, that neither Cephalon or C MergerCo will become an “acquiring person” under the Rights Agreement.

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 these 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 of milestones; from up-front product development license fees as fees are recognized ratably over the expected development term of the proposed products; and from royalties on the sales of products that we manufacture, which are sold by pharmaceutical companies under license from us. The determination of SAB 101 criteria (3) and (4) for

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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.

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 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. As of December 31, 2002, the Company had a valuation reserve of $6.4 million resulting in a net deferred tax asset of $11.4 million. As of September 30, 2003, the Company had a valuation reserve of $4.3 million resulting in a net deferred tax asset of $9.4 million.

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Results of Operations

Three and Nine Month Periods Ended September 30, 2003 and 2002

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

* Net income for the three and nine months ended September 30, 2003 reflected tax expense provisions of $715,000 and $3.9 million, respectively; whereas net income for the three and nine months ended September 30, 2002 reflected a tax benefit of $617,000 and $1.1 million, respectively.

Operating Revenues. Total operating revenues for the third quarter ended September 30, 2003 were $20.3 million, an increase of $7.8 million, or 62%, over the same period in 2002. The third quarter increases in total operating revenues resulted from increases in two out of three of our revenue components: revenues from the sales of products we manufacture and sell to our pharmaceutical company partners and royalties on the sales of products we manufacture which are sold by pharmaceutical companies under licenses from us. The third source of our revenues, product development fees and licensing revenue, declined from the third quarter of 2002. For the nine months ended September 30, 2003, total operating revenues were $55.3 million, an increase of $24.2 million, or 78%, over the same period of 2002. The changes for the nine-month period by revenue component followed the same pattern as the quarter. For additional information, readers are directed to Note 9 in the Notes to Financial Statements in this Form 10-Q.

Generally speaking, we respond to the product demand forecasts of our pharmaceutical partners. Accordingly, sales of manufactured products to our pharmaceutical partners may vary from period to period based on our partners’ demand. In the third quarter of 2003, revenues from net sales of products we manufacture for our pharmaceutical partners were $13.3 million, an increase of $7.3 million, or 119%, over the same period of 2002. The increase was primarily due to production of Alavert for Wyeth which was launched in December 2002, higher manufacturing volumes of Remeron SolTab for Organon (sales increased 40%) and Triaminic Softchews for Novartis (sales increased 23%), partially offset by lower revenues from production of Zomig for AstraZeneca (sales decreased 37%) and NuLev for Schwarz Pharma (sales decreased 52%). Excluding the sales of Alavert to Wyeth, the third quarter sales increase related to product lines in existence for more than one year was 24%. For the nine months ended September 30, 2003, revenues from net sales of products we manufacture for our pharmaceutical partners were $35.7 million, an increase of $20.7 million, or 138%, versus the first nine months of 2002. The increase was due to revenues from production of Alavert for Wyeth, and increased volumes of Remeron SolTabs for Organon (sales increased 102%) and NuLev for Schwarz (sales increased 21%) offset in part by declines in volume of Triaminic Softchews for Novartis (sales decreased 13%) and Zomig for AstraZeneca (sales decreased 11%). Excluding the sales of Alavert to Wyeth, the first nine months sales related to product lines in existence for more than one year increased 56%. For the full year 2003, we expect revenues from net sales of products we manufacture for our pharmaceutical partners to more than double from 2002. Sales of branded prescription products to our pharmaceutical company partners (Organon, AstraZeneca, and Schwarz Pharma) increased over $8.7 million and represented 56% of our total product sales in the first nine months of 2003, compared with 76% the first nine months of 2002. Over-the-counter product sales to our pharmaceutical company partners (Wyeth, Novartis, and Bristol

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Myers-Squibb) increased nearly $12.0 million and accounted for 44% of total product sales compared with 24% in the first nine months of last year. We expect lower contributions to our revenues from prescription products and higher contributions from over-the-counter products for the full year 2003 compared to 2002, although the contributions may vary by quarter.

Revenues from product development fees and licensing were $1.4 million in the third quarter of 2003, a decrease of $1.8 million, or 58%, from the same period of 2002. This decrease resulted from a maturing of certain agreements for proposed new products, including our achievement of certain milestones under existing agreements. The timing of product development fees and licensing revenues can vary based on the nature and scope of the activities being performed. The majority of revenues for both years was related to the seven product development project with Schwarz Pharma. Activities on behalf of Alamo contributed approximately equal percentages to 2003 and 2002. We are actively pursuing new development agreements while increasing efforts in support of our proprietary compounds. For the first nine months of 2003, revenues from product development fees and licensing were $4.6 million, a decrease of $4.0 million, or 47%, from the first nine months of 2002. The same factors that caused a decrease in the third quarter affected revenues in the nine-month period. For 2003, we expect combined revenues attributable to product development fees and licensing to range from 50% to 60% less than full-year 2002 levels. In May 2003, we agreed to reschedule and reconfigure as future milestone payments certain product development fees payable by Schering Plough, which has the effect of delaying revenues from 2003 to 2004 and 2005.

We receive royalties based upon our pharmaceutical partners’ end-product sales into their respective markets. Revenues from royalties were $5.6 million in the third quarter of 2003, an increase of $2.4 million or 76% over the same quarter of 2002. The increase was due primarily to increased end-customer sales by Organon of Remeron SolTab (a 144% increase), by AstraZeneca of Zomig Rapimelt (the non-U.S. equivalent of Zomig-ZMT) in Europe and Zomig-ZMT in the United States (a 19% increase), and by Wyeth’s introduction of Alavert in the fourth quarter of 2002. Royalties related to partner-marketed product lines in existence for more than 12 months increased 56% in the third quarter. For the nine months ended September 30, 2003, revenues from royalties were $15.1 million, an increase of $7.5 million, or 100% versus the first nine months of 2002. Royalties related to partner-marketed product lines in existence for more that 12 months increased 70% in the first nine months of 2003. The increase for the nine months was caused by the same factors as the third quarter (Organon increased 144% and AstraZeneca increased 42%). For 2003, we expect royalties to increase by 80% to 90% from 2002 levels.

Cost of goods sold. Cost of goods sold was $9.5 million and $24.7 million in the third quarter and first nine months of 2003, respectively, compared to $4.9 million and $11.9 million, respectively, for the same periods of 2002. These increases were primarily due to additional labor and materials related to higher production volumes over the same periods in 2002. In the first three quarters of the year, material costs increased by approximately $8.3 million, or about 152%, largely in line with the 138% increase in net sales revenue, but marginally higher due to the cost of the active ingredient (loratadine) in the Alavert product manufactured for Wyeth. Labor costs were up approximately $1.1 million, or about 93%, reflecting better efficiencies on the higher net sales volume. Overhead was up approximately $4.5 million, or about 70%, reflecting the high overhead absorption from running at nearly full capacity in the nine months of 2003. For 2003, we expect cost of goods sold to increase from 2002 levels in terms of dollar amount, but to decrease as a percentage of net sales as we continue to run at full capacity for the balance of the year.

Gross profit on product sales was $3.9 million and $11.0 million in the third quarter and first nine months of 2003, compared to $1.1 million and $3.0 million, respectively, in the same periods of 2002. Gross margins on product sales were 29% and 31% of total product sales in the third quarter and first nine months of 2003 compared with 19% and 20%, respectively, for the same periods of 2002. For the first nine months of 2003, nearly all of this improvement is due to higher manufacturing efficiencies from full capacity utilization, as manufacturing volume has increased by over 106% while overhead spending has risen only 43%. For the full year of 2003, we expect gross profits on product sales to increase from 2002 levels in terms of dollar amounts and as a percentage of product sales.

Research and product development expenses. Research and product development expenses were $3.6 million in the third quarter of 2003, an increase of $280,000, or 8.4%, over the same period of 2002. For the first nine months of 2003, research and product development expenses were $8.8 million, an increase of $1.0, or 13.3% over the first nine months of 2002. The increase in the first nine months was due primarily to additional staffing (approximately $850,000), infrastructure investments (approximately $650,000), increased energy costs (approximately $150,000), and outside testing services ($125,000), offset partly by reduced external spending on development projects (approximately $100,000) and reduced spending on materials used in creating prototypes ($700,000). For 2003,

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we expect research and product development expenses to increase by 20% to 25% from 2002 levels due to increased development efforts and clinical trial costs related to our proprietary products, increased staffing costs, and higher infrastructure costs.

Selling, general and administrative expenses. Selling, general and administrative expenses were $2.9 million in the third quarter of 2003, an increase of $874,000, or 44.1%, over the third quarter of 2002. This increase was due primarily to costs associated with increased professional staffing and payroll related costs (approximately $480,000), increased employee headcount related expenses (approximately $150,000), property and insurance expense (approximately $100,000), increased advertising and promotion costs (approximately $115,000), and management transition costs (approximately $25,000). For the first nine months of 2003, selling, general and administrative expenses were $9.0 million, an increase of $3.4 million, or 60.6% over the first nine months of 2002. The increase in the first nine months was due primarily to costs associated with increased legal fees (approximately $1.0 million), increased professional staffing and payroll related costs (approximately $1.1 million), management transition costs (approximately $375,000), increased employee headcount related expenses (approximately $350,000), property and business insurance costs (approximately $215,000), increased advertising and promotion costs (approximately $150,000), and efforts to comply with the Sarbanes-Oxley Act (approximately $100,000). For 2003, we expect selling, general and administrative expenses to increase by more than 60% from 2002 levels due to increased legal fees, increased professional staffing costs, management transition costs, property and business insurance costs and costs of efforts to comply with the Sarbanes-Oxley Act.

Merger-related expenses. Merger-related expenses were $3.5 million in the third quarter of 2003 and $3.7 million for the first nine months of 2003. For the remainder of 2003, transaction related costs associated with the terminated merger agreement with aaiPharma and preparation for the merger with Cephalon are expected to require expenditures of $13-15 million in the fourth quarter of 2003, $12.5 million of which is attributable to the $11.5 million termination fee paid to aaiPharma and a fee paid to the Company’s investment bankers in connection with the delivery of a fairness opinion relating to the Cephalon transaction. Depending on the progress of the Cephalon transaction during the fourth quarter, there could be differing levels of legal costs, advisory costs related to our performance of due diligence activities and regulatory filings, and other transaction-related costs.

Other income (expense). Other income was $757,000 and $2.7 million in the third quarter and first nine months of 2003, respectively, a decrease of $692,000 and $2.5 million from the comparable periods of 2002, respectively. Other income consists primarily of investment income comprised of interest earned on securities and gains realized on the sale of securities. The decrease from 2002 levels was due primarily to lower interest rates on our investments and lower levels of cash available for investment. For 2003, we expect other income to decrease by 40% to 50% from 2002 levels due to lower interest rates and expected capital expenditures that will reduce the level of cash available for investment.

Provision for income taxes. 2003 is the first year since turning profitable in the fourth quarter of 1999 that we have reported a provision for income tax expense on our income statement. The provision for income tax expense for the quarter ended September 30, 2003 was $715,000, compared with a tax benefit of $617,000 recognized in the third quarter of 2002. For the nine months ended September 30, 2003, the tax provision recorded was $3.9 million, compared to a tax benefit of $1.1 million for the first nine months of 2002. We have recognized approximately $1.2 million of U.S. tax credits related to the utilization of net operating loss carryforwards in the third quarter of 2003 and $1.9 million in the first nine months of 2003 from the years when we were not profitable. Without these credits, our cumulative tax expense since turning profitable would have been approximately $20.1 million, based on an effective tax rate of 37.5%.

The effective tax rate of 42.4% used in computing net income in the third quarter resulted from the assumed non-deductibility of merger-related expenses related to our strategic transaction with aaiPharma, offset in part by recognition of tax benefits from net operating loss carryforwards. As discussed elsewhere in this Form 10-Q, the merger agreement with aaiPharma was terminated on November 3, 2003, and the expenses associated with that transaction now will be treated as deductible. We expect that the recharacterization of those third quarter merger expenses and additional expenses associated with the aaiPharma transaction (including the $11.5 million termination fee paid by the Company) will have a significant impact on the fourth quarter and full year 2003 effective tax rate. This impact has not yet been quantified.

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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, and royalties.

Working capital increased from $83.7 million at December 31, 2002 to $97.9 million at September 30, 2003, primarily due to an increase in cash and the current portion of available-for-sale securities. Cash and available-for-sale securities, including both current and non-current securities, were $129.9 million at September 30, 2003, down from $131.7 million at December 31, 2002. Capital expenditures during the first nine months of 2003 totaled $13.8 million. These expenditures were essentially funded by cash generated from operating activities. We invest excess cash in interest-bearing money market accounts and investment grade securities.

During 2003, we plan to spend approximately $25 million to complete various improvement projects at our Eden Prairie manufacturing facility and our Brooklyn Park R&D center. These projects include: the addition of a production line in Eden Prairie for products requiring blister packaging in response to the increased demand by our pharmaceutical company partners for manufactured products; and the establishment of a second manufacturing site in our Brooklyn Park facility to provide bottling production capabilities. We expect the Brooklyn Park manufacturing site to be operational in late 2003. In addition to these improvement projects, we expect to fund additional product development activities related to our OraVescent technology. Transaction related costs associated with the terminated merger agreement with aaiPharma and preparation for the merger with Cephalon are expected to require expenditures of $13-15 million in the fourth quarter of 2003, $12.5 million of which is attributable to the $11.5 million termination fee paid to aaiPharma and a fee paid to the Company’s investment bankers in connection with the delivery of a fairness opinion relating to the Cephalon transaction. 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 also consider carefully the proxy statement regarding our proposed transaction with Cephalon, Inc. when it becomes available because it will contain important information about the transaction. 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.

Our Business And Stock Price May Suffer Prior To Completion Of, Or If We Do Not Complete The Proposed Transaction With Cephalon.

     If the transaction with Cephalon is not completed, we could be subject to a number of risks that may adversely affect our business and stock price, including:

•

our day-to-day operations may be disrupted due to the substantial time and effort our management must devote to seeking to complete the transaction;

•

if the merger agreement is terminated under certain conditions, we may be required to pay Cephalon termination fees and expenses of up to $16.25 million;

•

the market price of our common stock may decline to the extent that the current market price of such shares reflects a market assumption that the transaction will be completed;

•

we must pay various costs related to the transactions, such as our legal, investment advisor and accounting fees; and

•

if our board of directors determines to seek another merger or business combination, we may not be able to find a partner willing to enter into a transaction with more favorable terms and conditions than that agreed to by Cephalon.

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     The announcement of the planned transaction with Cephalon, and related uncertainty concerning our future, may make it more difficult for us to enter into long-term relationships with certain pharmaceutical company partners and other third parties, which could have an adverse effect on our revenues.

     Third parties with whom we currently have relationships may terminate or otherwise reduce the scope of their relationship with us in anticipation or as a result of the transaction. Speculation regarding the likelihood of the closing of the transaction with Cephalon could increase the volatility of the price of our common stock.

     We intend to comply with the securities and antitrust laws of the United States and any other jurisdiction in which the proposed transaction is subject to review. The reviewing authorities may seek to impose conditions before giving their approval or consent to the transaction.A delay in obtaining the necessary regulatory approvals will delay the completion of the transaction. We have not yet obtained any governmental or regulatory approvals required to complete the transaction. We may be unable to obtain these approvals or to obtain them within the timeframe contemplated by the merger agreement.

The Loss Of One Of Our Top Four Major Customers Could Reduce Our Revenues Significantly.

     Revenues from AstraZeneca, Organon, Schwarz Pharma, and Wyeth together represented approximately 90% and 76% of our total revenues for the first nine months of 2003 and 2002, respectively. 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 a significant portion 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 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, Or The Sales Of Those Products May Be Affected By Factors Beyond The Control Of Those Third Parties.

     Our pharmaceutical company partners market and sell the products we develop and manufacture for them. If one or more of our pharmaceutical company partners fails to pursue the marketing of products incorporating our technology 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, 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 delivery 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 products that incorporate our drug delivery technologies. 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.

     For the year ended December 31, 2002, net sales from manufacturing and royalties from our partners’ sales of our top four products accounted for approximately 71% of our operating revenues. For the nine months ended September 30, 2003, net sales from manufacturing and royalties from our partners’ sales of our top four products accounted for approximately 89% of our total operating revenues. Our top four products are AstraZeneca’s Zomig-ZMT and its equivalent for markets outside the U.S., Organon’s Remeron SolTab and its equivalent for markets outside the U.S., Wyeth’s Alavert and Novartis’ Triaminic Softchews. We cannot be certain that these products will continue to be accepted in their markets. Specifically, the following factors, among others, could affect the level of market acceptance of Remeron SolTab and its non-U.S. equivalents, Zomig-ZMT and its non-U.S. equivalents, and Alavert:

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the perception of the healthcare community of their safety and efficacy, both in an absolute sense and relative to that of competing products;

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unfavorable publicity regarding these products or similar products;

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product price relative to other competing products or treatments;

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changes in government and third-party payor reimbursement policies and practices; and

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regulatory developments affecting the manufacture, marketing or use of these products.

If We Do Not Enter Into Additional Collaborative Agreements With Pharmaceutical Companies, We May Not Be Able To Achieve Sustained Profitability.

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     We primarily 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 products incorporating our technology, 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:

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any existing or future collaborative agreements may not result in additional commercial products;

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additional commercial products that we develop with our pharmaceutical company partner may not be successful;

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we may not be able to meet the milestones established in our current or future collaborative agreements;

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we may not be able to successfully develop new drug delivery technologies that will be attractive in the future to potential pharmaceutical company partners; and

•

our pharmaceutical company partners may exercise their rights to terminate their collaborative agreements with us.

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 at our Eden Prairie facility for product requiring blister packaging, which collectively have an estimated annualized production capacity in excess of 500 million tablets. In 2003, we plan to add a third production line at our Eden Prairie facility, which is expected to be completed and commissioned in the first half of 2004. We also are installing a production line for bottled product at our Brooklyn Park facility, which is expected to be completed and commissioned in the fourth quarter of 2003. We estimate that the total annualized capacity for the production lines in Eden Prairie will increase from approximately 500 million to approximately 1.0 billion tablets after the third production line is completed and commissioned. We estimate that the total annualized capacity of the production line in Brooklyn Park will be approximately 700 million bottled tablets. If we are unable to increase our production capacity as scheduled or if our partners significantly increase their requirements for product deliveries prior to completing the scheduled increases in capacity, we may be required to allocate our production capacity until we have completed these capacity improvements. If this should happen, 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.

     Our operating revenues increased 78% in the first nine months of 2003, 46% in the year ended December 31, 2002, and 34% in the year ended December 31, 2001, 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 also need to expand our finance, administrative and operations staff. We may not be able to complete the improvements 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.

Sales Of Our Pharmaceutical Company Partners’ Products May Decline As A Result Of Competition From Generic Prescription Products And Regulatory Actions That Could Switch A Prescription Product To An Over-The-Counter Product, Which May Result In A Decline In Our Revenues And Profitability.

     Many of our pharmaceutical company partners face intense competition from manufacturers of generic drugs. Generic competition may reduce the demand and/or price for our partners’ products. Products that our

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pharmaceutical company partners produce may also be subject to regulatory actions that result in prescription products becoming available to consumers over-the-counter. Such a change could also reduce the demand and/or price for our partners’ products. Because we derive a significant portion of our revenue from manufacturing products for and receipt of royalties from our pharmaceutical company partners, a decline in the sales of products that we produce for our partners, whether as a result of the introduction of competitive generic products or other competitive factors, could have a material adverse effect on our revenues and profitability.

     In January 2002, Mylan Laboratories and Teva Pharmaceutical Industries announced that they received tentative approval from the FDA to sell mirtazapine tablets, which are expected to be generic substitutes for Organon’s Remeron standard tablets. We developed and manufacture an OraSolv formulation of Remeron, Remeron SolTab, for Organon. 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 Laboratories, Inc. for infringing its U.S. patent for Remeron SolTab (mirtazapine orally disintegrating tablets). On December 18, 2002, a federal district court ruled that the generic version of mirtazapine developed by Teva did not infringe Organon’s patent covering Remeron. Although Organon has appealed this court’s ruling, it is unlikely that the appeals court will reverse or delay the trial court’s ruling. Teva launched its generic form of mirtazapine in the U.S. market in 2003. We expect other generic manufacturers, including Mylan Laboratories, to launch their generic versions of mirtazapine, subject to FDA approval, after Teva’s 180 day marketing exclusivity period expires. In addition, the U.S. market launch of generic orally disintegrating mirtazapine tablets developed by Barr Laboratories is expected to occur after it receives FDA approval. Organon’s market for Remeron SolTab may be affected negatively by the introduction of generic versions of standard or orally disintegrating mirtazapine tablets. The introduction of these generic tablets could be expected to lower Organon’s pricing for Remeron. Due to the large number of variables and high degree of uncertainty, we are unable to predict the timing of the market introduction of a generic orally disintegrating mirtazapine tablet or the effect that the introduction of generic mirtazapine may have on our business.

     On January 15, 2003, KV Pharmaceutical Company announced that it will begin marketing the first product utilizing its OraQuick orally disintegrating tablet technology. Hyoscyamine sulfate orally disintegrating tablets, 0.125 mg, is a prescription anticholinergic/antispasmodic product. This product is equivalent to and substitutable for NuLev, which we developed and manufacture for Schwarz Pharma. Due to the large number of variables, we are unable to predict the effect of this product introduction by KV Pharmaceutical on our business. For details regarding a lawsuit between KV Pharmaceutical and CIMA, see information under the heading “Legal Proceedings” contained elsewhere in this document.

     On January 27, 2003, Andrx Corporation and Perrigo Company announced that they have entered into a multi-year agreement for Andrx to supply Perrigo with Andrx’s over-the-counter orally disintegrating tablet formulation of loratadine, which is expected to be equivalent to and substitutable for Schering-Plough’s Claritin RediTabs and Wyeth’s Alavert. Andrx has received FDA approval of its Abbreviated New Drug Application for an orally disintegrating tablet formulation of loratadine. We developed and manufacture Alavert for Wyeth. Perrigo is one of the largest providers of store brand over-the-counter products in the U.S. In February 2003, Wyeth received its second FDA approval, an Abbreviated New Drug Application, for a DuraSolv loratadine product, which is identical to Alavert, but was initially intended for the prescription market. . Due to the large number of variables, we are unable to predict the exact timing and effect of such a product introduction by the Perrigo Company on our business, although Andrx has announced that it expects to begin shipping this product to Perrigo prior to year-end.

We May Experience Significant Delays In Expected Product Releases While We And Our Pharmaceutical Company Partners Seek Regulatory Approvals For The Products We Develop And Manufacture And, If Either Of Us 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 they are not successful, our revenues and profitability may decline. We, and our pharmaceutical company partners, cannot control the timing of regulatory approval for the products we develop.

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     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. In addition, prior to obtaining FDA approval for a product, the manufacturing facility for the product must be pre-approved by the FDA. Our failure to obtain FDA pre-approval of our manufacturing facilities could significantly delay or cause the rejection of FDA approval for products we and our pharmaceutical company partners intend to manufacture and sell. 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. We cannot guarantee that any future inspections will proceed without any compliance issues requiring time and resources to resolve.

     On August 1, 2003 the Minneapolis District Office of the FDA completed an inspection of our facilities that focused on compliance with current Good Manufacturing Practice regulations for manufacturers of pharmaceuticals. The FDA also conducted reviews under the Pre-Approval Inspection program related to three of our partners’ pending applications and collected profile samples. The FDA issued two form 483s at the close of the inspection that listed seven objectionable conditions. We provided a formal response to the Minneapolis District Office on September 2, 2003 that described our correction of each condition identified in the 483s. We believe that the corrections we implemented are adequate and substantially complete. Corrective actions are subject to verification and review at the next FDA inspection.

     Regarding the three pending applications that the Minneapolis District office reviewed under the Pre-Approval Inspection program, the Minneapolis District office issued a letter on August 22, 2003 documenting its District level approval recommendation to the FDA Center for Drug Evaluation and Research. The Minneapolis District Office’s recommendation is not binding on the FDA, and action by the FDA’s Center for Drug Evaluation and Research on our partners’ applications is required before approval is final. An approval recommendation by the Minneapolis District Office is a prerequisite to final approval by the FDA’s Center for Drug Evaluation and Research of an application.

We May Be Exposed To Liability Claims Associated With The Use Of Hazardous Materials And Chemicals.

     Our research and development and manufacturing activities involve the controlled use of hazardous materials and chemicals. Although we believe that our safety procedures for using, storing, handling and disposing of these materials comply with federal, state and local laws and regulations, we cannot completely eliminate the risk of accidental injury or contamination from these materials. In the event of such an accident, we could be held liable for any resulting damages, and any liability could materially adversely affect our business, financial condition and results of operations. In addition, the federal, state and local laws and regulations governing the use, manufacture, storage, handling and disposal of hazardous or radioactive materials and waste products may require us to incur substantial compliance costs that could materially adversely affect our business, financial condition and results of operations.

Our Products May Contain Controlled And Potent Substances, The Supply And Manufacture Of Which May Be Limited Or Regulated By U.S. Government Agencies.

     The active ingredients in some of our current and proposed products, including OraVescent fentanyl, are controlled substances under the Controlled Substances Act of 1970 and are regulated by the U.S. Drug Enforcement Agency. These products are subject to DEA and OSHA regulations relating to manufacturing, storage, distribution and physician prescription procedure. Products containing controlled substances may generate public controversy. Opponents of these products may seek restrictions on marketing and withdrawal of any regulatory approvals. In addition, these opponents may seek to generate negative publicity in an effort to persuade the medical community to reject these products. Political pressures and adverse publicity could lead to delays in, and increased expenses for, and limit or restrict the introduction and marketing of products containing controlled substances. Furthermore, the DEA could impose significant penalties and fines against us and our pharmaceutical company partners for violating the Controlled Substances Act and DEA regulations.

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     Regulations under the Occupational Safety and Health Act establish certain standards related to safety in handling and manufacturing potent substances, such as fentanyl citrate. Under these regulations, we believe that our production of fentanyl citrate would require a specialized manufacturing environment that prevents fentanyl citrate from coming in contact with humans. We may develop other products that would require a specialized manufacturing environment. Currently, none of our existing production lines in Eden Prairie nor our planned production lines in Eden Prairie and Brooklyn Park are capable of manufacturing potent substances. In the event we pursue the development of our OraVescent fentanyl product through regulatory submission or other potential products with a comparable safety profile to fentanyl, we will be required to identify a manufacturer with appropriate resources to manufacture potent substances or to develop those capabilities internally. We are presently assessing the feasibility of contracting with third party manufacturers that have these specialized manufacturing capabilities and of developing these capabilities internally. In the event we decide to manufacture OraVescent fentanyl or other potent products in our facilities, we will be required to add potent substance manufacturing capabilities that comply with these safety regulations, which could require capital expenditures in the excess of $10 million. If we choose not to invest in potent substance manufacturing capabilities, our future revenues may not grow as fast because we will be unable to compete in certain important therapeutic markets for our technologies.

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:

•

adverse drug experience reporting regulations;

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product promotion;

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product manufacturing, including good manufacturing practices requirements; and

•

product changes or modifications.

     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:

•

issue warning letters;

•

impose fines;

•

seize products or order recalls;

•

issue injunctions to stop future sales of products;

•

refuse to permit products to be imported into, or exported out of, the U.S.;

•

totally or partially suspend our production;

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delay pending marketing applications; and

•

initiate criminal prosecutions.

We Have A Single Manufacturing Facility For Product Requiring Blister Packaging And We May Lose Revenues And Be Unable To Maintain Our Relationships With Our Pharmaceutical Company Partners If We Lose Production Capacity for Blistered Product.

     We manufacture all our current products on two production lines in our Eden Prairie facility. All of our commercialized products, except for Schwarz Pharma’s NuLev, are blister-packaged on one or both of our Eden Prairie production lines. 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 to 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. The production line we expect to add at our Brooklyn Park facility will be dedicated to bottled product, which is important for products currently under development, but does not reduce the risk associated with loss of capacity for product requiring blister packaging.

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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. While we have identified alternative suppliers, we may not be able to engage them 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 and materially adversely affect our business, financial condition, and results of operations.

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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the potential technologies may fail clinical studies;

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we may not find a pharmaceutical company willing to adopt the technologies;

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it may be difficult to apply the technologies on a commercial scale; or

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the technologies may be uneconomical to market.