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UNITED STATES SECURITIES AND EXCHANGE COMMISSION ~~WASHINGTON, D.C. 20549~~

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 Quarterly Period Ended September 30, 2003 o TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the Transition Period from to Commission File Number 0-18231

For the Quarterly Period Ended June 30, 2003

o TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the Transition Period from to

Commission File Number 0-18231

ATRIX LABORATORIES, INC.

(Exact name of registrant as specified in its charter)

Delaware		84-1043826
(State or other jurisdiction of		(I.R.S. Employer
incorporation or organization)		Identification No.)
2579 Midpoint Drive, Fort Collins, Colorado		80525
(Address of principal executive office)		(Zip Code)


Delaware (State or other jurisdiction of incorporation or organization)		84-1043826 (I.R.S. Employer Identification No.)


2579 Midpoint Drive, Fort Collins, Colorado (Address of principal executive office)		80525 (Zip Code)

Registrant’s telephone number, including area code: (970) 482-5868

Indicate by check mark whether the registrant: (1) has filed all reports required to be filed by Section 13 or 15 (d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes X x No o

~~The~~Indicate ~~number~~by ofcheck ~~shares~~mark ~~outstanding~~whether of the registrant’s ~~common~~is ~~stock~~an asaccelerated offiler (as ~~July~~defined in Rule ~~31,~~12b-2 ~~2003,~~of ~~was~~the ~~20,965,630~~Exchange Act). Yes x No o

The number of shares outstanding of the registrant’s common stock as of October 31, 2003, was 21,455,772 (par value $0.001 per share).

TABLE OF CONTENTS

PART I. FINANCIAL INFORMATION
	Item 1. FINANCIAL STATEMENTS.
		CONSOLIDATED BALANCE SHEETS
		CONSOLIDATED STATEMENTS OF OPERATIONS
		CONSOLIDATED STATEMENTS OF CASH FLOWS
		NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
	Item 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS.
	Item 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES CONCERNING MARKET RISKS.
		Item 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK.
	~~Item 4. CONTROLS AND PROCEDURES.~~	Item 4. CONTROLS AND PROCEDURES.
	Item 5. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS.
PART II. OTHER INFORMATION
	Item 1. LEGAL PROCEEDINGS
	Item 6. EXHIBITS AND REPORTS ON FORM 8-K.
~~SIGNATURES~~		SIGNATURES
EXHIBIT INDEX
EX-10.1 Termination Agreement
EX-31.1 Rule 13a-14(a) Certification of CEO
EX-31.2 Rule 13a-14(a) Certification of CFO
EX-32.1 Section 1350 Certification of CEO
EX-32.2 Section 1350 Certification of CFO
EX-32.2 Section 1350 Certifcation of CFO

~~PART~~ATRIX ILABORATORIES, INC. ~~FINANCIAL~~AND ~~INFORMATION~~SUBSIDIARIES

~~Item 1.~~TABLE ~~FINANCIAL~~OF ~~STATEMENTS.~~CONTENTS

ATRIX LABORATORIES, INC. AND SUBSIDIARIES CONSOLIDATED BALANCE SHEETS (IN THOUSANDS, EXCEPT SHARE DATA) (Unaudited)


			Page

PART I. FINANCIAL INFORMATION			3
	Item 1. Financial Statements		3
		Consolidated Balance Sheets—December 31, 2002 and September 30, 2003 (unaudited)	3
		Consolidated Statements of Operations—Three and Nine Months Ended September 30, 2003 and 2002 (unaudited)	4
		Consolidated Statements of Cash Flows—Nine Months Ended September 30, 2003 and 2002 (unaudited)	5
		Notes to Consolidated Financial Statements (unaudited)	6
	Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations		11
	Item 3. Quantitative and Qualitative Disclosures About Market Risk		23
	Item 4. Controls and Procedures		23
PART II. OTHER INFORMATION			24
	Item 1. Legal Proceedings		24
	Item 6. Exhibits and Reports on Form 8-K		24

			June 30, 2003			December 31, 2002
ASSETS
CURRENT ASSETS:
	Cash and cash equivalents		$	16,958		$	30,698
	Marketable securities available-for-sale, at fair value			81,087			81,767
	Accounts receivable, net of allowance for doubtful accounts of $781 and $623			7,208			6,140
	Interest receivable			518			679
	Inventories, net of reserve of $205 and $0			11,237			8,694
	Prepaid expenses and deposits			3,232			2,253
		Total current assets		120,240			130,231
PROPERTY, PLANT AND EQUIPMENT, NET				21,954			15,431
OTHER ASSETS:
	Goodwill			399			399
	Intangible and other assets, net of accumulated amortization of $3,567 and $3,116			3,039			3,964
		Other assets		3,438			4,363
		TOTAL ASSETS	$	145,632		$	150,025
LIABILITIES AND SHAREHOLDERS’ EQUITY
CURRENT LIABILITIES:
	Accounts payable — trade		$	2,618		$	7,261
	Accrued expenses and other			1,023			1,042
	Deferred revenue			9,905			7,889
		Total current liabilities		13,546			16,192
DEFERRED REVENUE				37,400			37,064
COMMITMENTS AND CONTINGENCIES
CONVERTIBLE EXCHANGEABLE PREFERRED STOCK:
	Series A convertible exchangeable preferred stock, $.001 par value, 20,000 shares authorized; 14,274 an 13,787 shares issued and outstanding. Liquidation preference $14,720 and $14,227			15,008			14,514
SHAREHOLDERS’ EQUITY:
	Preferred stock, $.001 par value; 5,000,000 shares authorized Series A preferred stock, $.001 par value, 200,000 shares authorized, none issued or outstanding			—			—
	Common stock, $.001 par value; 45,000,000 shares authorized; 20,822,189 and 20,516,069 shares issued and 19,955,389 and 19,858,369 shares outstanding			21			21
	Additional paid-in capital			245,517			242,699
	Treasury stock, 866,800 and 657,700 shares, at cost			(13,615	)		(10,740	)
	Accumulated other comprehensive income			2,776			1,590
	Accumulated deficit			(155,021	)		(151,315	)
		Total shareholders’ equity		79,678			82,255
		TOTAL LIABILITIES AND SHAREHOLDERS’ EQUITY	$	145,632		$	150,025

See notes to the consolidated financial statements.

~~ATRIX~~ PART ~~LABORATORIES, INC~~I. ~~AND~~FINANCIAL ~~SUBSIDIARIES~~INFORMATION ~~CONSOLIDATED STATEMENTS OF OPERATIONS~~ ~~(IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA)~~ ~~(Unaudited)~~

			For the Three Months Ended June 30,
			2003			2002
REVENUES:
Net sales and royalties			$	4,563		$	1,474
Contract research and development revenue				5,689			3,513
Licensing, marketing rights and milestone revenue				2,091			1,497
		Total revenues		12,343			6,484
OPERATING EXPENSE:
Cost of sales				1,862			792
Research and development				9,277			7,512
Administrative and marketing				2,636			2,407
Gain on extinguished debt				—			(44	)
		Total operating expenses		13,775			10,667
LOSS FROM OPERATIONS				(1,432	)		(4,183	)
OTHER INCOME (EXPENSE):
Equity in loss of joint venture				(4	)		(335	)
Investment income and expense, net				681			1,154
Gain (loss) on sale and write-down of marketable securities				309			(1,005	)
Other				(17	)		(6	)
		Net other income (expense)		969			(192	)
NET LOSS				(463	)		(4,375	)
Accretion of dividends on preferred stock				(249	)		(233	)
NET LOSS APPLICABLE TO COMMON STOCK			$	(712	)	$	(4,608	)
Basic and diluted loss per common share:
	Net loss		$	(.02	)	$	(.22	)
	Accretion of dividends on preferred stock			(.02	)		(.01	)
	Net loss applicable to common stock		$	(.04	)	$	(.23	)
	Basic and diluted weighted average common shares outstanding			19,773,194			20,229,830

ATRIX LABORATORIES, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(In thousands, except share data)
(unaudited)
ASSETS


					September 30,			December 31,
					2003			2003

CURRENT ASSETS:
			Cash and cash equivalents		$	23,607		$	30,698
			Marketable securities available-for-sale, at fair value			75,663			81,767
			Accounts receivable, net of allowance for doubtful accounts of $1,041 and $623			8,783			6,140
			Interest receivable			601			679
			Inventories, net of reserves of $649 and $0			11,693			8,694
			Prepaid expenses and deposits			3,793			2,253

				Total current assets		124,140			130,231

PROPERTY, PLANT AND EQUIPMENT, NET						22,258			15,431

OTHER ASSETS:
			Goodwill			399			399
			Intangible and other assets, net of accumulated amortization of $3,755 and $3,116			2,971			3,964

				Total other assets		3,370			4,363

				TOTAL ASSETS	$	149,768		$	150,025

				LIABILITIES AND SHAREHOLDERS’ EQUITY
CURRENT LIABILITIES:
			Accounts payable — trade		$	2,857		$	7,261
			Accrued expenses and other			1,206			1,042
			Deferred revenue			9,844			7,889

				Total current liabilities		13,907			16,192

	DEFERRED REVENUE					34,918			37,064

	COMMITMENTS AND CONTINGENCIES
			Series A Convertible Exchangeable Preferred Stock, $.001 par value, 20,000 shares authorized; 13,787 shares issued and outstanding at December 31, 2002, liquidation preference $14,227			—			14,514

		SHAREHOLDERS’ EQUITY:
			Series A Convertible Exchangeable Preferred Stock, $.001 par value, 20,000 shares authorized; 14,770 issued and outstanding at September 30, 2003, liquidation preference $14,979			—			—
			Preferred stock, $.001 par value; 5,000,000 shares authorized Series A Convertible Exchangeable Preferred Stock, $.001 par value, 200,000 shares authorized, none issued or outstanding			—			—
			Common stock, $.001 par value; 45,000,000 shares authorized; 21,430,887 and 20,516,069 shares issued and 20,564,087 and 19,858,369 shares outstanding			21			21
			Additional paid-in capital			268,428			242,699
			Treasury stock, 866,800 and 657,700 shares, at cost			(13,615	)		(10,740	)
			Accumulated other comprehensive income			1,177			1,590
			Accumulated deficit			(155,068	)		(151,315	)

				Total shareholders’ equity		100,943			82,255

				TOTAL LIABILITIES AND SHAREHOLDERS’ EQUITY	$	149,768		$	150,025

See notes to the consolidated financial statements.

ATRIX LABORATORIES, INC. AND SUBSIDIARIES ~~CONSOLIDATED STATEMENTS OF OPERATIONS~~ ~~(IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA) (Unaudited)~~

			For the Six Months Ended June 30,
			2003			2002
REVENUES:
Net sales and royalties			$	7,783		$	2,632
Contract research and development revenue				9,999			6,008
Licensing, marketing rights and milestone revenue				4,022			2,859
		Total revenues		21,804			11,499
OPERATING EXPENSES:
Cost of sales				3,290			1,303
Research and development				17,969			14,074
Administrative and marketing				5,491			4,230
Administrative — stock option compensation				22			1,256
Gain on extinguished debt				—			(30	)
		Total operating expenses		26,772			20,833
LOSS FROM OPERATIONS				(4,968	)		(9,334	)
OTHER INCOME (EXPENSE):
Equity in loss of joint venture				(77	)		(745	)
Investment income and expense, net				1,420			2,380
Gain (loss) on sale and write-down of marketable securities				428			(1,076	)
Debt conversion expense				—			(125	)
Other				(16	)		(5	)
		Net other income		1,755			429
NET LOSS				(3,213	)		(8,905	)
Accretion of dividends on preferred stock				(494	)		(461	)
NET LOSS APPLICABLE TO COMMON STOCK			$	(3,707	)	$	(9,366	)
Basic and diluted loss per common share:
	Net loss		$	(.16	)	$	(.45	)
	Accretion of dividends on preferred stock			(.03	)		(.02	)
	Net loss applicable to common stock		$	(.19	)	$	(.47	)
	Basic and diluted weighted average common shares outstanding			19,757,480			20,079,496

CONSOLIDATED STATEMENTS OF OPERATIONS
(In thousands, except share and per share data)
(Unaudited)


				Three Months Ended						Nine Months Ended
				September 30,						September 30,

				2003			2002			2003			2002

REVENUE:
	Net sales and royalties			$	5,342		$	1,587		$	13,125		$	4,230
	Contract research and development revenue				5,773			4,306			15,772			10,314
	Licensing, marketing rights, and milestone revenue				2,524			1,731			6,546			4,591

		Total revenue			13,639			7,624			35,443			19,135

OPERATING EXPENSES:
	Cost of sales				2,901			502			6,191			1,815
	Research and development				8,738			9,438			26,707			23,512
	Administrative and marketing				2,387			2,413			7,879			6,597
	Administrative — stock option compensation				—			—			22			1,257

		Total operating expenses			14,026			12,353			40,799			33,181

LOSS FROM OPERATIONS					(387	)		(4,729	)		(5,356	)		(14,046	)

OTHER INCOME (EXPENSE):
	Equity in loss of joint venture				(6	)		(195	)		(83	)		(940	)
	Investment income and expense, net				638			1,047			2,059			3,427
	Gain (loss) on sale and write-down of marketable securities				139			(15	)		567			(1,091	)
	Debt conversion expense				—			—			—			(125	)
	Other, net				(7	)		(27	)		(23	)		(32	)

			Other income, net		764			810			2,520			1,239

NET INCOME (LOSS)					377			(3,919	)		(2,836	)		(12,807	)
	Accretion of dividends and beneficial conversion feature charge on preferred stock				(424	)		(242	)		(918	)		(703	)

NET LOSS APPLICABLE TO COMMON STOCK				$	(47	)	$	(4,161	)	$	(3,754	)	$	(13,510	)

Basic and diluted loss per common share:
	Net income (loss)			$	.02		$	(.20	)	$	(.14	)	$	(.64	)
	Accretion of dividends and beneficial conversion feature charge on preferred stock				(.02	)		(.01	)		(.05	)		(.03	)

	Net loss applicable to common stock			$	—		$	(.21	)	$	(.19	)	$	(.67	)

	Basic and diluted weighted average common shares outstanding				20,257,238			20,202,479			19,925,896			20,122,029

See notes to the consolidated financial statements.

ATRIX LABORATORIES, INC. AND SUBSIDIARIES ~~CONSOLIDATED STATEMENTS OF CASH FLOWS~~

~~(IN~~CONSOLIDATED ~~THOUSANDS)~~STATEMENTS OF CASH FLOWS (In thousands, Unaudited)

					For the Six Months Ended June 30,
					Nine Months Ended September 30,
					2003			2002
CASH FLOWS FROM OPERATING ACTIVITIES:
	Net loss				$	(32,~~213~~836	)	$	(812,~~905~~807	)
	Adjustments to reconcile net loss to net cash provided by (used in) operating activities:
			Depreciation and amortization			12,~~570~~488			12,~~557~~437
			Amortization of deferred revenue			(47,~~907~~523	)		(47,~~274~~928	)
			Equity in loss of joint venture			77			745
			Provision for inventory write-offs			649			—
			Loss (gain) on sale and write-down of marketable securities			(428	)		1,076
			Provision for doubtful accounts			660			303
			Stock and stock option compensation			22			1,256
			Equity in loss of joint venture			83			940
			Debt conversion expense			—			125
			Loss (gain) on sale and write-down of marketable securities			(567	)		1,091
			Interest expense converted to equity			—			110
			Stock and stock option compensation			22			1,257
			Gain on extinguished debt			—			(30	)
			Other non-cash items			70			238
			Other non-cash items			60			8
		Net changes in operating assets and liabilities:
			Accounts receivable			(~~888~~3,212	)		6(1,545	)
			Interest receivable			~~161~~77			~~108~~185
			Inventories			(23,~~484~~569	)		(1,~~460~~810	)
			Prepaid expenses and deposits			(~~978~~1,538	)		(1,~~361~~374	)
			Accounts payable			(54,~~145~~957	)		~~(249~~1,177	)
			Accrued expenses and other			~~(28~~157	)		~~882~~316
			Deferred revenue			7,~~160~~333			1011,~~095~~661
				Net cash used in operating activities		(912,~~021~~663	)		(~~311~~5,859	)
CASH FLOWS FROM INVESTING ACTIVITIES:
			Acquisition of property, plant and equipment			(67,~~564~~529	)		(14,~~812~~317	)
			Investment in intangible and other assets			(~~395~~515	)		(~~419~~1,296	)
			Proceeds from maturity and sale of marketable securities			2332,~~189~~596			1551,~~067~~546
			Investment in marketable securities			(2126,~~264~~710	)		(2756,~~873~~185	)
			Investment in joint venture			(~~207~~302	)		(1,~~178~~500	)
				Net cash used in investing activities		(52,~~241~~460	)		(1611,~~215~~752	)
CASH FLOWS FROM FINANCING ACTIVITIES:
			Proceeds from issuance of equity securities, net of issuance costs	~~Proceeds from issuance of equity securities, net of issuance costs~~		210,~~796~~275			23,~~532~~025
			Payments to acquire treasury stock	~~Payments to acquire treasury stock~~		(2,~~876~~875	)		(~~671~~6,344	)
				Net cash provided by (used in) financing activities		~~(80~~7,400	)		1(3,~~861~~319	)
NET EFFECT OF EXCHANGE RATE ON CASH						~~602~~632			~~346~~437
NET DECREASE IN CASH AND CASH EQUIVALENTS						(137,~~740~~091	)		(1420,~~319~~493	)
CASH AND CASH EQUIVALENTS, BEGINNING OF PERIOD						30,698			50,058
CASH AND CASH EQUIVALENTS, END OF PERIOD					$	1623,~~958~~607		$	3529,~~739~~565
Non-cash investing and financing activities (in thousands):
2003
Reclassified $15,432 of Series A Convertible Exchangeable Preferred Stock to permanent equity
Issued restricted common stock valued at $22 as part of employment separation agreements
Issued preferred stock valued at $983 to Elan for accreted dividends
Long-term deposits on equipment of $869 were reclassified to property, plant and equipment
2002
Issued common stock valued at $5,331 in exchange for $5,206 of the 7% Convertible Subordinated Notes
Vested incentive stock options valued at $1,257 for an executive officer in conjunction with a termination agreement
Issued preferred stock valued at $917 to Elan for accreted dividends

Non-cash investing and financing activities (in thousands):

2003

Issued restricted common stock valued at $22 as part of employment separation agreements.

Issued preferred stock valued at $487 to Elan for accreted dividends.

Long-term deposits on equipment of $869 were reclassified to property, plant and equipment

2002

Issued common stock valued at $5,331 in exchange for $5,206 of the 7% Convertible Subordinated Notes.

Vested incentive stock options valued at $1,257 for an executive officer in conjunction with a termination agreement.

See notes to the consolidated financial statements.

ATRIX LABORATORIES, INC. AND SUBSIDIARIES ~~NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS~~ ~~For the Six Months Ended June 30, 2003 and 2002~~

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
(unaudited)

NOTE 1. BASIS OF PRESENTATION

The accompanying unaudited consolidated financial statements of Atrix Laboratories, Inc. and its subsidiaries (collectively referred to as “Atrix” or “the Company”) have been prepared in accordance with generally accepted accounting principles (“GAAP”) for interim consolidated financial statements and with the instructions to Form 10-Q and Article 10 of Regulation S-X. In the opinion of management, all adjustments considered necessary, consisting of ~~normal~~ normal recurring accruals, for a fair presentation have been included. ~~Operating~~The preparation of financial statements in conformity with GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Significant estimates include allowances for doubtful accounts and inventory reserves. Operating results for the ~~six~~ nine months ended ~~June~~September 30, 2003 are not necessarily indicative of the results that may be expected for the year ending December 31, 2003. These consolidated financial statements should be read in conjunction with the ~~audited~~ audited consolidated financial statements and notes thereto, for the year ended December 31, 2002, filed with the Securities and Exchange Commission (the “SEC”), in the Company’s Annual Report on Form 10-K.

NOTE 2. ORGANIZATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

Atrix Laboratories, Inc. was formed in August 1986 as a Delaware corporation. In November 1998, the Company acquired ViroTex Corporation. In ~~June~~ June 1999, the Company organized its wholly owned subsidiary Atrix Laboratories Limited, which is based in London, England. In February 2000, the Company organized its wholly owned subsidiary Atrix Laboratories GmbH, which is based in Frankfurt, Germany, to conduct its European operations. In June 2000, the Company ~~entered into~~ formed a ~~research~~ joint venture, Transmucosal Technologies, Ltd., with Elan International Services, Ltd. (“~~Elan~~EIS”) and Elan Corporation plc (together with EIS, a“Elan”) ~~wholly~~to develop ~~owned~~and ~~subsidiary~~commercialize ofoncology and pain management products. The joint ~~Elan~~venture ~~Corporation~~agreement was terminated in September 2003, ~~plc~~see below.

Atrix is an emerging specialty pharmaceutical company focused on advanced ~~drug~~ drug delivery. With five unique patented drug delivery technologies, the Company is currently developing a diverse portfolio of products, including ~~proprietary~~ proprietary oncology, dermatology and pain management products. The Company also forms strategic alliances with a variety of pharmaceutical and ~~biotechnology~~ biotechnology companies to develop and/or commercialize products utilizing various drug ~~delivery~~ ~~systems~~delivery ~~and/or to commercialize products~~systems. These strategic alliances presently include ~~collaborations~~ collaborations with Pfizer Inc., Sanofi-Synthelabo Inc., Fujisawa Healthcare, Inc., Geneva Pharmaceuticals, Inc., Sosei Co. Ltd., MediGene AG, and CollaGenex Pharmaceuticals, Inc.

Critical Accounting Policies

Principles of consolidation

The accompanying consolidated financial statements include the accounts of Atrix and its wholly owned subsidiaries Atrix Laboratories Limited and Atrix Laboratories, GmbH. All significant intercompany transactions and balances have been eliminated. While the Company initially ~~owns~~owned 80.1% of Transmucosal Technologies, Ltd.’s outstanding common stock, Elan and its subsidiaries ~~have retained~~ retained significant minority investor rights that ~~are~~were considered “participating rights” as defined in Emerging Issues Task Force Consensus 96-16, “Investor’s Accounting for an Investee When the Investor Has a Majority of the Voting Interest, but the Minority Shareholder or Shareholders Have Certain Approval or Veto Rights.” Elan’s significant rights in Transmucosal Technologies, Ltd. that ~~are~~ were considered participating rights ~~include~~included equal representation in the management of the joint venture and development of its business plan and approval rights on the board of directors as it relates to the business plan. Accordingly, the Company ~~accounts~~accounted for its investment in Transmucosal Technologies, Ltd. under the equity method of accounting. Additionally, the joint venture ~~contracts~~contracted with Atrix to perform certain research and development activities. The joint venture agreement was terminated in September 2003. During the period the joint venture was in operation, the Company accounted for its investment in Transmucosal Technologies, Ltd. using the

Revenue recognition

The Company recognizes revenue on product sales and contract manufacturing at the time of shipment when title to the product transfers and the customer bears risk of loss. Royalty revenue is recorded when product is

~~shipped~~equity bymethod. ~~licensees~~Because ~~based~~the onCompany obtained the ~~invoiced~~control ~~amount~~of byTransmucosal Technologies, Ltd. in September 2003, Transmucosal Technologies, Ltd. has been consolidated with the ~~licensee~~Company’s ~~and~~consolidated ~~royalty~~financial statements since that ~~rates~~date. asSee ~~specified~~Note in7 ~~the~~for ~~agreement~~further ~~with~~information related to the ~~licensee~~termination.

~~All contract research and development is performed on a best effort basis under signed contracts.~~ Revenue under contracts with a fixed price is recognized over the term of the agreement on a straight-line basis, which is consistent with the pattern of work performed. Billings are made in accordance with schedules as specified in each agreement, which generally include an up-front payment as well as periodic payments. Payments received in advance of revenue recognition ~~are recorded as deferred revenue. Revenue under other~~ ~~contracts is recognized based on terms as specified in the contracts, including~~ billings for time incurred at rates as specified in the contracts and as reimbursable expenses are incurred. Such arrangements are regularly evaluated on an individual basis. Billings under the contracts are made monthly.

The Company ~~has~~recognizes ~~licensing~~revenue ~~agreements~~on ~~that~~product ~~generally~~sales ~~provide for non-refundable license fees~~ and~~/or~~ ~~milestone~~contract ~~payments.~~manufacturing ~~The licensing~~at ~~agreements~~the ~~typically~~time ~~require~~of ashipment ~~non-refundable~~when ~~license~~title ~~fee~~to ~~and allow~~ the ~~Company’s~~ ~~partners~~product totransfers ~~sell~~and ~~its~~the ~~proprietary~~customer ~~products in a defined territory for~~bears arisk ~~defined~~of ~~period~~loss. ~~Non-refundable~~Royalty ~~license fees are initially reported as deferred~~ revenue ~~and recognized as contract revenue over the remaining contractual term using the straight-line method or until the agreement~~ is ~~terminated.~~ ~~License~~recorded ~~fees received in connection with arrangements where the Company has no continuing involvement are recognized as revenue~~ when ~~the amounts~~product ~~are received or when collection of the license fee~~ is ~~assured, whichever~~shipped ~~is earlier. A milestone payment is a payment made~~ by ~~a corporate~~licensees ~~partner~~based toon ~~the~~information ~~Company~~provided ~~upon~~by the ~~achievement~~licensee ofand aroyalty ~~pre-determined~~rates ~~milestone~~and formulas as ~~defined~~specified in ~~the~~agreements ~~applicable~~with ~~agreement~~licensees. ~~Milestone~~Generally, ~~payments~~royalties are ~~initially~~based ~~reported~~on asestimated ~~deferred~~net ~~revenue~~sales ~~and~~(gross ~~recognized~~sales asless ~~milestone~~discounts, ~~revenue~~allowances ~~over~~and ~~the~~other ~~remaining~~items) of ~~contractual~~a ~~term~~product ~~using~~based ~~the~~on ~~straight-line~~information ~~method~~supplied ~~when~~to the ~~milestone event has occurred and the~~ Company ~~has~~by ~~completed all milestone-related services such that~~ the ~~milestone~~licensee ~~payment is currently due~~ and ismay require ~~non-refundable~~future revisions.

Contract research and development is performed on a best effort basis under signed contracts. Revenue under contracts with a fixed price is recognized over the term of the agreement on a straight-line basis, which is consistent with the pattern of work performed. Billings are made in accordance with schedules as specified in each agreement, which generally include an up-front payment as well as periodic payments. Payments received in advance of revenue recognition are recorded as deferred revenue. Revenue under other contracts is recognized based on terms as specified in the contracts, including billings for time incurred at rates as specified in the contracts and as reimbursable expenses are incurred. Such arrangements are regularly evaluated on an individual basis. Billings under the contracts are made monthly.

The Company has licensing agreements that generally provide for non-refundable license fees and/or milestone payments. The licensing agreements typically require a non-refundable license fee and allow the Company’s partners to sell its proprietary products in a defined territory for a defined period. Non-refundable license fees are initially reported as deferred revenue and recognized as licensing revenue over the remaining contractual term or as covered by patent protection, whichever is earlier, using the straight-line method or until the agreement is terminated. A milestone payment is a payment made by a strategic alliance partner to the Company upon the achievement of a pre-determined event, as defined in the applicable agreement. Milestone payments are initially reported as deferred revenue. Milestone revenue subsequently is recognized using the straight-line method over the remaining contractual term or the remaining period covered by patent protection, whichever is earlier, following occurrence of the milestone event. No milestone revenue is recognized until the Company has completed the required milestone-related services.

Research and Development

Costs incurred in connection with research and development activities are expensed as incurred. These costs consist of direct and indirect costs associated with specific projects, as well as fees paid to various entities that perform certain research on the Company’s behalf. Additionally, licensing fees paid by the Company to acquire technology are expensed as incurred if no alternative future use exists. A portion of overhead costs is allocated to research and development on a weighted-average percentage basis among all projects under development.

The following table summarizes research and development activities funded, in in whole or in part, by our collaborators, as well as research and development activities funded by the Company ~~for the six months ended June 30 (amounts in thousands)~~:

		Three months ended June 30,				Six months ended June 30,
		Three months ended				Nine months ended
		September 30,				September 30,
		2003		2002		2003		2002
Research and Development — Funded		$	7,706	$	3,649	$	13,624	$	6,865
				(In thousands)
Research and Development — Not Funded			1,571		3,863		4,345		7,209
Research and Development
	Research and Development	$	9,277	$	7,512	$	17,969	$	14,074
	Funded, in whole or in part	$	8,351	$	4,909	$	21,944	$	11,377
	Not funded		387		4,529		4,763		12,135
Total		$	8,738	$	9,438	$	26,707	$	23,512

Pro Forma Effect of Stock Option Issuances

The Company accounts for options under the Performance Stock Option Plan, the 2000 Stock Incentive Plan, the Non-Qualified Stock Option Plan and the 1999 Non-Employee Director Stock Incentive Plan using the intrinsic value method as permitted by SFAS No. 123. Accordingly, no compensation expense has been recognized for stock option grants. Had compensation cost been determined based on the fair value of the options at the grant dates of awards under the 1987 Plan, 2000 Plan and DSI Plan consistent with SFAS No. 123, the Company’s net loss applicable to common stock and basic and diluted loss per common share would have been changed to the pro forma amounts indicated below (net loss applicable to common stock amounts in thousands):

		Three months ended June 30,						Six months ended June 30,
		2003			2002			2003			2002
Net loss applicable to common stock:
	— as reported	$	(712	)	$	(4,608	)	$	(3,707	)	$	(9,366	)
	— stock option grants		(1,767	)		(3,687	)		(3,535	)		(4,937	)
	— pro forma	$	(2,479	)	$	(8,295	)	$	(7,242	)	$	(14,303	)
Basic and diluted net loss per common share:
	— as reported	$	(0.04	)	$	(0.23	)	$	(0.19	)	$	(0.47	)
	— pro forma	$	(0.13	)	$	(0.41	)	$	(0.37	)	$	(0.71	)
Weighted-average Black-Scholes fair value per option granted:		$	9.21		$	13.42		$	9.07		$	13.16
Expected volatility:			60.5	%		62.2	%		60.5	%		62.2	%
Risk free interest rate:			5.0	%		5.0	%		5.0	%		5.0	%
Expected life of options (in years):			5			5			5			5

Stock-Based Compensation

~~Recent~~As permitted under Statement of Financial Accounting ~~Pronouncements~~Standards (“SFAS”) No. 123, “Accounting for Stock-Based Compensation,” the Company accounts for stock-based compensation using the intrinsic value method in accordance with Accounting Principles Board Opinion No. 25, “Accounting for Stock Issued to Employees” and related interpretations. Accordingly, no compensation expense has been recognized for fixed stock option grants to employees with an exercise price equal to market value at the date of grant. The Company accounts for equity instruments issued to non-employees in accordance with the provisions of SFAS No. 123 and related interpretations. In accordance with the interim disclosure provisions of SFAS No. 148, “Accounting for Stock-Based Compensation—Transition and Disclosure, an Amendment of SFAS No. 123,” the following table illustrates the effect on net loss applicable to common stock and basic and diluted loss per common stock if the Company had applied the fair value based method of SFAS No. 123 to stock-based compensation:

In April 2002, SFAS No. 145 (FAS 145), “Rescission of FASB Statements No. 4, 44, and 64, Amendment of FASB Statement No. 13, and Technical Corrections” was issued by the Financial Accounting Standards Board (FASB). FAS 145 rescinds FASB Statement No. 4, “Reporting Gains and Losses from Extinguishment of Debt,” and an amendment of that Statement, FASB Statement No. 64, “Extinguishments of Debt Made to Satisfy Sinking-Fund Requirements.” This Statement also rescinds FASB Statement No. 44, “Accounting for Intangible Assets of Motor Carriers.” This Statement amends FASB Statement No. 13, “Accounting for Leases,” to eliminate an inconsistency between the required accounting for sale-leaseback transactions and the required accounting for certain lease modifications that have economic effects that are similar to sale-leaseback transactions. This Statement also amends other existing authoritative pronouncements to make various technical corrections, clarify meanings, or describe their applicability under changed conditions. The Company adopted FAS 145 in the first quarter of 2003 and, as a result, the comparative financial statements were restated to reclassify the extraordinary loss on extinguishment of debt to be included in loss from operations.


	Three Months Ended						Nine Months Ended
	September 30,						September 30,

	2003			2002			2003			2002

	(In thousands, except per share data)
Net loss applicable to common stock, as reported	$	(47	)	$	(4,161	)	$	(3,754	)	$	(13,510	)
Add: Stock-based compensation expense included in reported net loss, net of related tax effects		—			—			22			1,257
Deduct: Total stock-based compensation expense determined under fair-value based method, net of related tax effects		(2,551	)		(1,805	)		(8,310	)		(9,525	)

Pro forma net loss applicable to common stock	$	(2,598	)	$	(5,966	)	$	(12,042	)	$	(21,778	)
Basic and diluted net loss per share:
As reported	$	—		$	(.21	)	$	(.19	)	$	(.67	)
Pro forma	$	(.13	)	$	(.30	)	$	(.60	)	$	(1.08	)

InNOTE ~~December 2002, the FASB issued SFAS No~~3. ~~148,~~ ~~“Accounting~~RECENT ~~for Stock-Based~~ACCOUNTING ~~Compensation—Transition and Disclosure", an amendment of SFAS No.~~PRONOUNCEMENTS ~~123. The statement provides alternative methods of transition for a voluntary~~ ~~change to the fair value method of accounting for stock-based employee~~ compensation. In addition, the statement requires companies to disclose in both annual and interim financial statements the method of accounting for stock-based compensation and the effect of the method used on reported results. The statement is effective for annual periods ending after December 15, 2002 and interim periods beginning after December 15, 2002. The statement is not expected to have a material impact on the Company’s consolidated financial statements. The Company has adopted the disclosure provisions of SFAS No. 148, however, it has not adopted the fair value method, and expects to continue to recognize compensation cost in accordance with the guidance in APB No. 25 unless future accounting rules dictate a change in method. If the Company was to adopt the fair value method, management believes there would be a material impact on the Company’s consolidated results of operations.

In ~~May 2003~~April 2002, ~~the FASB issued~~ SFAS No. ~~150~~145 (SFAS 145), “~~Accounting~~Rescission ~~for~~of ~~Certain~~FASB Statements No. 4, ~~Financial~~44, ~~Instruments~~and ~~with~~64, ~~Characteristics~~Amendment of ~~both~~FASB ~~Liabilities~~Statement No. 13, and ~~Equity~~Technical Corrections” was ~~(SFAS~~issued ~~150).~~by ~~SFAS~~the ~~150~~Financial ~~establishes~~Accounting ~~standards~~Standards ~~for~~Board ~~how~~(FASB). anFAS ~~issuer~~145 ~~classifies and~~rescinds ~~measures~~FASB ~~certain~~Statement ~~financial~~No. 4, ~~instruments~~“Reporting ~~with~~Gains ~~characteristics~~and ofLosses ~~both~~from ~~liabilities~~Extinguishment of Debt,” and ~~equity.~~an Itamendment ~~requires~~of that anStatement, ~~issuer~~FASB ~~classify~~Statement aNo. 64, ~~financial~~“Extinguishments ~~instrument that is~~of ~~within~~Debt ~~its~~Made ~~scope~~to asSatisfy aSinking-Fund ~~liability~~Requirements.” ~~(or~~This anStatement ~~asset~~also inrescinds FASB ~~some~~Statement ~~circumstances)~~No. 44, ~~many~~“Accounting for Intangible Assets of Motor Carriers.” ~~which~~This ~~were~~Statement ~~previously~~amends ~~classified~~FASB asStatement ~~equity~~No. 13, ~~The~~“Accounting ~~provisions~~for ofLeases,” ~~SFAS~~to eliminate ~~150~~an ~~are effective~~inconsistency between the required accounting for ~~financial~~sale-leaseback transactions ~~instruments~~and ~~entered~~the ~~into~~required oraccounting ~~modified~~for ~~after~~certain ~~May 31,~~lease ~~2003~~modifications that ~~and,~~have ~~with~~economic ~~one~~effects ~~exception,~~that isare ~~effective~~similar atto ~~the~~sale-leaseback ~~beginning~~transactions. ofThis Statement ~~the~~also ~~first~~amends ~~interim~~other existing authoritative pronouncements to make ~~period~~various ~~beginning~~technical ~~after~~corrections, ~~June 15~~clarify meanings, ~~2003~~or describe their applicability under changed conditions. The ~~adoption~~Company adopted FAS 145 in the first quarter of ~~SFAS~~2003 ~~150~~and, isas ~~not~~a ~~expected~~result, the comparative financial statements were restated to ~~have~~reclassify athe ~~material~~extraordinary ~~effect~~loss on ~~the~~extinguishment ~~Company’s~~of ~~consolidated~~debt ~~financial~~to be ~~statements~~included in loss from operations.

In May 2003, the FASB issued SFAS No. 150, “Accounting for Certain Financial Instruments with Characteristics of both Liabilities and Equity” (SFAS 150). SFAS 150 establishes standards for how an issuer classifies and measures certain financial instruments with characteristics of both liabilities and equity. It generally requires that an issuer classify a financial instrument that is within its scope as a liability (or an asset in some circumstances), many of which were previously classified as equity. The provisions of SFAS 150 are effective for financial instruments entered into or modified after May 31, 2003 and, with one exception, is effective at the beginning of the first interim period beginning after June 15, 2003. The adoption of SFAS 150 did not have a material effect on the Company’s consolidated financial statements.

In ~~January 2003~~November 2002, the FASB issued ~~Financial~~ Interpretation No. 4645 (FIN 4645), “~~Consolidation~~Guarantor’s Accounting ofand ~~Variable~~Disclosure ~~Interest~~Requirements ~~Entities.”~~for ~~FIN~~Guarantees, 46Including ~~provides~~Indirect Guarantees ~~guidance~~of onIndebtedness ~~how to~~of ~~identify~~Others.” aFIN ~~variable~~45 ~~interest~~requires ~~entity~~that ~~(VIE) and~~a ~~determine~~liability ~~when~~be recorded in the ~~assets, liabilities,~~guarantor’s ~~and~~balance ~~results~~sheet ofupon ~~operations~~issuance of a ~~VIE~~guarantee. ~~need~~FIN to45 also berequires ~~included~~additional indisclosures ~~a company’s~~about ~~consolidated~~the ~~financial~~guarantees ~~statements.~~an ~~FIN~~entity 46has ~~also requires additional~~issued, ~~disclosures~~including bya ~~primary~~roll-forward ~~beneficiaries~~of ~~and~~the ~~other~~entity’s ~~significant~~product ~~variable~~warranty ~~interest~~liabilities. The ~~holders~~Company inwill aapply ~~VIE.~~the ~~The~~recognition provisions of FIN 4645 ~~are~~prospectively ~~effective~~to guarantees ~~immediately~~issued ~~for~~or ~~all VIEs~~modified ~~created~~ after ~~January~~December 31, ~~2003~~2002. ~~For~~The ~~VIEs~~disclosure requirements ~~created~~were ~~before~~effective ~~February 1,~~for ~~2003,~~ the ~~provisions~~Company’s offinancial ~~FIN~~statements 46for ~~must be adopted at~~ the ~~beginning of the first interim~~year orended ~~annual reporting period beginning after June~~December 1531, ~~2003~~2002. The ~~Company does not have any VIEs and does not expect the~~ adoption of FIN 4645 todid not have aan ~~material effect~~impact on the Company’s consolidated financial ~~position or results of operations~~statements.

In ~~November 2002~~January 2003, the FASB issued ~~Emerging~~Financial ~~Issues~~Interpretation ~~Task Force (EITF) Issue~~ No. ~~00-21,~~46 ~~“Accounting~~(FIN ~~for~~46), "Consolidation ~~Revenue~~of ~~Arrangements~~Variable ~~with~~Interest ~~Multiple Deliverables~~Entities.” ~~EITF~~ ~~00-21~~FIN ~~addresses~~46 ~~how~~provides toguidance ~~determine~~on ~~whether a revenue arrangement involving~~how ~~multiple~~to ~~deliverables~~identify ~~contains~~a ~~more~~variable ~~than~~interest ~~one~~entity ~~unit~~(VIE) and ofdetermine ~~accounting~~when ~~for~~ the assets, ~~purposes~~liabilities, ~~of revenue recognition~~ and ~~how~~results ~~the~~of ~~revenue~~operations ~~arrangement~~of ~~consideration should~~a beVIE ~~measured~~need to ~~the~~be ~~separate~~included ~~units~~in ~~of accounting. EITF 00-21 provides~~a ~~guidance~~company’s ~~with~~consolidated ~~respect~~financial tostatements. ~~the~~FIN ~~effect~~46 ofalso ~~certain~~requires ~~customer rights due to company~~additional ~~non-performance~~disclosures onby ~~the~~primary ~~recognition~~beneficiaries ofand ~~revenue~~other ~~allocated~~significant tovariable ~~delivered units of~~interest ~~accounting.~~holders ~~EITF~~in ~~00-21~~a ~~also~~VIE. ~~addresses~~The ~~the~~provisions ~~impact on the measurement and/or allocation~~ of ~~arrangement~~FIN ~~consideration~~46 ofare ~~customer~~effective ~~cancellation~~immediately ~~provisions~~for ~~and~~all ~~consideration~~VIEs ~~that~~created ~~varies~~or asacquired aafter ~~result~~January 31, of2003. ~~future~~For ~~actions~~VIEs ofcreated ~~the customer~~ or ~~the~~acquired ~~Company.~~prior ~~Finally, EITF 00-21 provides guidance with respect~~ to ~~the~~February 1, ~~recognition of~~2003, the ~~cost~~provisions of ~~certain~~FIN ~~deliverables~~46 ~~that~~must ~~are~~be ~~excluded~~adopted ~~from~~at the ~~revenue~~ ~~accounting~~beginning ~~arrangement.~~of ~~EITF~~the ~~00-21~~first ~~applies~~interim toor ~~revenue~~annual ~~arrangements~~reporting ~~that~~period ~~the Company~~beginning ~~enters into~~ after ~~June~~ December 15, 2003. The Company ~~has~~does not ~~yet~~have ~~determined~~VIEs ~~the impact~~and, ifas ~~any~~such, ~~that~~the ~~EITF~~adoption of ~~00-21~~FIN ~~will~~46 did not have ona ~~its~~material ~~consolidated~~effect ~~financial position~~on ~~and~~the ~~results~~Company’s ofconsolidated financial ~~operations~~statements.

~~NOTE~~In 3November 2002, the FASB issued Emerging Issues Task Force Issue No. 00-21 (EITF ~~INVENTORIES~~00-21), “Accounting for Revenue Arrangements with Multiple Deliverables.” EITF 00-21 addresses how to determine whether a revenue arrangement involving multiple deliverables contains more than one unit of accounting for the purposes of revenue recognition and how the revenue arrangement consideration should be measured to the separate units of accounting. EITF 00-21 provides guidance with respect to the effect of certain customer rights due to company non-performance on the recognition of revenue allocated to delivered units of accounting. EITF 00-21 also addresses the impact on the measurement and/or allocation of arrangement consideration of customer cancellation provisions and consideration that varies as a result of future actions of the customer or the Company. Finally, EITF 00-21 provides guidance with respect to the recognition of the cost of certain deliverables that are excluded from the revenue accounting arrangement. EITF 00-21 applies to revenue arrangements that the Company enters into after June 15, 2003. The Company does not expect EITF 00-21 to have a material effect on its consolidated financial statements.

~~Inventories~~NOTE ~~are stated at the lower of cost, determined by the first-in, first-out (FIFO) method, or market~~4. ~~Inventories include the cost of materials,~~INVENTORIES ~~direct labor and overhead. The components of inventory are as follows as of~~ ~~June 30, 2003 and December 31, 2002 (amounts in thousands):~~

	June 30, 2003			December 31, 2002
Raw materials	$	9,077		$	6,590
Work in process		309			1,035
Finished goods		2,056			1,069
Reserve		(205	)		—
	$	11,237		$	8,694

Inventories are stated at the lower of cost, determined by the first-in, first-out (FIFO) method, or market. Inventories consist of the cost of materials, direct labor and overhead. Inventories include pre-clinical and clinical products that are expensed as research and development costs, as used, if those inventories have alternative use either in products or other research and development projects. The components of inventory are as follows:

NOTE 4. NET INCOME (LOSS) PER COMMON SHARE


	September 30, 2003			December 31, 2002

	(In thousands)
Raw materials	$	10,566		$	6,590
Work in process		129			1,035
Finished goods		1,647			1,069
Reserves		(649	)		—

	$	11,693		$	8,694

~~Basic~~The ~~net~~Company ~~income~~increased ~~(loss) per~~its ~~common~~inventory ~~share~~reserves ~~excludes dilution and is computed~~ by ~~dividing net income (loss)~~$0.2 bymillion ~~the~~and ~~weighted-average number of common shares outstanding during the periods presented~~$0. ~~Diluted net income (loss)~~6 ~~per common~~million ~~share~~for ~~reflects~~ the ~~potential~~three ~~dilution~~and ofnine ~~securities~~months ~~that~~ended ~~could~~September 30, ~~participate~~2003, ~~in the earnings. Stock options~~respectively, ~~warrants~~as ~~outstanding and their equivalents are~~a ~~included~~result inof ~~diluted~~its ~~earnings~~evaluation ~~per~~of ~~share~~obsolete ~~computations~~or ~~through~~potential ~~the~~unmarketable ~~“treasury stock” method unless they are antidilutive~~inventory. ~~Convertible securities are~~The ~~included~~Company inmanufactured ~~diluted~~launch ~~earnings~~quantities ~~per~~of ~~share~~a ~~computations~~generic ~~through~~dermatology ~~the~~product ~~“if converted”~~during ~~method unless they are antidilutive. There was no diluted effect on earnings per share computations for~~ the ~~assumed~~fourth ~~conversion~~quarter of ~~the~~2002 ~~Series A~~and ~~Convertible Preferred~~first ~~Stock~~quarter ~~shares~~of ~~under~~2003 ~~the~~prior ~~“if~~to ~~converted”~~receiving ~~method~~FDA approval. ~~Additionally,~~During ~~since~~ the ~~Company~~three ~~has~~months ~~not~~ended ~~drawn any proceeds under the convertible promissory note agreement with Elan, as of June~~September 30, 2003, ~~there~~the ~~was~~Company ~~no effect on earnings per~~booked ~~share~~a ~~computations~~reserve ~~pertaining~~allowance tofor this ~~convertible~~inventory ~~promissory~~in ~~note~~response ~~for~~to ~~the periods~~a ~~presented.~~non-approval ~~Common~~letter received ~~share equivalents are excluded~~ from the ~~computations in loss periods, as their effect would be antidilutive~~FDA. ~~For~~This ~~the~~amount ~~six~~was ~~months ended~~charged ~~June 30,~~to ~~2003~~research and ~~2002,~~development expense. ~~approximately~~The ~~1.1 million~~Company ~~and~~believes ~~1.2 million equivalent~~it ~~dilutive~~followed ~~securities~~the ~~(primarily~~guidelines ~~related~~provided toby the ~~assumed conversion of~~FDA ~~Elan~~in ~~Series A~~the ~~Convertible~~submission ~~Preferred Stock, incentive stock options~~ and ~~stock warrants~~is ~~held~~currently ~~with~~appealing ~~Elan),~~the ~~respectively,~~non-approval. ~~have~~Pending ~~been excluded from~~ the ~~weighted-average~~outcome ~~number~~ of ~~common~~the ~~shares~~appeal, ~~outstanding for~~ the ~~diluted~~Company ~~net~~may ~~loss per~~incur ~~share~~additional ~~computations~~write-offs asor ~~they~~may reverse ~~are~~the ~~antidilutive~~reserve.

NOTE 5. NET INCOME (LOSS) PER COMMON SHARE

Basic net income (loss) per common share excludes dilution and is computed by dividing net income (loss) by the weighted-average number of common shares outstanding during the periods presented. Diluted net income (loss) per common share reflects the potential dilution of securities that could participate in earnings. Stock options, warrants outstanding and their equivalents are included in diluted earnings per share computations through the “treasury stock” method unless they are antidilutive. Convertible securities are included in diluted earnings per share computations through the “if converted” method unless they are antidilutive. Common share equivalents are excluded from the computations in loss periods, as their effect would be antidilutive.

For the nine months ended September 30, 2003 and 2002, approximately 1.5 million and 1.7 million equivalent dilutive securities (primarily related to the assumed conversion of the Series A Convertible Exchangeable Preferred Stock, incentive stock options and stock warrants held by Elan), respectively, have been excluded from the weighted-average number of common shares outstanding for the diluted net loss per share computations as they are antidilutive. For the three months ended September 30, 2003 and 2002, approximately 2.2 million and 0.8 million equivalent dilutive securities (primarily related to the assumed conversion of the Series A Convertible Exchangeable Preferred Stock, incentive stock options and stock warrants held by Elan), respectively, have been excluded from the weighted-average number of common shares outstanding for the diluted net loss per share computations as they are antidilutive.

NOTE 6. COMPREHENSIVE INCOME (LOSS)

Comprehensive income (loss) comprises net income (loss) and certain changes in equity that are excluded from net income (loss), such as foreign currency translation adjustments and unrealized holding gains and losses on available-for-sale marketable securities. Comprehensive loss for the three months ended September 30, 2003 and 2002 was $1.2 million and $3.5 million, respectively. Comprehensive loss for the nine months ended September 30, 2003 and 2002 was $3.2 million and $12.4 million, respectively.

NOTE 7. TERMINATION OF JOINT VENTURE

On September 10, 2003, the Company entered into a termination agreement with Elan for the termination of the Company’s joint venture, Transmucosal Technologies, Ltd. Pursuant to the terms of the agreement, the Company acquired Elan’s preferred shares in Transmucosal Technologies, Ltd. in exchange for a royalty interest on certain future revenues and payments to the Company, if any, related to certain technology rights retained by the Company. The Company now owns 100% of Transmucosal Technologies, Ltd. The Company estimated that the fair value of the future contingent royalty payments is not material and, accordingly, no liability has been reflected in the Company’s financial statements.

In connection with the termination, Elan and its affiliates agreed to forego the exchange right included in the Series A Convertible Exchangeable Preferred Stock of the Company (which is held by a wholly-owned subsidiary of Elan). Additionally, the Company plans to transfer all of the assets of Transmucosal Technologies, Ltd. to the Company or an affiliate of the Company. As a result, as of September 30, 2003, the Company has reclassified the Series A Convertible Exchangeable Preferred Stock to permanent equity, which increased equity by $15.4 million.

NOTE 8. LEGAL PROCEEDINGS

On November 3, 2003, TAP Pharmaceutical Products, Inc. and two additional plaintiffs filed suit in U.S. District Court, Northern District of Illinois, Eastern Division, Tap Pharmaceutical Products, Inc., et al v. Atrix Laboratories, Inc., et al, alleging that the Eligard delivery system infringes a patent that claims, among other things, a biodegradable high molecular polymer, which patent is licensed to TAP Pharmaceuticals by the two other plaintiffs. The plaintiffs seek an injunction and unspecified damages. We believe the claims are without merit and intend to defend against them vigorously.

Item 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS.

The following Management’s Discussion and Analysis of Financial Condition ~~and~~ and Results of Operations, as well as information contained elsewhere in this Report, contains statements that constitute “forward-looking statements” within the meaning of Section 27A of the Securities Act of 1933 and Section 21E of the Securities Exchange Act of 1934. ~~These~~Words such as “expects,” “anticipates,” “intends,” “plans,” “believes,” “seeks,” “estimates,” and variations of such words and similar expressions are intended to identify such forward-looking statements. ~~include~~Such statements ~~regarding~~involve known and unknown risks, uncertainties, and other factors which may cause the ~~intent~~actual results, ~~belief~~performance or achievements ~~current~~of ~~expectations~~the Company to be materially different from the results of operations ~~us,~~or ~~our~~plans ~~directors~~expressed or ~~our~~implied ~~officers~~by such forward-looking statements. ~~with~~Such ~~respect~~factors toinclude, among other things: (1) whether we will receive, and the timing of, regulatory approvals or clearances to market potential products; (2) the results of current and future clinical trials; (3) the time and expenses associated with the regulatory approval process for products; (4) the safety and effectiveness of our products and technologies; (5) the Company’s expectation that its marketing partners will be able to successfully market its products; (6) its expectation of receiving royalties on sales of its products and its plans to manufacture certain of its products at its facility in Fort Collins, Colorado; and (7) the timing of new product launches~~; and (8) expected future additional equity losses for Transmucosal Technologies, Ltd~~. The success of our business operations is dependent on factors such as the receipt and timing of regulatory approvals or clearances for potential products, the ~~effectiveness~~ effectiveness of our marketing strategies to market our current and any future products, our ability to manufacture products on a commercial scale, the appeal of our mix of products, our success at entering into and collaborating with others to conduct effective strategic alliances and joint ventures, general ~~competitive~~ competitive conditions within the biotechnology and drug delivery industry and ~~general~~ general economic conditions. Forward-looking statements are not guarantees of ~~future~~ future performance and involve risks and uncertainties. Actual results may ~~differ~~ differ materially from those projected in the forward-looking statements as a ~~result~~ result of various factors, including those described below under “Item 1.—-Business-Factors Affecting Our Business and Prospects” in our Annual Report on Form 10-K for the year ended December 31, 2002.

Overview

Atrix Laboratories, Inc. and its subsidiaries are collectively referred to herein as “Atrix,” “the Company,” “we,” “our” or “us.” We are an emerging specialty pharmaceutical company focused on advanced drug delivery. With five unique patented drug delivery technologies, we are currently ~~developing~~working aon the development of a diverse portfolio of products, including proprietary oncology, dermatology and pain management products. We also form strategic alliances with a variety of pharmaceutical and biotechnology companies to develop products utilizing our various drug delivery systems and/or to commercialize our products. Current strategic alliances include collaborations with Pfizer, Inc., Sanofi-Synthelabo, Inc., Fujisawa Healthcare, Inc., Geneva Pharmaceuticals, Inc., Sosei Co. Ltd., MediGene AG and CollaGenex Pharmaceuticals, Inc. ~~In July~~ ~~2000, we formed a joint venture, Transmucosal Technologies, Ltd., with Elan to~~ ~~develop and commercialize oncology and pain management products.~~

Our drug delivery systems deliver controlled amounts of drugs in time ~~frames~~ frames ranging from “minutes to months” to address a range of therapeutic and ~~patient~~ patient needs. Atrigel is our original proprietary sustained release ~~biodegradable~~ biodegradable polymer drug delivery system. We believe that the Atrigel system may provide benefits over traditional methods of drug administration such as safety and effectiveness, ease of ~~applications~~use, site-specific or systemic delivery, customized release rates and biodegradability. ~~With~~Our ~~the acquisition of ViroTex Corporation in November 1998, we added~~ four additional drug delivery systems include: BEMA™, SMP™, MCA™ and BCP™.

Recent Developments

The following discussion highlights significant events for our company ~~during~~ during the ~~six~~nine months ended ~~June~~September 30, 2003:

Atrisone acne product

In June 2003, we announced completion of enrollment for the pivotal Phase ~~III~~ III clinical trials for our Atrisone acne product. Final patient evaluations ~~are~~ are expected to conclude inby ~~early~~the ~~2004~~end of 2003 followed by a data ~~collections~~collection/processing effort. We expect to file a New Drug Application, or NDA, with the U.S. Food and Drug Administration, or FDA, for the Atrisone acne product in mid-2004.

1011

Eligard 30-mg four-month product

We received approval from the FDA for our Eligard 30-mg four-month product in in February 2003. In March 2003, Sanofi-Synthelabo Inc. launched the product into the U.S. market and we received a $6.0 million milestone payment in April 2003 for the first commercial sale of the Eligard 30-mg four-month product.

Eligard 45-mg six-month product

In June 2003, we reported that all of the patients in our Eligard 45-mg six-month product Phase III clinical trials have completed the first six months of treatment and have received the second injection required under the clinical protocol. We expect to complete the pivotal Phase III clinical trials by the end of 2003 and submit an NDA to the FDA in the first ~~half~~quarter of 2004.

Eligard International

In January 2003, we entered into an exclusive licensing agreement with ~~Sosei~~ Sosei Co., Ltd. to develop and commercialize our Eligard products in Japan. WeSosei ~~received~~paid anus upa one-~~front~~time non-refundable license fee of $01.90 million, and ~~may~~we may receive additional payments for research and development support and payments for specific ~~clinical,~~ regulatory and sales milestones. In addition to the milestone payments, we will receive royalty payments based on sales of the Eligard products, ~~upon~~if ~~approval~~approved for marketing by the Japanese Ministry of Health, Labor and Welfare, or MHLW. Sosei will be responsible for ~~submission~~any pre-clinical and clinical studies required for approval and will be responsible for submission of the necessary documents to obtain marketing authorization from the MHLW. We will manufacture the Eligard products for Sosei at our Fort Collins’ facility ~~and will earn manufacturing margins~~.

Additionally, in November 2003, Sanofi-Synthelabo Canada has received a notice of compliance from the Therapeutic Products Directorate of Health Canada for Eligard 7.5mg one-month and 22.5mg three-month products. Sanofi-Synthelabo Canada will be responsible for marketing the products in Canada.

Other Products

In ~~January~~ August 2003, we ~~announced~~submitted ~~the~~an ~~submission~~investigational ofnew ~~three~~drug ~~Abbreviated New Drug Applications~~application, or ~~ANDAs~~IND, to the FDA for ~~approval~~an Atrigel formulation of ~~generic~~octreotide, ~~formulations~~which ofis designed to ~~undisclosed~~deliver ~~dermatology~~the ~~products,~~pharmaceutical ~~bringing~~over ~~our~~a ~~total~~30-day ~~ANDA~~period ~~submissions~~for tothe ~~seven, all~~long term treatment of severe ~~which~~diarrhea ~~are~~and ~~currently~~flushing ~~under~~episodes ~~FDA~~associated ~~review~~with metastatic carcinoid tumors.

~~Principal~~We ~~Consolidated~~received ~~Statements~~approval offrom ~~Operations~~the ~~Items~~FDA for our Abbreviated New Drug Application, or ANDA, for lidocaine/prilocaine cream in August 2003. Our product is the AB-rated generic to EMLA Anesthetic Cream (lidocaine 2.5% and prilocaine 2.5%). Our partner Geneva Pharmaceuticals is marketing this product.

~~Revenues~~In August 2003, we received a non-approval letter from the FDA indicating that a generic dermatology product was not approved. We are currently appealing this action through the FDA; however, there can be no assurance that our appeal will be successful.

~~Net~~In ~~sales~~January 2003, ~~and~~we ~~royalties~~announced ~~consist~~the ~~principally~~submission of ~~sales~~three ANDAs to the FDA, and ~~royalties~~in September 2003 ~~from~~one additional ANDA was submitted to the FDA for approval of ~~our~~generic ~~Eligard~~formulations of certain dermatology products, ~~Atridox~~bringing ~~product~~our ~~and~~total ~~Doxirobe~~ANDA submissions ~~product~~currently under FDA review to seven.

~~Contract~~An ~~research~~agreement ~~and~~to ~~development~~terminate ~~revenue~~our ~~consists~~joint ~~principally~~venture with a subsidiary of ~~revenue~~Elan weCorporation ~~earn~~was ~~from~~reached ~~unaffiliated~~in ~~third~~September 2003. ~~parties~~Termination ~~and~~of ~~from~~the ~~our~~ joint venture returns ~~with~~the BEMA-fentanyl product to us. Upon termination, we acquired Elan’s ownership interest in the joint venture, Transmucosal Technologies Ltd., in exchange for ~~performing~~Elan ~~contract~~receiving ~~research~~a portion of any consideration we receive from the licensing of BEMA-fentanyl and ~~development~~a ~~activities~~royalty ~~using~~based ~~our~~on ~~various~~net sales of BEMA-fentanyl if ~~patented~~the ~~drug~~product ~~delivery~~is ~~technologies~~commercialized.

~~Licensing, marketing rights and milestone revenue consists principally of~~12 ~~revenue earned on our Eligard products, our dental products, and the Atrisone~~ ~~topical dermatological product for the rights extended to our partners to sell~~ ~~our proprietary products in a defined territory for a defined period or for the achievement of a pre-determined milestone as defined in the applicable agreement.~~

Principal Consolidated Statements of Operations Items

Revenue

Net sales and royalties consist principally of sales and royalties from our Eligard products, the Atridox product and the Doxirobe product.

Contract research and development revenue consists principally of revenue we earn from unaffiliated third parties.

Licensing, marketing rights and milestone revenue consists principally of revenue earned on our Eligard products, our dental products, and the Atrisone topical dermatological product for the rights granted to our partners to sell our proprietary products in a defined territory for a defined period or for the achievement of a pre-determined milestone as defined in the applicable agreement.

Operating Expenses

Cost of sales consists principally of costs associated with the manufacture, packaging, storage, shipping, stability, and other product-related fees for the Eligard products, the Atridox product and the Doxirobe product.

Research and development expenses consist principally of funds paid for services and materials during development, manufacturing and formulation enhancements, clinical trials, statistical analysis, report writing, ~~and~~ regulatory compliance costs and associated overhead for both partner-funded and internally-funded projects.

Administrative and marketing expenses consist principally of personnel salaries and benefits, direct marketing costs, business development and corporate relations costs, professional, legal and consulting fees, insurance and general office expenses.

Investment income and expense, net, consists principally of interest and dividends earned on marketable securities available for sale and money market accounts net of ~~commission~~commissions, fees and other ~~bank~~ charges.

Results of Operations

Three Months Ended ~~June~~ September 30, 2003 Compared to Three Months Ended ~~June~~ September 30, 2002

Total revenue for the three months ended June 30, 2003 was $12.3 million compared to $6.5 million for the three months ended June 30, 2002, representing an 89% increase.


	Three Months Ended September 30,

Revenue	2003		2002		% Change

	(In thousands)
Net sales and royalties	$	5,342	$	1,587		237	%
Contract research and development revenue		5,773		4,306		34	%
Licensing, marketing rights and milestone revenue		2,524		1,731		46	%

	$	13,639	$	7,624		79	%

~~Net~~Total ~~sales~~revenue ~~and royalties were $4.6 million~~ for the three months ended ~~June~~ September 30, 2003 was $13.6 million compared to $17.56 million for the three months ended ~~June~~September 30, 2002, representing a ~~207~~79% increase. ~~This~~Net ~~increase~~sales isand ~~primarily~~royalties ~~related~~were to$5.3 million for the ~~increase~~three inmonths ~~sales~~ended ~~and~~September 30, ~~royalties~~2003 ofcompared ~~our~~to ~~Eligard products of~~ $21.6 million ~~from~~for the three ~~$0.5 million~~months toended ~~$3.1~~September ~~million~~30, an2002, ~~increase~~representing ina ~~domestic~~237% ~~and~~increase. ~~European~~For ~~sales~~the third quarter of ~~our Atridox~~2003, ~~product~~we ofreceived $04.64 million in sales and anroyalty ~~increase~~revenue infor ~~sales~~our Eligard ofproducts in the ~~Doxirobe product~~US ~~of $0~~market.~~2 million.~~ This ~~increase~~is ~~was offset by~~ a $0.3.8 million ~~decrease~~ increase in sales and ~~from~~royalties ~~contract~~of ~~manufacturing~~our asEligard aproducts ~~result~~compared ofto ~~our~~the ~~shift~~third inquarter ~~focus~~of ~~toward~~2002. ~~the~~This ~~Eligard~~was ~~products~~offset by a decrease of $0.1 million Wein other product sales. We expect net sales and royalty revenues to increase in 2003 as a result of the Eligard product line as a result of a full year of product sales of our Eligard 7.5-mg one-month and Eligard 22.5-mg three-month products launched in May 2002 ~~and~~ ~~September~~and September 2002, respectively. Additionally, the FDA approved our Eligard 30-mg four-month product in February 2003, ~~which~~and the product was launched in March 2003.

Contract research and development revenue was $5.7 million for the three months ended June 30, 2003 compared to $3.5 million for the three months ended June 30, 2002, representing a 63% increase. This increase is primarily related to a $1.9 million increase in revenue from Fujisawa for partial funding of Atrisone research costs and a $0.9 million increase in revenue from Sanofi-Synthelabo for funding of an Eligard 45-mg six-month formulation. These increases were offset by a $0.2 million decrease in revenue from research activities funded by other parties and a $0.4 million decrease in revenue recognized in conjunction with our joint venture as a result of the completion of feasibility work performed by us. We cannot be certain whether contract research and development revenue from our partner-funded research and development expenses will increase or decrease for the foreseeable future as the timing of such expenses being incurred may vary. Accordingly, the revenue recognition may vary depending on the terms of the corresponding agreements.

Licensing, marketing rights and milestone revenue for the three months ended June 30, 2003 was $2.1 million compared to $1.5 million for the three months ended June 30, 2002, representing a 40% increase. This increase is primarily related to the recognition of $0.5 million in additional milestone revenue for our Eligard products under the Sanofi-Synthelabo agreement and the recognition of $0.1 million of additional revenue for our Eligard products under various international partner agreements. We expect licensing, marketing rights and milestone revenue to increase in 2003 as a result of a full year of revenue recognition from licensing and milestone payments received from our marketing partners in 2002 and recognition of revenue for licensing and milestone payments received in the first half of 2003, including a $6.0 million milestone payment we received from Sanofi-Synthelabo in April 2003 for the first commercial sale of our Eligard four-month product and recognition of revenue for payments that we may receive from our current or future partners in the second half of 2003. All licensing,

marketing rights and milestone payments received are deferred and recognized over the remaining term of the related agreement.

Cost of sales for the three months ended June 30, 2003 was $1.9 million compared to $0.8 million for the three months ended June 30, 2002, representing a 138% increase. The increase primarily relates to the costs associated with sales of our Eligard 7.5-mg one-month, Eligard 22.5-mg three-month and Eligard 30-mg four-month products and domestic and European sales of Atridox. We expect that cost of sales will increase in line with our expected revenue growth.

Research and development expenses for the three months ended June 30, 2003 were $9.3 million compared to $7.5 million for the three months ended June 30, 2002, representing a 24% increase. An increase of $2.5 million was related to clinical costs associated with Phase III clinical trials for our Atrisone acne product and an increase of $0.9 million was related to the development of our generic dermatology products. These increases were offset by a decrease in research and development expenses of $1.6 million on other projects including joint venture activities, Eligard development and BEMA development. We cannot be certain whether our partner-funded research and development expenses will increase or decrease for the foreseeable future as the timing of such expenses being incurred may vary depending on the terms of the corresponding agreements. However, we expect that research and development expenses for internally funded activities will decrease in 2003 due to our current focus on completion of Atrisone clinical studies and development of generic dermatology products.

Administrative and marketing expenses for the three months ended June 30, 2003 were $2.6 million compared to $2.4 million for the three months ended June 30, 2002, representing an 8% increase. The increase is primarily related to increased European sales and marketing efforts for Atridox of $0.9 million offset by reductions in general administrative support of $0.7 million. We expect that our administrative and marketing expenses will increase for the foreseeable future as we continue to grow.

We recognized a loss of $0.3 million for the three months ended June 30, 2002 for our 80.1% equity share in the loss of Transmucosal Technologies, our joint venture with Elan. The joint venture has completed feasibility work on two projects and the projects are currently under review for further development. As a result, the amount and timing of future recognition of equity in loss of our joint venture is uncertain at this time.

Investment income for the three months ended June 30, 2003 was $0.7 million compared to $1.2 million for the three months ended June 30, 2002, representing a 42% decrease. The decrease was primarily the result of a decrease in our average cash, cash equivalents and available-for-sale marketable securities balances. Additionally, interest rates on investments in the second quarter of 2003 were lower compared to the second quarter of 2002. We expect investment income to decrease in 2003 as a result of expected lower interest rates and lower balances of cash and cash equivalents and marketable securities as compared to 2002 interest rates and balances.

Gain on sale of marketable securities for the three months ended June 30, 2003 was $0.3 million compared to a loss on sale and a write-down of marketable securities of $1.0 million for the three months ended June 30, 2002. The gain on sale of marketable securities in the second quarter of 2003 was due to the sale of certain government securities and corporate notes. In the second quarter of 2002, we recorded a charge of $0.7 million for the write-down of WorldCom, Inc. Senior Corporate Notes and recognized a loss on sale of marketable securities of $0.3 million for the sale of a portion of the WorldCom, Inc. Senior Corporate Notes. We cannot be certain whether we will incur gains or losses on the sale of marketable securities in the future.

We issued shares of Series A Convertible Exchangeable Preferred Stock to Elan in July 2000 in connection with the formation of our joint venture with Elan. Related to this issuance, we recognized $0.2 million for accretion of dividends on the shares of preferred stock for the three months ended June 30, 2003 compared to $0.2 million for the three months ended June 30, 2002.

For the reasons described above, we recorded a consolidated net loss applicable to common stock of $0.7 million, or $0.04 per share, for the three months ended June 30, 2003 compared to a consolidated net loss applicable to common stock of $4.6 million, or $0.23 per share, for the three months ended June 30, 2002.

~~Six~~Contract ~~Months~~research ~~Ended~~and ~~June~~development revenue was $5.8 million for the three months ended September 30, 2003 ~~Compared~~compared to ~~Six~~$4.3 million ~~Months~~for ~~Ended~~the ~~June~~three months ended September 30, 2002, representing a 34% increase. This increase is primarily related to a $2.0 million increase in revenue from Fujisawa Healthcare, Inc. for partial funding of research costs for the Atrisone acne product. This increase was offset by a $0.5 million decrease in revenues primarily related to Sanofi-Synthelabo Inc. and Transmucosal Technologies, Ltd. We cannot be certain whether contract research and development revenue from our partner-funded research and development expenses will increase or decrease for the foreseeable future as the timing of such expenses being incurred may vary. Accordingly, the amount and timing of revenue recognition may vary depending on the terms of the corresponding agreements.

~~Total~~Licensing, marketing rights and milestone revenue for the ~~six~~three months ended ~~June~~ September 30, 2003 was $212.85 million compared to $111.57 million for the ~~six~~ three months ended ~~June~~September 30, 2002, representing a 9046% increase. This increase is primarily related to the recognition of $0.3 million in additional milestone revenue for our Eligard products under the agreement with Sanofi-Synthelabo Inc. and the recognition of $0.5 million of additional revenue as a result of the termination of our endometriosis licensing agreement with EmerGen, Inc. We expect licensing, marketing rights and milestone revenue to increase in 2003 as a result of a full year of revenue recognition from licensing and milestone payments received from our marketing partners in 2002 and recognition of revenue for licensing and milestone payments received in the nine months ended September 30, 2003, including a $6.0 million milestone payment we received from Sanofi-Synthelabo Inc. in April 2003 for the first commercial sale of our Eligard 30-mg four-month product and recognition of revenue for payments that we may receive from our current or future partners in the fourth quarter of 2003. All licensing, marketing rights and milestone payments received are initially reported as deferred revenue and recognized as licensing revenue over the remaining contractual term or as covered by patent protection, whichever is earlier, using the straight-line method or until the agreement is terminated.

Net sales and royalties were $7.8 million for the six months ended June 30, 2003 compared to $2.6 million for the six months ended June 30, 2002, representing a 200% increase. This increase is primarily related to the increase in sales and royalties of our Eligard products of $4.4 million from $0.5 million to $4.9 million, an increase in domestic and European sales of our Atridox product of $1.2 million and an increase in sales of the Doxirobe product of $0.2 million. This increase was offset by a $0.6 million decrease in sales from contract manufacturing as a result of our shift in focus toward the Eligard products. We expect net sales and royalty revenues to increase in 2003 as a result of a full year of product sales of our Eligard 7.5-mg one-month and Eligard 22.5-mg three-month products launched in May 2002 and September 2002, respectively. Additionally, the FDA approved our Eligard 30-mg four-month product in February 2003, which was launched in March 2003.


	Three Months Ended September 30,

Operating expenses	2003		2002		% Change

	(In thousands)
Cost of sales	$	2,901	$	502		478	%
Research and development		8,738		9,438		(7	)%
Administrative and marketing		2,387		2,413		(1	)%

	$	14,026	$	12,353		14	%

~~Contract~~Cost ~~research~~of ~~and~~sales ~~development was $10.0 million~~ for the ~~six~~three months ended ~~June~~September 30, 2003 was $2.9 million compared to $6.0.5 million for the ~~six~~three months ended ~~June~~September 30, 2002, representing a 67478% increase. ~~This~~The increase is primarily ~~related~~relates to ~~a $3.9 million~~the ~~increase in revenue from Fujisawa for partial funding of Atrisone research~~ costs ~~and a $1.4 million increase in revenue from Sanofi-Synthelabo~~ ~~for~~associated ~~funding~~with sales of anour Eligard 457.5-mg ~~six~~one-month, ~~formulation.~~Eligard ~~These increases were offset by a $0~~22.5 ~~million decrease in revenue from research activities funded by~~-mg ~~other~~three-month ~~parties~~ and aEligard ~~$0.8 million~~30-mg ~~decrease~~four-month ~~in revenue recognized in conjunction with our joint venture as a result of the completion of feasibility work performed by us~~products. We ~~cannot~~expect bethat ~~certain~~cost ~~whether~~of ~~contract research and~~sales ~~development revenue from our partner-funded research and development expenses~~ will increase orin ~~decrease~~line ~~for~~with ~~the~~our ~~foreseeable~~expected ~~future as the timing of such expenses being incurred may vary. Accordingly, the~~ revenue ~~recognition may vary depending on the terms of the corresponding agreements~~growth.

~~Licensing,~~Research ~~marketing rights~~ and ~~milestone~~development ~~revenue~~expenses for the ~~six~~three months ended ~~June~~ September 30, 2003 were ~~was~~ $48.07 million compared to $2.9.4 million for the ~~six~~three months ended ~~June~~ September 30, 2002, representing a 387% ~~increase~~decrease. This ~~increase~~decrease is primarily ~~related~~ relates to ~~the~~a decrease ~~recognition~~in research and development expenses of $1.08 million ~~in additional milestone revenue~~ for ~~our~~ Eligard projects, ~~products~~$1.2 million ~~under~~for ~~the Sanofi~~internally-~~Synthelabo~~funded ~~agreement~~projects and ~~the recognition of~~ $0.1 million ~~of additional revenue~~ for ~~our Eligard products under various~~ ~~international~~ partner-funded ~~agreements~~projects. WeThis ~~expect~~decrease ~~licensing,~~was ~~marketing~~offset ~~rights~~by ~~and milestone~~an ~~revenue to~~ increase ~~in 2003 as a result~~ of ~~a full year of revenue~~$2.4 ~~recognition~~million ~~from~~in ~~licensing~~expenses ~~and~~related ~~milestone~~to ~~payments~~Phase ~~received~~III ~~from~~clinical ~~our~~trials ~~marketing partners in 2002 and recognition of revenue~~ for ~~licensing~~our ~~and~~Atrisone ~~milestone~~acne ~~payments~~product. ~~received~~We inexpect ~~the~~that ~~first~~research ~~half~~and ofdevelopment ~~2003,~~expenses ~~including~~for ~~a $6.0 million milestone~~internally- ~~payment~~funded weactivities ~~received~~will ~~from~~be ~~Sanofi~~lower in ~~April~~ 2003 ~~for~~due ~~the~~to ~~first~~our ~~commercial~~current ~~sale~~focus ofon completion ~~our~~of ~~Eligard~~Atrisone ~~four-month~~clinical ~~product,~~studies and ~~recognition~~development of ~~revenue~~generic ~~for~~dermatology ~~payments that we may receive from our current or future partners in the second half of 2003~~products. ~~All~~In ~~licensing~~2004, ~~marketing~~we ~~rights~~expect ~~and~~to ~~milestone~~return ~~payments~~our ~~received~~focus ~~are~~to ~~deferred and~~research ~~recognized~~activities ~~over~~on ~~the remaining term of the related agreement~~non-partnered projects.

~~Cost~~Administrative ofand ~~sales~~marketing expenses for the ~~six~~three months ended ~~June~~September 30, 2003 ~~was~~were $32.34 million compared to $12.34 million for the ~~six~~three months ended ~~June~~ September 30, 2002~~, representing a 154% increase~~. ~~The~~We ~~increase~~expect ~~primarily~~that ~~relates to the costs associated with sales of~~ our ~~Eligard~~administrative ~~7.5-mg one-month, Eligard 22.5-mg three-month~~ and ~~Eligard 30-mg~~marketing ~~four-month products and domestic and European sales of Atridox. We~~expenses ~~expect~~will ~~that~~increase ~~cost~~for ofthe ~~sales~~foreseeable ~~will~~future ~~increase~~as inwe ~~line~~continue ~~with~~to ~~revenue growth~~grow.

Research and development expenses for the six months ended June 30, 2003 were $18.0 million compared to $14.1 million for the six months ended June 30, 2002, representing a 28% increase. An increase of $4.9 million was related to clinical costs associated with Phase III clinical trials for our Atrisone acne product and an increase of $1.3 million was related to the development of our generic dermatology products. These increases were offset by a decrease in research and development expenses of $2.3 million on other projects including joint venture activities, Eligard development and BEMA development. We cannot be certain whether our partner-funded research and development expenses will increase or decrease for the foreseeable future as the timing of such expenses being incurred may vary depending on the terms of the corresponding agreements. However, we expect that research and development expenses for internally funded activities will decrease in 2003 due to our current focus on completion of Atrisone clinical studies and development of generic dermatology products. Following completion of these programs, we expect internal product development expenses to increase again in the foreseeable future.

Administrative and marketing expenses, excluding stock and stock option compensation, for the six months ended June 30, 2003 were $5.5 million compared to $4.2 million for the six months ended June 30, 2002, representing a 31% increase. The increase is primarily related to increased European sales and marketing efforts for Atridox of $1.6 million offset by decreases in general administrative support of $0.3 million. We expect that our administrative and marketing expenses will increase for the foreseeable future as we continue to grow.


	Three Months Ended September 30,

Other Income (Expense)	2003			2002			% Change

	(In thousands)
Equity in loss of joint venture	$	(6	)	$	(195	)		(97	)%
Investment income and expense, net		638			1,047			(39	)%
Gain (loss) on sale of marketable securities		139			(15	)		1,027	%
Other, net		(7	)		(27	)		(74	)%

	$	764		$	810			(6	)%

~~Stock~~We ~~option~~recognized ~~compensation~~a loss of $6,000 for the ~~six~~three months ended ~~June~~September 30, ~~2002 was $1.3~~2003 ~~million,~~compared ~~which~~to ~~was~~a ~~recognized~~loss inof ~~connection~~$0.2 million ~~with~~for the ~~retirement~~three ofmonths anended ~~executive~~September 30, ~~officer~~2002 for our 80.1% Weequity ~~may,~~share in the ~~future,~~loss ~~incur~~of ~~additional~~Transmucosal ~~costs~~Technologies, ~~for~~Ltd., our ~~stock~~joint ~~compensation and~~venture ~~performance-based~~with ~~compensation~~Elan. ~~activities,~~In ~~however~~September 2003, we ~~cannot~~terminated ~~predict~~our ~~if or~~joint ~~when~~venture ~~that~~with ~~may~~Elan ~~happen~~and, ortherefore, ~~what~~will ~~the~~not ~~cost~~recognize ~~may~~any befuture equity loss charges for Transmucosal Technologies, Ltd.

WeInvestment ~~recognized~~income aand ~~loss~~expense, ofnet, ~~$0.1 million~~ for the ~~six~~three months ended ~~June~~September 30, 2003 ~~for~~was ~~our 80~~$0.1%6 million ~~equity share in the loss of Transmucosal Technologies, our joint venture with Elan,~~ compared to ~~a loss of~~ $01.70 million for the ~~six~~three months ~~ended~~ ~~June~~ended September 30, 2002, representing ana 8639% decrease. The ~~joint~~decrease ~~venture~~was ~~has~~primarily ~~completed~~the ~~feasibility~~result ~~work~~of ona ~~two~~decrease ~~projects~~in ~~and~~our ~~the~~average ~~projects~~cash, ~~are~~cash ~~currently~~equivalents ~~under~~and ~~review~~ available-for-sale ~~further~~marketable ~~development~~securities balances. AsAdditionally, ainterest rates ~~result,~~on ~~the~~investments ~~amount~~in ~~and~~the ~~timing~~third quarter of ~~future~~2003 were lower compared to the ~~recognition~~third quarter of ~~equity~~2002. We expect investment income to decrease in ~~loss~~2003 as a result of ~~our~~expected ~~joint~~lower ~~venture~~interest isrates ~~uncertain~~and atlower ~~this~~balances ~~time~~of cash and cash equivalents and marketable securities as compared to 2002 interest rates and balances.

~~Investment~~Gain ~~income~~on sale of marketable securities for the ~~six~~three months ended ~~June~~September 30, 2003 was $~~1.4 million~~ 139,000 compared to a loss on sale of marketable securities of $~~2.4 million~~15,000 for the ~~six~~three months ended ~~June~~September 30, 2002~~, representing a 42% decrease~~. The ~~decrease~~gain ~~was~~on ~~primarily~~sale ~~the result~~ of ~~a decrease in our~~ ~~average cash, cash equivalents and available-for-sale~~ marketable securities ~~balances.~~ ~~Additionally, interest rates on investments~~ in the ~~first~~third ~~half~~quarter of 2003 ~~were~~was ~~lower~~due ~~compared~~ to the ~~first~~sale ~~half~~ of ~~2002. We expect investment~~ ~~income~~certain togovernment ~~decrease~~securities, incorporate ~~2003~~notes asand acorporate ~~result~~equities. ofWe cannot ~~expected~~be ~~lower~~certain ~~interest~~whether ~~rates~~we ~~and lower~~will ~~balances~~incur ofgains ~~cash~~or ~~and~~losses ~~cash~~on ~~equivalents~~the ~~and~~sale of marketable securities ~~as compared~~in tothe ~~2002 interest rates and balances~~future.

~~Gain~~We onrecognized ~~sale~~$0.2 million ~~of marketable securities~~ for ~~the~~accretion ~~six~~of ~~months~~dividends ~~ended~~on ~~June~~the Series ~~30,~~A ~~2003~~Convertible ~~was~~Exchangeable ~~$0.4 million~~Preferred ~~compared~~Stock toand a ~~loss~~charge ~~and write-down~~ of ~~marketable securities of~~ $10.12 million for the ~~six months ended June 30, 2002. The gain~~ onrelated ~~sale~~beneficial ofconversion ~~marketable~~feature ~~securities~~for in the ~~six~~three months ended ~~June~~September 30, 2003 ~~was primarily~~compared ~~due~~ to ~~the sale of certain government securities and corporate notes. The loss and write-down of marketable securities during the six months ended June 30, 2002 was due to the sale of our~~ $0.82 million ~~principal amount of WorldCom, Inc. Senior Corporate Notes in May 2002~~ for ~~proceeds~~accretion of ~~$0.4 million, which~~dividends ~~resulted in a loss on sale of marketable securities of $0.4 million. In June 2002, we incurred a $0.7 million charge~~ for athe ~~write-down~~three ~~of our remaining~~months ~~position~~ended ~~in WorldCom Senior Corporate Notes, principal value of $0.8~~September ~~million~~30, ~~upon~~ ~~WorldCom’s bankruptcy filing in July~~ 2002. ~~We cannot be certain whether~~ ~~we will incur gains or losses on the sale of marketable securities or recognize~~ ~~charges for write-downs in the future.~~

During the six months ended June 30, 2002 we exchanged 279,901 shares of our common stock for $5.2 million in outstanding principal amount of our 7% Convertible Subordinated Notes. Of the 279,901 shares issued, 273,984 shares were valued at the conversion price of $19.00 per share and the remaining 5,917 shares were valued at $21.09 per share, the closing market price of our common stock on the date of exchange. As a result of the conversions, we recognized a gain of $30,000, for the write-off of $80,000 of pro-rata unamortized deferred finance charges net of $0.1 million interest expense payable eliminated as a result of these exchanges. Additionally, of the 5,917 shares exchanged, a debt conversion expense of approximately $0.1 million was recognized for the six months ended June 30, 2002. The 7% Convertible Subordinated Notes were fully extinguished in May 2002.

We issued Series A Convertible Exchangeable Preferred Stock to Elan in July 2000 in connection with the formation of our joint venture with Elan. Related to this issuance, we recognized $0.5 million for accretion of dividends on the shares of preferred stock for the six months ended June 30, 2003 compared to $0.5 million for the six months ended June 30, 2002.

For the reasons described above, we recorded a consolidated net loss applicable to common stock of $3.7 million, or $0.19 per share, for the six months ended June 30, 2003 compared to a consolidated net loss applicable to common stock of $9.4 million, or $0.47 per share, for the six months ended June 30, 2002.

~~Liquidity~~ Nine ~~and~~Months ~~Capital~~Ended ~~Resources~~September 30, 2003 Compared to Nine Months Ended September 30, 2002

As of June 30, 2003, we had cash and cash equivalents of $17.0 million, marketable securities (at fair value) of $81.1 million, net accounts receivable of $7.2 million, inventories of $11.2 million and other current assets of $3.7 million for total current assets of $120.2 million. We had accounts payable of $2.6 million, short-term deferred revenue of $9.9 million and other current liabilities of $1.0 million for total current liabilities of $13.5 million, which resulted in working capital of $106.7 million.


	Nine Months Ended September 30,

Revenue	2003		2002		% Change

	(In thousands)

Net product sales and royalties	$	13,125	$	4,230		210	%
Contract research and development revenue		15,772		10,314		53	%
Licensing, marketing rights and milestone revenue		6,546		4,591		43	%

	$	35,443	$	19,135		85	%

~~During~~Total revenue for the ~~six~~nine months ended ~~June~~September 30, 2003, ~~net~~was ~~cash used in operating~~$35.4 million ~~activities~~compared ~~was~~to $919.01 million. ~~This~~for ~~was primarily~~ the ~~result~~nine ofmonths ~~the~~ended ~~net~~September 30, ~~loss for~~2002, ~~the~~representing ~~period~~an of85% $3increase.~~2 million,~~ ~~adjusted~~Net ~~for~~sales ~~certain~~and ~~non-cash~~royalties ~~expenses,~~were ~~and~~$13.1 million ~~changes~~for inthe ~~operating~~nine ~~assets~~months ~~and~~ended ~~liabilities~~September 30, as2003 ~~set~~compared ~~forth~~to in$4.2 million for the ~~consolidated statements~~nine ofmonths ~~cash~~ended ~~flows.~~September 30, We2002, ~~recognized~~representing a ~~cash~~210% ~~inflow~~increase. ~~from~~This ~~the~~increase is ~~receipt~~primarily ofrelated ~~deferred milestone~~to ~~payments,~~the ~~licensing~~increase ~~fees~~in sales and ~~certain~~royalties ~~contract~~of ~~research~~our ~~and~~Eligard ~~development~~products ~~payments~~ of $78.2 million, ~~offset~~and byan ~~amortization~~increase in domestic and European sales of ~~deferred~~our ~~revenue~~dental products of $41.93 million. ~~Other~~This ~~significant~~increase ~~uses~~was ofoffset ~~cash~~by ~~included:~~a $20.5 6 million decrease ~~due~~in toother ~~increasing~~product ~~inventory~~sales ~~levels~~including ~~primarily~~contract ~~related~~manufacturing. We expect net sales and royalty revenues to ~~the~~increase ~~production of~~in ~~our~~2003 ~~Eligard~~as ~~products~~a ~~and~~result ~~inventory~~of ~~buildup~~a ~~related~~full toyear of product sales of our ~~generic dermatology~~Eligard ~~products~~7.5-mg one-month and $5Eligard 22.~~1 million~~5-mg three-month ~~decrease~~products launched in ~~accounts~~May 2002 ~~payable~~and ~~primarily~~September 2002, respectively. ~~related~~Additionally, tothe ~~payments~~FDA ~~for~~approved ~~inventory~~our ~~raw~~Eligard ~~materials~~30-mg ~~and~~four-month ~~components~~product ~~and~~in ~~plant~~February ~~expansion~~2003, ~~costs~~which was launched in March 2003.

~~Net~~Contract ~~cash~~research ~~used~~and indevelopment ~~investing activities~~ was $515.28 million ~~during~~for the ~~six~~ nine months ended ~~June~~ September 30, 2003 compared to $10.3 million for the nine months ended September 30, 2002, representing a 53% increase. This ~~was~~increase is primarily related ~~due~~ to a $216.30 million ~~used~~increase toin revenue from Fujisawa Healthcare, Inc. ~~fund~~for ~~the~~partial ~~purchases~~funding of ~~various~~Phase ~~available-~~III clinical research costs for~~-sale~~ ~~marketable~~our ~~securities~~Atrisone ~~offset~~acne byproduct ~~proceeds~~and ~~received~~a ~~from~~$1.0 million ~~the~~increase ~~maturity~~in ~~and~~revenue ~~sale~~from Sanofi-Synthelabo Inc. for funding of ~~available~~the Eligard 45-~~for~~mg six-~~sale~~month formulation. These increases were ~~marketable~~offset ~~securities~~by ofa $231.20 million. ~~During~~decrease ~~the~~in ~~first~~revenue ~~half~~recognized ofin ~~2003,~~conjunction with our ~~various~~joint ~~marketable~~venture ~~securities~~and ~~matured~~a or$0.5 million ~~were~~decrease ~~called~~in ~~and~~revenue ~~the~~from ~~proceeds~~research ~~were~~activities ~~subsequently~~funded ~~reinvested~~by inother ~~high~~parties. ~~rated~~We ~~corporate~~cannot ~~notes,~~be ~~U.S.~~certain ~~government securities,~~whether ~~and~~contract ~~diversified~~research ~~bond~~and development ~~mutual~~revenue ~~funds~~from toour ~~minimize~~partner-funded ~~our~~research ~~exposure~~and todevelopment expenses ~~credit~~will ~~risk.~~increase Inor ~~addition,~~decrease ~~cash~~for ~~used~~the inforeseeable ~~investing~~future ~~activities~~as ~~included~~the ~~$6.6~~timing of such ~~million~~expenses ~~for~~being ~~capital~~incurred ~~expenditures~~may ~~primarily~~vary. ~~related~~Accordingly, tothe ~~our~~amount ~~plant~~and ~~expansion~~timing asof ~~discussed~~revenue ~~further~~recognition ~~under~~may ~~“Future~~vary ~~Capital~~depending ~~Requirements”~~on ~~below~~the terms of the corresponding agreements.

~~Net~~Licensing, ~~cash~~marketing ~~used~~rights inand ~~financing~~milestone ~~activities~~revenue for the nine months ended September 30, 2003 was $06.15 million ~~during~~compared to $4.6 million for the ~~six~~nine months ended ~~June~~September 30, ~~2003~~2002, representing a 43% increase. This ~~was~~increase is primarily ~~the~~related ~~result~~to of the ~~repurchase~~ recognition of $21.93 million ofin ~~our~~additional ~~common~~milestone revenue ~~stock~~for inour ~~the~~Eligard ~~open~~products ~~market.~~under Inthe ~~November~~agreement ~~2002,~~with ~~our~~Sanofi-Synthelabo ~~Board~~Inc., ofthe ~~Directors~~recognition ~~amended~~of ~~our~~$0.5 million ~~stock~~as ~~repurchase~~a ~~program~~result toof ~~provide~~the ~~that~~termination weof ~~may~~our ~~acquire~~licensing upagreement towith aEmerGen, ~~maximum~~Inc. and the recognition of $~~20.~~0.1 million of additional revenue for our ~~common~~Eligard ~~stock~~products inunder ~~the~~various ~~open~~international ~~market~~partner oragreements. inWe ~~privately~~expect ~~negotiated~~licensing, ~~transactions~~marketing ~~under~~rights ~~this~~and ~~program.~~milestone ~~The~~revenue ~~program~~to ~~terminates~~increase onin ~~the~~2003 ~~earlier~~as ofa ~~the~~result ~~date~~of ~~that~~a wefull ~~have~~year ~~repurchased $20.0 million~~ of ~~our~~ ~~common~~revenue ~~stock~~recognition orfrom licensing ~~December 31,~~and ~~2003.~~milestone ~~Since~~payments ~~the~~received ~~inception~~from ofour ~~the~~marketing ~~program,~~partners wein 2002 ~~repurchased~~and arecognition ~~total~~ of ~~866,800~~revenue ~~shares~~for oflicensing ~~our~~and ~~common~~milestone ~~stock~~payments received in the nine ~~open~~months ~~market for~~ended ~~$13.6~~September ~~million~~30, or2003, anincluding ~~average~~a ~~price~~$6.0 million ~~per~~milestone payment ~~share~~we ofreceived ~~$15.71.~~from ~~For~~Sanofi-Synthelabo ~~the~~Inc. ~~six~~in ~~months ended June~~April ~~30,~~ 2003, wefor ~~repurchased~~the ~~209,100~~first commercial ~~shares~~sale of our ~~common~~Eligard ~~stock~~30-mg infour-month ~~the open~~product ~~market~~and recognition of revenue for ~~$2.9 million,~~payments orthat anwe ~~average~~may ~~share~~receive ~~price~~from ~~per~~our ~~share~~current ofor ~~$13.75 under~~future partners in the ~~program.~~fourth Asquarter of ~~June 30,~~ 2003. All licensing, ~~$6.4 million~~marketing ~~remains~~rights ~~available~~and tomilestone ~~repurchase~~payments ~~our~~received ~~common~~are ~~stock~~initially ~~under~~reported ~~the~~as ~~program.~~deferred ~~Additionally,~~revenue weand ~~received~~recognized as ~~proceeds~~licensing ~~from~~revenue ~~issuance~~over ofthe ~~equity~~remaining ~~securities~~contractual ofterm ~~$2.8 million~~or ~~primarily~~as incovered by patent ~~conjunction~~protection, ~~with~~whichever is earlier, using the ~~exercise~~straight-line ofmethod ~~incentive~~or ~~stock~~until ~~options~~the agreement is terminated.

In July 2000, we formed Transmucosal Technologies, a joint venture, with Elan to develop and commercialize oncology and pain management products. Subject to the satisfaction of certain conditions, Elan has agreed to loan us up to $8.0 million under a convertible promissory note in support of our 80.1% share of the joint venture’s research and development costs. The note matures on July 18, 2006, has an interest rate of 7% per annum and interest is compounded semi-annually and added to principal. The Note is convertible, at Elan’s option, into our common stock at a $14.60 conversion price. As of June 30, 2003, we had not drawn any amounts under the note. We are required to fund 80.1% of the joint venture’s obligations, representing our proportionate share of the joint venture. Our share of the joint venture obligations totaled $0.2 million for the six months ended June 30, 2003 and $1.2 million for the six months ended June 30, 2002. As a result, the amount and timing of future recognition of equity in loss of our joint venture is uncertain. The joint venture has completed feasibility work on two projects and the projects are currently under review for further development.

we established a $1.0 million line of credit with another bank. The second line of credit expires in June 2004. Borrowings under the second line of credit bear interest at a rate of 5.25%. As of June 30, 2003, there was no obligation outstanding under either of these lines of credit.


	Nine Months Ended September 30,

Operating expenses	2003		2002		% Change

	(In thousands)
Cost of sales	$	6,191	$	1,815		241	%
Research and development		26,707		23,512		14	%
Administrative and marketing		7,879		6,597		19	%
Administrative and marketing — stock option compensation		22		1,257		(98	)%

	$	40,799	$	33,181		23	%

WeCost have historically funded our operations through debt and equity offerings, payments received for licenses, milestones and research and development support under contractual arrangements and, to a lesser extent, product sales and royalties. We anticipate future funding of ~~our operations to be achieved through continued licensing fees, milestone payments and net~~ sales ~~and~~ ~~royalties~~for ofthe ~~our~~nine ~~products.~~months Atended ~~June~~September 30, 2003, wewas ~~had~~ $176.02 million ~~of cash~~ ~~and~~compared ~~cash~~to ~~equivalent investments and~~ $~~81.~~1.8 million ~~of available-~~for~~-sale marketable~~ ~~securities~~the ~~(at~~nine ~~fair~~months ~~value)~~ended toSeptember 30, ~~fund~~2002, representing ~~future~~a ~~operations~~241% ~~and capital requirements~~increase. ~~Our~~The ~~available-for-sale~~increase ~~marketable securities include~~ primarily ~~U.S.~~ ~~government~~relates ~~bonds,~~to ~~diversified~~the ~~bond mutual funds and investment grade~~costs ~~corporate~~associated ~~notes.~~with ~~Our~~sales ~~portfolio~~ of ~~corporate notes is diversified and, under~~ our ~~policy,~~Eligard ~~we only invest in investment grade corporate notes~~7.5-mg Weone-month, ~~believe~~Eligard ~~the~~22.5-mg ~~quality~~three-month ofand ~~the~~Eligard ~~notes~~30-mg wefour-month ~~hold~~products and ~~the~~domestic ~~diversity of our portfolio significantly mitigates our credit~~ and ~~market risks; however from time to time we have~~European ~~experienced~~sales ~~investment losses as some~~ of ~~the issuers of our investment grade corporate notes have declared bankruptcy~~Atridox. We ~~believe~~expect that wecost ~~have~~of ~~adequate liquidity~~sales ~~and~~will ~~capital~~increase ~~resources~~in toline ~~fund~~with our ~~operations and capital requirements~~ ~~for~~expected ~~the~~revenue ~~foreseeable future~~growth. ~~However, we may have to raise additional funds to~~ ~~complete the development of our technologies as discussed below.~~

AtResearch ~~December~~and development expenses for the nine months ended September 3130, ~~2002~~2003 were we$26.7 million ~~had~~compared ~~available~~to $23.5 million for ~~federal~~the ~~income~~nine ~~tax~~months ~~purposes~~ended September 30, ~~net operating~~2002, ~~loss~~representing ~~carry-forwards~~a 14% increase. An increase of $927.43 million was related to Phase III clinical trials for our Atrisone acne product and an increase of $31.87 million was related to the development of our generic dermatology products. These increases were offset by a decrease in research ~~and~~ and development ~~tax~~expenses ~~credits~~of $1.9 million for Eligard development, ~~which~~$1.7 million for ~~expire~~other ~~through~~externally-funded ~~2022~~projects and $2.2 ~~Our~~for ~~ability~~internal toproject ~~utilize~~research. We cannot be certain whether our partner-funded research and development ~~purchased~~expenses ~~net~~will ~~operating~~increase ~~loss~~or ~~acquired~~decrease ~~with~~for the ~~acquisition~~foreseeable future as the timing of such ~~ViroTex,~~expenses being incurred may vary depending on the terms of the ~~alternative~~corresponding ~~minimum~~agreements. ~~tax~~However, ~~and~~we expect that research and development expenses ~~credit~~for ~~carry~~internally-~~forwards~~funded ~~is subject~~activities will decrease in 2003 due to anour current ~~annual~~focus ~~limitation~~on incompletion ~~future~~of ~~periods.~~Phase ~~This~~III isclinical ~~pursuant~~studies tofor ~~the~~our Atrisone acne ~~“change~~product inand ~~ownership”~~development ~~rules~~of ~~under~~generic ~~Section 382~~dermatology products. Following completion of ~~the~~these ~~Internal~~programs, ~~Revenue~~we ~~Code~~expect ofinternal product development expenses to increase ~~1986,~~again asin ~~amended~~the foreseeable future.

~~Future~~Administrative ~~Capital~~and ~~Requirements~~marketing expenses, excluding stock and stock option compensation, for the nine months ended September 30, 2003 were $7.9 million compared to $6.6 million for the nine months ended September 30, 2002, representing a 19% increase. The increase is primarily related to increased European sales and marketing efforts for Atridox of $1.6 million offset by decreases in general administrative support of $0.3 million, including personnel, public relations and legal costs. We expect that our administrative and marketing expenses will increase for the foreseeable future as we continue to grow.

~~Our~~Stock ~~long-term~~option ~~capital~~compensation ~~expenditure~~for ~~requirements~~the ~~will~~nine ~~depend~~months onended ~~numerous~~September 30, ~~factors~~2002 was $1.3 million, ~~including:~~which was recognized in connection with the retirement of an executive officer. We may, in the future, incur additional costs for stock compensation and performance-based compensation activities, however, we cannot predict if or when that may happen or what the cost may be.

• the progress of our research and development programs, • the time required to file and process regulatory approval applications, • the development of our commercial manufacturing facilities, • the potential for expenses related to the implementation of a specialty sales force, • our ability to obtain additional licensing arrangements, and • the demand for our products.

We expect to continue to incur substantial expenditures for research and development, testing, regulatory compliance, market development in European countries, possible repurchases of our common stock and for hiring additional management, scientific, manufacturing and administrative personnel. We will also continue to expend a significant amount of funds for our ongoing clinical studies. Depending on the results of our research and development activities, we may determine to accelerate or expand our efforts in one or more proposed areas and may, therefore, require additional funds earlier than previously anticipated. We believe our existing cash and cash equivalent assets in addition to our marketable securities will be sufficient to fund our operations for the foreseeable future. However, underlying assumed levels of revenue and expense may not prove to be accurate.


	Nine Months Ended September 30,

Other Income (Expense)	2003			2002			% Change

	(In thousands)
Equity in loss of joint venture	$	(83	)	$	(940	)		(91	)%
Investment income and expense, net		2,059			3,427			(40	)%
Gain (loss) on sale and write-down of marketable securities		567			(1,091	)		152	%
Debt conversion expense		—			(125	)		—
Other, net		(23	)		(32	)		(28	)%

	$	2,520		$	1,239			103	%

We recognized a loss of $0.1 million for the nine months ended September 30, 2003 compared to a loss of $0.9 million for the nine months ended September 30, 2002 for our 80.1% equity share in the loss of Transmucosal Technologies, Ltd., our joint venture with Elan. In September 2003, we terminated our joint venture with Elan and, therefore, will not recognize any future equity loss charges for Transmucosal Technologies, Ltd.

Investment income and expense, net for the nine months ended September 30, 2003 was $2.1 million compared to $3.4 million for the nine months ended September 30, 2002, representing a 40% decrease. The decrease was primarily the result of a decrease in our average cash, cash equivalents and available-for-sale marketable securities balances. Additionally, interest rates on investments in the nine months ended September 30, 2003 were lower compared to the nine months ended September 30, 2002. We expect investment income to decrease in 2003 as a result of expected lower interest rates and lower balances of cash and cash equivalents and marketable securities as compared to 2002 interest rates and balances.

Gain on sale of marketable securities for the nine months ended September 30, 2003 was $0.6 million compared to a loss and write-down of marketable securities of $1.1 million for the nine months ended September 30, 2002. The gain on sale of marketable securities for the nine months ended September 30, 2003 was primarily due to the sale of certain government securities, corporate notes, and corporate equities. The loss and write-down of marketable securities during the nine months ended September 30, 2002 was due to the sale of our $0.8 million principal amount of WorldCom, Inc. Senior Corporate Notes in May 2002 for proceeds of $0.4 million, which resulted in a loss on sale of marketable securities of $0.4 million. In June 2002, we incurred a $0.7 million charge for a write-down of our remaining position in WorldCom Senior Corporate Notes, principal value of $0.8 million, upon WorldCom’s bankruptcy filing in July 2002. We cannot be certain whether we will incur gains or losses on the sale of marketable securities or recognize charges for write-downs in the future.

During the nine months ended September 30, 2002 we exchanged 279,901 shares of our common stock for $5.2 million in outstanding principal amount of our 7% Convertible Subordinated Notes. Of the 279,901 shares issued, 273,984 shares were valued at the conversion price of $19.00 per share and the remaining 5,917 shares were valued at $21.09 per share, the closing market price of our common stock on the date of exchange. As a result of the conversions, we recognized a gain of $30,000, for the write-off of $80,000 of pro-rata unamortized deferred finance charges net of $0.1 million interest expense payable eliminated as a result of these exchanges. Additionally, of the 5,917 shares exchanged, a debt conversion expense of approximately $0.1 million was recognized for the nine months ended September 30, 2002. The 7% Convertible Subordinated Notes were fully extinguished in May 2002.

We recognized $0.7 million for accretion of dividends on our Series A Convertible Exchangeable Preferred Stock and $0.2 million for a beneficial conversion feature charge in July 2003 on the shares of preferred stock for the nine months ended September 30, 2003 compared to $0.7 million accretion of dividends for the nine months ended September 30, 2002.

Liquidity and Capital Resources

As of September 30, 2003, we had cash and cash equivalents of $23.6 million, available-for-sale marketable securities (at fair value) of $75.7 million, net accounts receivable of $8.8 million, inventories of $11.7 million and other current assets of $4.3 million for total current assets of $124.1 million. We had accounts payable of $2.9 million, short-term deferred revenue of $9.8 million and other current liabilities of $1.2 million for total current liabilities of $13.9 million, which resulted in working capital of $110.2 million.

During the nine months ended September 30, 2003, we used net cash in operating activities of $12.7 million. This was primarily the result of the net loss for the period of $2.8 million, adjusted for certain non-cash income and expenses, and changes in operating assets and liabilities as set forth in the consolidated statements of cash flows. We recognized a cash inflow from the receipt of milestone payments, licensing fees and certain contract research and development payments of $7.3 million, offset by amortization of deferred revenue of $7.5 million. Other significant uses of cash included: $3.2 million due to an increase in accounts receivable primarily related to Eligard product sales and royalty accruals, $3.6 million due to increasing inventory levels primarily related to the production of our Eligard products and inventory buildup related to our generic dermatology products and $5.0 million decrease in accounts payable primarily related to payments for inventory raw materials and components and plant expansion costs since December 31, 2002.

We used net cash in investing activities of $2.5 million during the nine months ended September 30, 2003. Cash used to fund investing activities included $7.5 million for capital expenditures primarily related to our plant expansion as discussed further under “Future Capital Requirements” below. Other uses of cash for various investing activities totaled $0.9 million. Net marketable securities activity resulted in a cash inflow of $5.9 million as a result of the maturity and sale of marketable securities of $32.6 million offset by $26.7 million to fund the purchases of various marketable securities. During the nine months ended September 30, 2003, various marketable securities were sold, matured or were called and the majority of proceeds were subsequently reinvested in high rated corporate notes, U.S. government securities, and diversified bond mutual funds.

Net cash provided by financing activities was $7.4 million during the nine months ended September 30, 2003. This was primarily the result of proceeds from issuance of equity securities of $10.3 million in conjunction with the exercise of incentive stock options. This was offset by the repurchase of $2.9 million of our common stock in the open market. In November 2002, our Board of Directors amended our stock repurchase program to provide that we may acquire up to a maximum of $20.0 million of our common stock in the open market or in privately negotiated transactions under this program. The program terminates on the earlier of the date that we have repurchased $20.0 million of our common stock or December 31, 2003. Since the inception of the program, we repurchased a total of 866,800 shares of our common stock in the open market for $13.6 million, or an average price per share of $15.71. For the nine months ended September 30, 2003, we repurchased 209,100 shares of our common stock in the open market for $2.9 million, or an average price per share of $13.75 under the program. As of September 30, 2003, $6.4 million remains available to repurchase our common stock under the program.

We have a revolving line of credit with a bank that expires in May 2004. Under the terms of the line of credit, we may borrow up to $1.0 million. Borrowings under the line bear interest at the prime rate and are subject to financial covenants requiring us to maintain certain levels of net worth and liquidity. Additionally, in July 2003, we established a $1.0 million line of credit with another bank. The second line of credit expires in June 2004. Borrowings under the second line of credit bear interest at the prime rate plus 1/2%. As of September 30, 2003, there was no obligation outstanding under either of these lines of credit.

We have historically funded our operations through debt and equity offerings, payments received for licenses, milestones, research and development support under contractual arrangements and product sales and royalties. We anticipate future funding of our operations to be achieved through continued licensing fees, milestone payments and net sales and royalties of our products. At September 30, 2003, we had $23.6 million of cash and cash equivalent investments and $75.7 million of available-for-sale marketable securities (at fair value) to fund future operations and capital requirements. Our available-for-sale marketable securities include primarily U.S. government bonds, diversified bond mutual funds and investment grade corporate obligations. Our portfolio of corporate debt is diversified and, under our policy, we initially invest only in investment grade corporate obligations. We believe the quality of the notes we hold and the diversity of our portfolio mitigates our credit and market risks; however, from time to time we have experienced investment losses as some of the issuers of our investment grade corporate notes have declared bankruptcy.

We believe that we have adequate liquidity and capital resources to fund our operations and capital requirements for the foreseeable future. However, we may have to raise additional funds to complete the development of our technologies as discussed below. In the normal course of business, we may investigate, evaluate, and discuss acquisitions, joint ventures, strategic alliance relationships and other business combination opportunities. In the event of any future acquisition or joint venture opportunities, we may consider using then-available cash or cash equivalents or issuing equity or other securities.

At December 31, 2002 we had available for federal income tax purposes, net operating loss carry-forwards of $92.4 million and $3.8 million in research and development tax credits, which expire through 2022. Our ability to utilize our net operating loss acquired with the acquisition of ViroTex Corporation, alternative minimum tax, and research and development credit carry-forwards is subject to an annual limitation in future periods. This limitation is pursuant to the “change in ownership” rules under Section 382 of the Internal Revenue Code of 1986, as amended.

Future Capital Requirements

Our long-term capital expenditure requirements will depend on numerous factors, including:

•

the number of products in our pipeline,

•

the progress of our research and development programs,

•

the time required to file and process regulatory approval applications,

•

the development of our commercial manufacturing facilities,

•

the potential for expenses related to the implementation of a specialty sales force,

•

our ability to obtain additional licensing arrangements, and

•

the demand for our products.

We expect to continue to incur substantial expenditures for research and development, testing, regulatory compliance, possible repurchases of our common stock and for hiring additional management, scientific, manufacturing and administrative personnel. We will also continue to expend a significant amount of funds for ongoing clinical studies. Depending on the results of our research and development activities, we may determine to accelerate or expand our efforts in one or more proposed areas and may, therefore, require additional funds earlier than previously anticipated. We believe our existing cash and cash equivalent assets in addition to our marketable securities will be sufficient to fund our operations for the foreseeable future. However, our underlying assumed levels of revenue and expense may not prove to be accurate.

Research and development

The following table summarizes research and development activities funded (in whole or in part) by our collaborators, as well as research and development activities funded solely by us, for the years ended December 31, 2002, 2001 and 2000 and the ~~six~~nine months ended ~~June~~September 30, 2003, including research and development costs inception-to-date and estimated completion dates and costs (in thousands):

								Expenses								Anticipated
																Anticipated
								2003				Total		Anticipated		Costs to
												Total		Anticipated		Costs to
		Expenses		Expenses		Expenses		Expenses		Expenses		Funding		Completion		Completion
Technology		2000		2001		2002		~~(as of June 30)~~2003*		Inception-to-Date		Inception-to-Date		(to market)		(to market)
Atrigel		$	10,845	$	13,727	$	13,011	$	57,~~637~~324	$	~~116~~115,~~158~~345	$	1113,~~917~~404	2004—2009	~~2003-2009~~	$	5035,000
SMP			3,090		4,604		6,547		711,~~532~~096		2427,~~100~~664		1013,~~989~~817		2005		2015,000
BEMA			259		2,397		2,~~582~~252		~~270~~281		6,~~061~~072		1,~~035~~029	On hold	~~2006-2007~~		~~10,000~~—
Other			2,541		4,907		10,~~599~~929		48,~~530~~006		3841,~~098~~089		1213,~~243~~702	2003—2007	~~2003-2007~~		5055,000
	Total	$	16,735	$	25,635	$	32,739	$	1726,~~969~~707	$	~~184~~190,~~417~~170	$	3641,~~184~~952	2003—2009	~~2003-2009~~	$	~~130~~105,000
Funded		$	1,921	$	10,626	$	18,721	$	13,624
Funded, in whole or in part		$	1,921	$	10,626	$	18,721		21,944
Not Funded			14,814		15,009		14,018		4,345
Not funded			14,814		15,009		14,018		4,763
	Total	$	16,735	$	25,635	$	32,739	$	1726,~~969~~707

~~The~~*Nine ~~predominate~~months ~~product lines included under the Atrigel technology are the Eligard products and the dental products which comprised 31% and 58%~~ended, ~~respectively,~~ ~~of the expenses from inception-to-date. Recently~~September 30, ~~the Eligard products comprised more of the research and development effort with 68%, 64%, 59% and 60% of the 2000, 2001, 2002 and year-to-date~~ 2003 ~~Atrigel expenses,~~ ~~respectively. As our dental products have moved into the market, research and~~ ~~development expenses have stabilized and comprised 25%, 10%, 7% and 3% of the~~ 2000, 2001, 2002 and year-to-date 2003 Atrigel expenses, respectively. Of the expenses funded by third parties, 13% of funds received were to support the dental products, 52% of funds were to support the Eligard products, and 35% of funds have come from direct support of research contracts with various companies.

The predominate product lines included under the Atrigel technology are the Eligard products and the dental products which comprised 32% and 57%, respectively, of the expenses from inception-to-date. Recently, the

Eligard products comprised more of the research and development effort with 68%, 64%, 59% and 59% of the 2000, 2001, 2002 and year-to-date 2003 Atrigel expenses, respectively. As our dental products have moved into the market, research and development expenses have stabilized and comprised 25%, 10%, 7% and 4% of the 2000, 2001, 2002 and year-to-date 2003 Atrigel expenses, respectively. Of the expenses funded by third parties, 13% of funds received were to support the dental products, 55% of funds were to support the Eligard products, and 32% of funds have come from direct support of research contracts with various companies.

The Atrisone acne product represents 100% of expenses and funding under the SMP technology.

Under the BEMA technology, 49% of expenses from inception-to-date relate to the development of two products through our joint venture with Elan, which joint venture has been terminated. One hundred percent of the funding for BEMA research and development has come from the joint venture.

Other research and development expenses from inception-to-date represent efforts to introduce additional products into our product pipeline. Expenses related to develop generic dermatology products are also included in this category and represent 3740% of expenses inception-to-date and 5054% of the funding.

Plant expansion

In April 2002, we announced our plans to expand our manufacturing and laboratory facilities to support current and future projects. The ~~current~~original 26,000 square foot facility iswas ~~being~~ expanded to 58,000 square feet. In the expanded facility we intend to manufacture the full line of our Eligard products, Atrisone topical dermatological product, generic dermatology products, dental products and clinical supplies for products currently in development. Approximately 40% of the building’s expansion ~~will~~is be devoted to manufacturing with the remainder ~~allotted~~allocated for warehousing, quality assurance and laboratory work. Construction began in the second quarter of 2002 and was completed during the second quarter of 2003. Anand ~~extensive~~ validation of the plant and equipment iswas ~~required, which is anticipated to be~~ completed byduring the third quarter of 2003 ~~at an estimated cost of $0~~.~~2 million.~~ As of ~~June~~September 30, 2003, approximately $9.56 million has been spent on construction costs and $3.06 million has been spent on equipment.

Recent Accounting Pronouncements

In April 2002, SFAS No. 145 (~~FAS~~SFAS 145), “Rescission of FASB Statements No. 4, 44, and 64, Amendment of FASB Statement No. 13, and Technical Corrections” ~~was~~ was issued by the Financial Accounting Standards Board (FASB). FAS 145 ~~rescinds~~ rescinds FASB Statement No. 4, “Reporting Gains and Losses from Extinguishment of Debt,” and an amendment of that Statement, FASB Statement No. 64, “Extinguishments of Debt Made to Satisfy Sinking-Fund Requirements.” This Statement also rescinds FASB Statement No. 44, “Accounting for Intangible Assets of Motor Carriers.” This Statement amends FASB Statement No. 13, “Accounting for Leases,” to eliminate an inconsistency between the required accounting for sale-leaseback transactions and the required accounting for certain lease modifications that have economic effects that are similar to sale-leaseback transactions. This Statement also amends other existing authoritative pronouncements to make various technical corrections, clarify meanings, or describe their applicability under changed conditions. We adopted FAS 145 in the first quarter of 2003 and, as a result, our comparative financial statements were restated to reclassify the extraordinary loss on extinguishment of debt to be included in loss from operations.

18In May 2003, the FASB issued SFAS No. 150, “Accounting for Certain Financial Instruments with Characteristics of both Liabilities and Equity” (SFAS 150). SFAS 150 establishes standards for how an issuer classifies and measures certain financial instruments with characteristics of both liabilities and equity. It generally requires that an issuer classify a financial instrument that is within its scope as a liability (or an asset in some circumstances), many of which were previously classified as equity. The provisions of SFAS 150 are effective for financial instruments entered into or modified after May 31, 2003 and, with one exception, is effective at the beginning of the first interim period beginning after June 15, 2003. The adoption of SFAS 150 did not have a material effect on our consolidated financial statements.

In November 2002, the FASB issued Interpretation No. 45 (FIN 45), “Guarantor’s Accounting and Disclosure Requirements for Guarantees, Including Indirect Guarantees of Indebtedness of Others.” FIN 45 requires that a liability be recorded in the guarantor’s balance sheet upon issuance of a guarantee. FIN 45 also requires additional disclosures about the guarantees an entity has issued, including a roll-forward of the entity’s product warranty liabilities. We will apply the recognition provisions of FIN 45 prospectively to guarantees issued or modified after

~~and an amendment of that Statement, FASB Statement No.~~December 6431, ~~“Extinguishments~~ ~~of Debt Made to Satisfy Sinking-Fund Requirements~~2002.” ~~This Statement~~The ~~also~~disclosure ~~rescinds~~requirements ~~FASB~~were ~~Statement~~effective ~~No. 44, “Accounting~~ for ~~Intangible Assets~~our ~~of Motor Carriers.” This Statement amends FASB Statement No. 13,~~financial ~~“Accounting~~statements for ~~Leases,” to eliminate an inconsistency between~~ the ~~required accounting~~year ~~for~~ended sale-leaseback transactions and the required accounting for certain lease modifications that have economic effects that are similar to sale-leaseback transactions. This Statement also amends other existing authoritative pronouncements to make various technical correctionsDecember 31, ~~clarify meanings, or describe their applicability under changed conditions~~2002. WeThe ~~adopted FAS~~adoption ~~145 in the first quarter~~ of ~~2003~~FIN ~~and,~~45 ~~as a result, our comparative~~did ~~financial~~not ~~statements~~have ~~were~~an ~~restated~~impact ~~to reclassify the extraordinary loss~~ on ~~extinguishment~~ ofour ~~debt~~consolidated tofinancial ~~be included in loss from operations~~statements.

In ~~December 2002~~January 2003, the FASB issued ~~SFAS~~Financial Interpretation No. ~~148,~~46 ~~“Accounting~~(FIN ~~for~~46), ~~Stock-Based Compensation—Transition and Disclosure~~",Consolidation ~~an amendment~~ of ~~SFAS~~Variable NoInterest Entities. ~~123.~~” ~~The~~FIN ~~statement~~46 provides ~~alternative~~guidance ~~methods~~on ofhow to ~~transition~~identify ~~for~~ a ~~voluntary change~~variable tointerest ~~the~~entity ~~fair~~(VIE) and ~~value~~determine ~~method~~when ofthe ~~accounting~~assets, liabilities, ~~for~~and ~~stock-based~~results ~~employee compensation.~~of Inoperations ~~addition,~~of ~~the~~a ~~statement~~VIE ~~requires~~need ~~companies~~ to ~~disclose~~be included in a ~~both~~company’s ~~annual~~consolidated ~~and interim~~ financial statements. ~~the~~FIN ~~method~~46 ofalso ~~accounting~~requires ~~for~~additional ~~stock-based~~disclosures ~~compensation~~by ~~and~~primary ~~the~~beneficiaries ~~effect~~and ofother ~~the~~significant ~~method~~variable ~~used~~interest holders onin ~~reported~~a ~~results~~VIE. The ~~statement~~provisions isof ~~effective~~FIN ~~for~~46 ~~annual~~are ~~periods~~effective ~~ending~~immediately ~~after~~for ~~December 15, 2002~~all ~~and~~VIEs ~~interim~~created ~~periods~~or ~~beginning~~acquired after ~~December~~January 1531, ~~2002~~2003. WeFor doVIEs ~~not~~created ~~believe~~or ~~that~~acquired ~~the~~prior ~~statement~~to ~~will~~February 1, ~~have~~2003, ~~a material impact on our consolidated financial statements. We have adopted~~ the ~~disclosure~~ provisions of ~~SFAS~~FIN ~~No. 148, however,~~46 wemust ~~have~~be ~~not~~ adopted ~~the~~at ~~fair value method, and expects to continue to~~the ~~recognize~~beginning ~~compensation~~of ~~cost~~the infirst ~~accordance~~interim ~~with~~or ~~the~~annual ~~guidance~~reporting inperiod ~~APB~~beginning ~~No. 25~~after ~~unless~~December 15, ~~future accounting rules dictate a change in method~~2003. IfWe wedo ~~were~~not tohave ~~adopt the~~VIES ~~fair~~and, ~~value~~as ~~method~~such, wethe ~~believe~~adoption ~~that~~of ~~there~~FIN ~~would~~46 bedid not have a material ~~impact~~effect on our consolidated ~~results~~financial ~~of operations~~statements.

In ~~May 2003~~November 2002, the FASB issued ~~SFAS~~Emerging Issues Task Force Issue No. ~~150~~00-21 (EITF 00-21), “Accounting for ~~Certain~~Revenue ~~Financial Instruments~~Arrangements with ~~Characteristics~~Multiple ofDeliverables.” EITF ~~both~~00-21 ~~Liabilities~~addresses ~~and~~how ~~Equity”~~to ~~(SFAS~~determine ~~150). SFAS~~whether ~~150~~a ~~establishes~~revenue ~~standards~~arrangement ~~for~~involving multiple ~~how~~deliverables ancontains ~~issuer~~more ~~classifies~~than ~~and~~one ~~measures certain~~unit ~~financial~~of ~~instruments~~accounting ~~with~~for ~~characteristics~~the purposes of ~~both~~revenue ~~liabilities~~recognition and how the revenue arrangement consideration ~~equity.~~should Itbe ~~requires~~measured ~~that~~to anthe ~~issuer~~separate ~~classify~~units aof ~~financial~~accounting. ~~instrument~~EITF ~~that~~00-21 isprovides ~~within~~guidance ~~its~~with ~~scope~~respect asto athe ~~liability~~effect ~~(or~~of ancertain ~~asset~~customer inrights ~~some~~due ~~circumstances),~~to ~~many of~~company ~~which~~nonperformance ~~were~~on ~~previously~~the ~~classified~~recognition asof ~~equity.~~revenue ~~The~~allocated ~~provisions~~to delivered units of accounting. ~~SFAS~~EITF ~~150~~00-21 ~~are effective~~also ~~for~~addresses ~~financial~~the ~~instruments~~impact ~~entered~~on ~~into~~the measurement and/or allocation ~~modified~~of ~~after~~arrangement ~~May 31,~~consideration ~~2003~~ of customer cancellation provisions and consideration ~~with~~that ~~one~~varies ~~exception,~~as isa ~~effective~~result atof ~~the~~future ~~beginning~~actions of the ~~first~~customer ~~interim~~or us. ~~period~~Finally, ~~beginning~~EITF ~~after~~00-21 ~~June 15,~~provides ~~2003.~~guidance ~~The~~with ~~adoption~~respect to the recognition of ~~SFAS~~the cost ~~150~~of iscertain ~~not~~deliverables ~~expected~~that are excluded from the revenue accounting toarrangement. ~~have~~EITF a00-21 ~~material~~applies ~~effect~~to onrevenue ~~the~~arrangements ~~Company’s~~that ~~consolidated~~we ~~financial~~enter ~~statements~~into after June 15, 2003.

In January 2003, the FASB issued Financial Interpretation No. 46 (FIN 46), “Consolidation of Variable Interest Entities.” FIN 46 provides guidance on how to identify a variable interest entity (VIE) and determine when the assets, liabilities, and results of operations of a VIE need to be included in a company’s consolidated financial statements. FIN 46 also requires additional disclosures by primary beneficiaries and other significant variable interest holders in a VIE. The provisions of FIN 46 are effective immediately for all VIEs created after January 31, 2003. For VIEs created before February 1, 2003, the provisions of FIN 46 must be adopted at the beginning of the first interim or annual reporting period beginning after June 15, 2003. We do not have any VIEs and do not expect the adoption of FIN 46 to have a material effect on our consolidated financial position or results of operations.

In November 2002, the FASB issued Emerging Issues Task Force (EITF) Issue No. 00-21, “Accounting for Revenue Arrangements with Multiple Deliverables.” EITF 00-21 addresses how to determine whether a revenue arrangement involving multiple deliverables contains more than one unit of accounting for the purposes of revenue recognition and how the revenue arrangement consideration should be measured to the separate units of accounting. EITF 00-21 provides guidance with respect to the effect of certain customer rights due to company nonperformance on the recognition of revenue allocated to delivered units of accounting. EITF 00-21 also addresses the impact on the measurement and/or allocation of arrangement consideration of customer cancellation provisions and consideration that varies as a result of future actions of the customer or us. Finally, EITF 00-21 provides guidance with respect to the recognition of the cost of certain deliverables that are excluded from the revenue accounting arrangement. EITF 00-21 applies to revenue arrangements that we enter into after June 15, 2003. We have not yet determined the impact, if any, that EITF 00-21 will have on our consolidated financial position and results of operations.

Critical Accounting Policies

Our critical accounting policies are described in Note 1 to the ~~Consolidated~~ Consolidated Financial Statements included in our Annual Report on Form 10-K for the year ended December 31, 2002. The accounting policies used in preparing our interim consolidated financial statements for the ~~six~~nine months ended ~~June~~September 30, 2003 are the same as those described in our Annual Report on Form 10-K.

Our critical accounting policies are those having the most impact to the reporting of our financial condition and results and those requiring significant judgments and estimates. Our critical accounting policies, ~~which are included in Note 1 of the notes to the accompanying financial statements,~~ include those related to (1) principles of consolidation, (2) revenue recognition and (3) research and development. With respect to these critical ~~accounting~~ accounting policies, our management believes that the application of judgments ~~and~~ and assessments is consistently applied and produces financial information, ~~which~~ which fairly depicts the results of operations for all periods presented.

Factors Affecting Our Business and Prospects

There are many factors that affect our business and the results of our operations, some of which are beyond our control. These factors include:

• Our history of operating losses and the ~~likelihood~~possibility of future losses. • Delay, difficulty, or failure in obtaining regulatory approval or clearance to market additional products, including delays or difficulties in development because of insufficient proof of safety or efficacy. • Failure of corporate partners to develop or commercialize successfully our products or to retain and expand markets served by the commercial collaborations; conflicts of interest, priorities, and commercial strategies that may arise between such corporate partners and us. • If we are unable to satisfy governmental regulations relating to the development of our product candidates, we may be unable to obtain or maintain necessary regulatory approvals to commercialize our products. • Our limited experience in the sale and marketing of our products. • Competitive or market factors that may limit the use or broad acceptance of our products. • Cancellation or termination of material collaborative agreements and the resulting loss of research or other funding, or marketing, sales and distribution capabilities. • Exchange rate fluctuations that may adversely impact net income (loss). • The ability to obtain, maintain and protect intellectual property rights, and the cost of acquiring in-process technology and other intellectual property rights, either by license, collaboration or purchase of another entity. • Limited experience in manufacturing products on a commercial scale, failure to manufacture present and future products in compliance with applicable regulations and at an acceptable cost. • Dependence on one contract manufacturer involved in the production of our Eligard products. • Product liability or other claims against us, which may result in substantial damages or reduce demand for our products. • Our insurance policies are expensive and protect us only from some business risks, which may leave us exposed to significant, uninsured liabilities.

20 • Delay, difficulty, or failure in obtaining regulatory approval or clearance to market additional products, including delays or difficulties in development because of insufficient proof of safety or efficacy.

•

Failure of corporate partners to develop or commercialize successfully our products or to retain and expand markets served by the commercial collaborations; conflicts of interest, priorities, and commercial strategies that may arise between such corporate partners and us.

•

Inability to satisfy governmental regulations relating to the development of our product candidates may prevent us from obtaining or maintaining necessary regulatory approvals to commercialize our products.

•

Limited experience in the sale and marketing of our products.

•

Competitive or market factors that may limit the use or broad acceptance of our products.

• ~~Our~~Cancellation ~~operations~~or ~~involve~~termination ~~hazardous~~of ~~materials,~~material ~~which~~collaborative ~~could~~agreements ~~subject~~and usthe toresulting ~~significant~~loss ~~liability.~~of •research ~~The~~or ~~ability~~other tofunding, ~~attract~~or ~~and retain highly qualified management~~marketing, ~~administrative~~sales and ~~scientific~~distribution ~~personnel~~capabilities. ~~• Our failure to manage our rapid growth could harm our business.~~

•

Exchange rate fluctuations that may adversely impact net income (loss).

•

Our ability to obtain, maintain and protect intellectual property rights, and the cost of acquiring in-process technology and other intellectual property rights, either by license, collaboration or purchase of another entity.

•

Limited experience in manufacturing products on a commercial scale, failure to manufacture present and future products in compliance with applicable regulations and at an acceptable cost.

•

Dependence on one contract manufacturer involved in the production of our Eligard products.

•

Product liability or other claims against us, which may result in substantial damages or reduce demand for our products.

•

Our insurance policies are expensive and protect us only from some business risks, which may leave us exposed to significant, uninsured liabilities.

•

Our operations involve hazardous materials, which could subject us to significant liability.

•

Our ability to attract and retain highly qualified management, administrative and scientific personnel with pharmaceutical experience.

•

Failure to manage our rapid growth could harm our business.

For a discussion of these and other factors affecting our business and prospects, see “Item 1.—Business—Factors Affecting our Business and Prospects” in our Annual Report on Form 10-K for the year ended December 31, 2002.

Item 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ~~CONCERNING~~ABOUT MARKET ~~RISKS~~RISK.

WeFor ~~own~~a ~~financial~~discussion ~~instruments~~of ~~that~~the ~~are~~Company’s ~~sensitive to~~ market risks, asrefer ~~part~~to ofthe Item 7A, ~~our~~“Quantitative ~~investment~~and ~~portfolio~~Qualitative ofDisclosures ~~cash~~About ~~equivalents~~Market ~~and~~Risk,” ~~marketable~~in ~~securities.~~the ~~The~~Company’s ~~investment~~2002 ~~portfolio~~Annual isReport. ~~used~~There tohave ~~preserve~~been ~~our~~no ~~capital~~material ~~until~~changes ~~it is required~~ to ~~fund~~ ~~operations,~~the ~~including our research and development activities. None of~~information ~~these~~provided ~~market-risk~~that ~~sensitive~~would ~~instruments~~require ~~are~~additional ~~held~~information ~~for~~with ~~trading~~respect ~~purposes~~to ~~and~~the ~~we do~~nine ~~not~~months ~~own~~ended ~~derivative~~September 30, ~~financial instruments~~2003.

Interest Rate Risk. Our investment portfolio includes fixed rate debt instruments that are primarily United States government and agency bonds and corporate notes with maturity dates ranging from one to fifteen years. To mitigate the impact of fluctuations in cash flow, we maintain the majority of our debt instruments as fixed rate. The market value of these bonds is subject to interest rate risk and could decline in value if interest rates increase. The portion maintained as fixed rate is dependent on many factors including judgments as to future trends in interest rates.

Our investment portfolio also includes mutual funds that invest in United States government and agency bonds, corporate bonds, mortgage-backed and asset-backed securities, and possibly foreign securities. The value of these mutual fund investments is also subject to interest rate risk, as well as maturity risks on mortgage-backed securities and possibly foreign market risks.

We regularly assess the above described market risks and have established policies and business practices to protect against the adverse effects of these and other potential exposures. Our investment policy restricts investments to U.S. government or government-backed securities or to high-rated commercial paper and other high-rated investments only. As a result, we do not anticipate any material credit losses in these investments, however, losses may still occur due to market, political and economic conditions.

For disclosure purposes, we use sensitivity analysis to determine the impacts that market risk exposures may have on the fair values of our debt and financial instruments. The financial instruments included in the sensitivity analysis consist of all of our cash and cash equivalents and short-term and long-term debt instruments.

To perform a sensitivity analysis, we assess the fair values loss risk from the impact of hypothetical interest rate changes on market sensitive instruments. The fair values are computed based on the present value of future cash flows as impacted by the changes in the rates attributable to the market risk being measured. The discount rates used for the present value computations were selected based on market interest rates in effect at June 30, 2003. The fair values that result from these computations are compared with the fair values of these financial instruments at June 30, 2003. The differences in this comparison are the hypothetical gains or losses associated with each type of risk. The results of the sensitivity analysis at June 30, 2003 are as follows:

Interest Rate Sensitivity: A 10% decrease in the levels of interest rates with all other variables held constant would result in an increase in the fair value of our financial instruments by approximately $0.3 million per year. A 10% increase in the levels of interest rates with all other variables held constant would result in a decrease in the fair value of our financial instruments by approximately $0.3 million per year. We maintain a portion of our financial instruments, including long-term debt instruments of approximately $33.2 million at June 30, 2003, at variable interest rates. If interest rates were to increase or decrease 10%, the impact of such instruments on cash flows or earnings would not be material.

The use of a 10% estimate is strictly for estimation and evaluation purposes only. The value of our assets may rise or fall by a greater amount depending on actual general market performances and the value of individual securities we own.

Exchange Rate Risk. We face foreign exchange rate fluctuations, primarily with respect to the British Pound and the Euro, as the financial results of our foreign subsidiaries are translated into United States dollars for consolidation. As exchange rates vary, these results when translated may vary from expectations and adversely impact net income (loss) and overall profitability. The effect of foreign exchange rate fluctuation for the period ended June 30, 2003 was not material. Based on our overall foreign currency rate exposure at June 30, 2003, we do not believe that a hypothetical 10% change in foreign currency rates would materially affect our financial position.

Item 4. CONTROLS AND PROCEDURES.

As of ~~June~~September 30, 2003, we carried out an evaluation, under the supervision and with the participation of our Chief Executive Officer and our Interim Chief Financial Officer, of the effectiveness of the design and operation of our disclosure controls and procedures. Our disclosure controls and procedures are designed ~~with~~to ~~the~~ensure ~~objective of ensuring~~ that information required to be disclosed in our reports filed under the Securities Exchange Act of 1934 is recorded, processed, summarized, and reported within the time periods specified in the ~~Security and Exchange Commission~~SEC’s ~~(SEC)~~ rules and forms. Based on this evaluation, our Chief Executive Officer and our Interim Chief Financial Officer concluded that our disclosure controls and procedures are effective in timely alerting them to material information required to be included in our periodic SEC ~~reports~~filings. InThere ~~addition,~~has ~~our~~been ~~Chief~~no ~~Executive~~change in ~~Officer~~our ~~and~~internal ~~our~~control ~~Chief~~over ~~Financial Officer~~financial ~~concluded~~reporting that occurred during the quarter ended ~~June~~September 30, 2003, ~~there~~that has ~~been~~materially affected, or is reasonably nolikely ~~change~~to inmaterially affect, our internal ~~controls~~control over financial reporting. Our ~~that~~internal ~~has~~control ~~materially affected,~~over orfinancial reporting is ~~reasonably~~designed ~~likely~~ to ~~materially~~provide ~~affect,~~reasonable assurance regarding the reliability of our ~~internal~~financial ~~controls~~reporting and preparation ~~over~~of financial ~~reporting~~statements for external purposes in accordance with generally accepted accounting principles.

It should be noted that the design of any system of controls is based in part upon certain assumptions about the likelihood of future events, and there can be no assurance that any design will succeed in achieving its stated goals under all potential future conditions, regardless of how remote.

~~Item 5. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS.~~23

Our Annual Meeting of Stockholders was held on April 27, 2003. At the meeting the stockholders voted on the re-election of Dr. D. Walter Cohen, Sander A. Flaum and Peter J. Schied as Class A directors, the amendment and restatement of our 2000 Stock Incentive Plan and the ratification of the appointment of Deloitte & Touche LLP as our independent auditors for the fiscal year ending December 31, 2003. The results of the voting are as follows:

1. Election of Class A Directors:

	For		Withheld
Dr. D. Walter Cohen		16,494,148		134,355
Sander A. Flaum		16,494,143		134,360
Peter J. Schied		16,493,970		134,533

The other directors whose terms continue after the meeting are David R. Bethune, Dr. Nicolas Bazan, H. Stuart Campbell, C. Rodney O’Connor and Dr. George J. Vuturo.

2. Amendment and Restatement of the 2000 Stock Incentive Plan:

		For				Against				Abstain
			8,610,443				1,651,214				25,044

3. Ratification of Appointment of Independent Auditors:

		For				Against				Abstain
			16,200,810				402,225				25,468

PART II. OTHER INFORMATION

Item 1. LEGAL PROCEEDINGS

Item 6. EXHIBITS AND REPORTS ON FORM 8-K.

(a) Exhibits.

(b) Reports on Form 8-K. ~~None~~We filed or furnished the following Current Reports on Form 8-K during the quarter ended September 30, 2003. The information provided under Item 12. Results of Operations and Financial Condition is not deemed to be “filed” for purposes of Section 18 of the Securities Exchange Act of 1934.:

23 • Current Report on Form 8-K dated July 30, 2003, furnished to the Securities and Exchange Commission on July 30, 2003, under Item 12. Results of Operations and Financial Condition.

•

Current Report on Form 8-K dated September 22, 2003, filed with the Securities and Exchange Commission on September 23, 2003, under Item 5. Other Events and Item 7. Exhibits

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.

	ATRIX LABORATORIES, INC
		ATRIX LABORATORIES, INC. (Registrant)
	(Registrant)
November 18, 2003	By:	/s/ David R. Bethune David R. Bethune Chairman of the Board and Chief Executive Officer (Principal Executive Officer)
August 1, 2003	By:	/s/ David R. Bethune
November 18, 2003	By:	/s/ Brian G. Richmond Brian G. Richmond Interim Chief Financial Officer (Principal Financial and Accounting Officer)
		David R. Bethune
		Chairman of the Board and
		Chief Executive Officer
		(Principal Executive Officer)
August 1, 2003	By:	/s/ Brian G. Richmond
		Brian G. Richmond
		Chief Financial Officer, Secretary and Treasurer
		(Principal Financial and Chief Accounting Officer)

2425

EXHIBIT INDEX

Exhibit No.		Description
10.1		Termination Agreement, dated as of September 10, 2003, by and among the Company, Elan Pharma International Limited, Elan International Services, Ltd. and Transmucosal Technologies, Ltd.
31.1		Rule 13a-14(a) Certification of Chief Executive Officer
31.2		Rule 13a-14(a) Certification of Interim Chief Financial Officer
32.1		Section 1350 Certification of Chief Executive Officer
32.2		Section 1350 Certification of Interim Chief Financial Officer

Exhibit No.

Description

Termination Agreement, dated as of September 10, 2003, by and among the Company, Elan Pharma International Limited, Elan International Services, Ltd. and Transmucosal Technologies, Ltd.

Rule 13a-14(a) Certification of Chief Executive Officer

Rule 13a-14(a) Certification of Interim Chief Financial Officer

Section 1350 Certification of Chief Executive Officer

Section 1350 Certification of Interim Chief Financial Officer

Filing Compare · ATRIX LABORATORIES INC