UNITED
STATES


SECURITIES
AND EXCHANGE COMMISSION


WASHINGTON,
D.C. 20549







FORM 10-K


(MARK
ONE)




ý
            Annual
      Report Pursuant to Section 13 or 15(d) of the Securities
      Exchange Act of 1934


For
the Fiscal Year Ended December 31, 2007


Or


o
            Transition
      Report Pursuant to Section 13 or 15(d) of the Securities
      Exchange Act of 1934




For
the Transition Period
From               To


COMMISSION
FILE NUMBER 33-90516





NEOPHARM, INC.


(Exact
Name of Registrant as Specified in its Charter)


DELAWARE
            51-0327886(State
      or other jurisdiction of
              incorporation
      or organization)
            (I.R.S.
      Employer
              Identification
      Number)


1850
LAKESIDE DRIVE


WAUKEGAN,
ILLINOIS  60085




(Address
of Principal Executive Offices) (Zip Code)




(847) 887-0800




(Registrant’s
Telephone Number, Including Area Code)




SECURITIES
REGISTERED PURSUANT TO SECTION 12(b) OF THE ACT:NONE




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




COMMON
STOCK, $.0002145 PAR VALUE




PREFERRED
STOCK PURCHASE RIGHTS




(Title of
each class)









Indicate
by check mark if the registrant is a well-known seasoned issuer, as defined in
Rule 405 of the Securities Act.


Yes  ̈  No ý




Indicate
by check mark if the registrant is not required to file reports pursuant to
Section 13 or Section 15(d) of the Act.


Yes o  No  ý




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  No o






Indicate
by check mark if disclosure of delinquent filers pursuant to Item 405 of
Regulation S-K is not contained herein, and will not be contained, to the
best of registrant’s knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any
amendment to this Form 10-K. o






Indicate
by check mark whether registrant is a large accelerated filer, an accelerated
filer, a non-accelerated filer or a smaller reporting company .  See
the definitions of “accelerated filer,” “large accelerated filer,” and “smaller
reporting company” in Rule 12b-2 of the Exchange Act. (Check one):






Large
      accelerated filer o
              Accelerated
      filer o
              Non-accelerated
      filer oSmaller
      reporting company  ý






Indicate
by check mark whether the registrant is a shell company (as defined in Rule
12b-2 of the Exchange Act).


Yes o  No  ý






The
aggregate market value of the registrant’s common stock held by non-affiliates
(affiliates being, for these purposes only, directors, executive officers and
holders of 10% of the registrant’s stock) of the registrant, par value $.0002145
per share, (based on the closing price of such shares on the NASDAQ on
June 30, 2007) was $25,965,000. As of February 29, 2008 there were
28,488,550 shares of common stock outstanding.
























Documents
Incorporated by Reference




Certain
information required in Part III of the registrant’s Annual Report on Form 10-K
for December 31, 2007 is incorporated by reference to portions of the
registrant’s definitive proxy statement for its 2008 Annual Meeting of
Stockholders, required to be filed with the Securities and Exchange Commission
not later than 120 days after the end of the fiscal year ended
December 31, 2007.














































FORM 10-K
TABLE OF CONTENTS




PagePART IItem 1.
            
            Business
            
            
            4Item 1A.
            
            Risk Factors
            
            
            17Item 1B.
            
            Unresolved Staff Comments
            
            
            32Item 2.
            
            Properties
            
            
            32Item 3.
            
            Legal Proceedings
            
            
            32Item 4.
            
            Submission of Matters to a Vote of Security
      Holders
            
            
            33PART IIItem 5.
            
            Market for the Registrant’s Common Equity, Related
      Stockholder Matters, and Issuer Purchases of Equity
      Securities
            
            
            34Item 6.
            
            Selected Financial Data
            
            
            36Item 7.
            
            Management’s Discussion and Analysis of Financial Condition
      and Results of Operation
            
            
            36Item 7A.
            
            Quantitative and Qualitative Disclosures About Market
      Risk
            
            
            44Item 8.
            
            Financial Statements and Supplementary
    Data
            
            
            44Item 9.
            
            Changes in and Disagreements with Accountants on Accounting
      and Financial Disclosure
            
            
            44Item 9A(T).
            
            Controls and Procedures
            
            
            44Item 9B.
            
            Other Information
            
            
            46PART IIIItem 10.
            
            Directors, Executive Officers and Corporate
      Governance
            
            
            46Item 11.
            
            Executive Compensation
            
            
            46Item 12.
            
            Security Ownership of Certain Beneficial Owners and
      Management and Related Stockholder Matters
            
            
            46Item 13.
            
            Certain Relationships and Related
      Transactions
            
            
            47Item 14.
            
            Principal Accounting Fees and Services
            
            
            47PART IVItem 15.
            
            Exhibits, Financial Statement Schedules
            
            
            47Signatures
            
            
            51













PART I




ITEM 1.
            BUSINESS




FORWARD
LOOKING STATEMENTS




This
annual report on Form 10-K includes forward looking statements within the
meaning of The Private Securities Litigation Reform Act of 1995. We have based
these forward looking statements largely on our current expectations and
projections about future events and financial trends affecting the financial
condition of our business. These forward looking statements are subject to a
number of risks, uncertainties, and assumptions about us, including, among other
things:




·
            failure
      to achieve positive results in clinical trials sufficient to advance
      products candidates through the regulatory
  process;




·
            ability
      to successfully manage our product candidates through the regulatory
      process;




·
            failure
      to maintain continued listing on a Nasdaq
  market;




·
            failure
      to successfully manufacture, or cause to be manufactured, product for
      clinical trials, regulatory filings and potential commercial
      sale;




·
            competitive
      factors;




·
            general
      economic conditions;




·
            the
      ability to attract and retain qualified
  management;




·
            available
      financial resources and inability to secure adequate funding for
      development projects;




·
              ability
      to liquidate investments held for sale to fund current and future
      operations;


·
            relationships
      with pharmaceutical and biotechnology
companies;




·
            the
      ability to develop safe and efficacious
drugs;




·
            variability
      of royalty, license, and other
revenue;




·
            uncertainty
      regarding the outcome of current legal
  proceedings;




·
            failure
      to satisfy performance obligations in our licenses or other
      contracts;




·
            ability
      to enter into future collaborative
agreements;




·
            uncertainty
      regarding our patents and patent rights and/or freedom to operate
      (including the risk that we may be forced to engage in costly litigation
      to protect such patent rights and/or defend ourselves from patent
      infringement claims and the material harm to us if there were an
      unfavorable outcome of any such
litigation);




·
            governmental
      regulation;




·
            technological
      change;




·
            changes
      in industry practices; and




·
            one-time
      events.




In
addition, in this annual report, the words “believe,” “may,” “will,” “estimate,”
“possible,” “potential,” “hope,”  “continue,” “anticipate,” “intend,”
“expect” and similar expressions, as they relate to us, our business, or our
management, are intended to identify forward looking statements. All of our
forward looking statements are qualified in their entirety by reference to the
factors discussed in this document under the heading ITEM 1A.— RISK FACTORS, and
any documents incorporated by reference that describe risks and factors that
could cause results to differ materially from those projected in these forward
looking statements.




We caution
you that the risk factors contained herein are not exhaustive. We operate in a
continually changing business climate which can be expected to impact our
forward looking statements, whether as a result of new information, future
events, or otherwise, after the date of this annual report. In light of these
risks and uncertainties, the forward looking events and circumstances discussed
in this annual report may not occur and actual results could differ materially
from those anticipated or implied in the forward looking statements.
Accordingly, you should not rely on forward looking statements as a prediction
of actual results.




4




BUSINESS
      OVERVIEW




NeoPharm, Inc.
is a Delaware corporation incorporated on June 15, 1990.




We are a
biopharmaceutical company engaged in the research, development, and
commercialization of drugs for the treatment of cancer and other diseases. We
have built our drug development program around our two proprietary technology
platforms: a tumor-targeting toxin platform and NeoLipid liposomal drug delivery
system. We have advanced five drug product candidates in various stages of
clinical and pre-clinical development for the treatment of cancer and one drug
product candidate in pre-clinical development for treatment of interstitial
pulmonary fibrosis, or IPF, and asthma. The following table summarizes key
information about our current drug product candidate pipeline:






Drug
      product candidate
              
              Clinical
      indication(s)
              
              2007
      Clinical
                development
      status
              Commercialization
                rightsCintredekin
      Besudotox
                (IL13-PE38QQR)
              Glioblastoma
      multiforme (brain cancer)
              Completed Phase
      III(1)
              World
      wideLEP-ETU
                (Liposomal
      Paclitaxel)
              Breast
      cancer, ovarian cancer and other solid tumors
              Planning Phase
      II
              
              World
      wideLE-SN38
                (Liposomal
      SN-38)
              Colorectal
      cancer and other solid tumors
              Phase
      II(2)
              
              World
      wideLE-DT
                (Liposomal
      Docetaxel)
              Breast
      cancer, ovarian cancer, prostate cancer and other solid
    tumors
              IND
      accepted, Planning Phase I
              World
      wideLE-rafAON
                (Liposomal-raf-Antisense
      Oligonucleotide)
              Pancreatic
      and prostate cancer
              Re-activate
      IND,  Planning Phase I
              United
      StatesCintredekin
      Besudotox
                (IL13-PE38QQR)
              Interstitial
      pulmonary fibrosis and asthma
              Pre-IND
              
              World
      wide




(1)
            Representatives
      of the United States Food and Drug Administration’s, or
      FDA,  Office of Oncology indicated during a review of the
      clinical data with the Company on March 28, 2007, that an additional Phase
      III clinical trial for Cintredekin Besudotox in the treatment of
      glioblastoma multiforme, or GBM, would be required before the FDA could
      accept the Company's Biologics License Application, or
      BLA.   The Company continues to evaluate its options
      regarding Cintredekin Besudotox, which is further discussed below in the
      Drug Product Candidate Summary.




(2)
            The
      Company announced on March 30, 2007 that the interim analysis of data
      following the completion of treatment of the first 21 patients
      demonstrated disease stabilization, but the study for LE-SN38 did not
      achieve the primary tumor response endpoint.  The Company is
      reassessing project next steps including additional data analyses and the
      possibility of other studies related to lung and breast
      cancer.




To date,
we have not received FDA approval for any of our drug product
candidates.  We expect to continue to incur losses for the foreseeable
future as we continue our research and development activities, which include the
sponsorship of human clinical trials for our drug product
candidates.  Until we are able to successfully commercialize one or
more of our drug product candidates, we anticipate that we will be required to
fund our research and development activities primarily by other means,
including, but not limited to, issuing equity or other securities, licensing
drug product candidates to third parties and collaborating with third parties to
develop formulations of their compounds using our technology.




The drug
product candidate which we have advanced the farthest is Cintredekin Besudotox,
a tumor-targeting toxin being developed as a treatment of recurrent GBM, a
deadly form of brain cancer.  During 2006 and the first quarter of
2007, the Company focused primarily on completing its Phase III PRECISE clinical
trial, the PRECISE Trial, for the treatment of recurrent GBM,
and  commercialization strategy for Cintredekin Besudotox, including
the preparation of the corresponding BLA submission to the FDA.  In
December 2006 ,we suffered a significant setback with the results of our PRECISE
Trial.  The PRECISE Trial did not meet the primary endpoint at 215
deaths, which was a statistically significant difference, or separation, in the
overall survival curve compared with the Gliadel Wafer®, or
Gliadel.  Upon review of the PRECISE trial results with the Company on
March 28, 2007, the FDA concluded that an additional Phase III trial would be
required prior to acceptance of a potential BLA filing by the Company and
potential commercialization. The Company is currently exploring the possibility
of undertaking an initial Phase III confirmatory trial for Cintredekin Besudotox
with the primary objective of overall survival and a secondary objective of
progression free survival for patients with recurrent GBM against the standard
of care.  If satisfactory results were obtained in such an initial
Phase III confirmatory trial, and additional resources to fund the project were
secured, the Phase III confirmatory trial might be expanded in the hope of
obtaining results that would support the submission of a BLA for Cintredekin
Besudotox to the FDA.  No prediction can be given as to the results of
any initial Phase III confirmatory trial that might be undertaken or the
Company's ability to secure additional financing to possibly expand such an
initial trial if such an expansion were to be warranted.




5




In 2007,
we reassessed and reprioritized our Cintredekin Besudotox and NeoLipid® platform
and strategy to focus our NeoLipid development efforts on LE-SN38, LEP-ETU,
LE-DT and LErafAON.  In addition we licensed Cintredekin Besudotox for
the treatment of interstitial pulmonary fibrosis, or IPF, and
asthma.




LEP-ETU is
our NeoLipid® liposomal formulation of the widely used cancer drug,
paclitaxel.  Paclitaxel, also known as Taxol® (Bristol-Myers Squibb
Company), has been approved in the US for the treatment of ovarian, breast and
lung cancers.  The Company expects to initiate patient enrollment
early in the second quarter of 2008 in a Phase II trial designed to assess the
safety and efficacy of LEP-ETU in recurrent breast cancer patients and, if
encouraging outcomes result from those clinical results, we may decide to
undertake multicenter and multinational Phase III trials in this indication
after thorough discussions with the FDA.




LE-SN38 is
our NeoLipid® liposomal
formulation of SN-38, the active metabolite of Camptosar® (Pfizer Inc.), a
chemotherapeutic pro-drug, which is used as a first-line and second-line
colorectal cancer treatment.  On March 30, 2007, the Company announced
that the interim analysis of data following the completion of treatment of the
first 21 patients demonstrated disease stabilization, but the study did not
achieve the primary tumor response endpoint.  The Company is also
assessing the potential  next steps for this project including
additional data analyses and the possibility of other studies related to lung
cancer and breast cancer with LE-SN38.




Pre-clinical
work has also advanced on our earlier stage liposomal formulation of the
anti-cancer agent docetaxel, LE-DT, which is the active ingredient in Sanofi
Aventis’ Taxotere® which is approved for use in certain breast cancer, non-small
cell lung cancer, gastric adenocarcinoma, head and neck cancer indications and
prostate cancer. On January 30, 2008, our
investigatonal new drug application, or IND, for this drug product candidate was
accepted by the FDA and we currently expect to start a Phase I trial with LE-DT
to define the toxicities, pharmacokinetics and maximum tolerated dose with this
new modality of treatment in the second quarter of 2008.




Preclinical
work with the new formulation of LE-rafAON is ongoing and we expect to submit a
revised IND to the FDA in the second or third quarter of 2008.




The
Company has licensed Cintredekin Besudotox from the National Institutes of
Health, or NIH, FDA, and University of Michigan as a potential therapeutic agent
for the treatment of pulmonary fibrosis and asthma.  We are currently
conducting preclinical studies, and we plan to submit an IND to the FDA in the
second half of 2008.  The FDA has indicated it will require
significant studies in animals to explore potential side effects in humans
before the agency will permit the clinical testing to begin.




The
NeoLipid® drug delivery technology combines drugs or other compounds with our
proprietary lipids and allows for the creation of a stable liposome. This
physical property is especially important during drug storage and after the drug
has been administered intravenously to the patient. We believe our NeoLipid
technology may have applications in a variety of other areas in addition to our
drug product candidates in clinical development.




During
2007, we continued to realign our organization and reduce the cost structure to
support our business objectives.  Following the Company’s announcement
on March 29, 2007 that an additional Phase III clinical trial will be required
for approval of its drug product candidate, Cintredekin Besudotox, the Company,
in April 2007, reduced the workforce by 16 employees to a total of 19
employees.   The reorganization included the agreement of Dr.
Jeffrey Sherman, the Company’s Executive VP-Chief Medical Officer and Mr.
Timothy Walbert, the Company’s Executive VP-Commercial Operations to step
down.  Including one additional employee released in the fourth
quarter of 2007, the employee termination costs related to 2007 reorganization
and separation agreements were $598,000.  As of December 31, 2007, we
had 17 employees.




In
January 2006, we completed the sale of 4,025,000 shares of our common stock
to the public. Proceeds to the Company were approximately $38.7 million net of
underwriting fees but before expenses. The proceeds from this sale of stock
continue to be used to fund clinical trials of our drug product candidates;
preclinical studies for other potential drug product candidates; and for working
capital, capital expenditures, and other general corporate
purposes.




MARKET
      OVERVIEW




According
to the American Cancer Society, ACS, 2008 Cancer Facts and
Figures, cancer is the second leading cause of death in the United
States, accounting for one in every four deaths. The ACS 2008 Cancer Facts and Figures
also estimates that doctors will diagnose approximately 1.4 million new cases of
cancer in the United States in 2008. The NIH estimate that the annual cost of
cancer in 2007 was approximately $219.2 billion, including $89.0 billion in
direct medical costs and $18.2 billion for morbidity costs, which includes the
cost of lost productivity.




6




Cancer is
characterized by uncontrolled cell division resulting in the growth of a mass of
cells commonly known as a tumor. Cancerous tumors can arise in almost any tissue
or organ and cancer cells, if not eradicated, spread, or metastasize, throughout
the body. Cancer is believed to occur as a result of a number of factors,
including hereditary and environmental factors.




For the
most part, cancer treatment depends on the type of cancer and the stage of
disease progression. Generally, staging is based on the size of the tumor and
whether the cancer has metastasized or spread. Following diagnosis, solid tumors
are typically surgically removed or the patient is given radiation therapy.
Chemotherapy is the principal treatment for tumors that are likely to, or have,
metastasized. Chemotherapy involves the administration of drugs which are
designed to kill cancer cells, affect the growth of tumors, or reduce blood flow
to tumors, in an effort to reduce or eliminate cancerous tumors.




Because in
most cases cancer is fatal, cancer specialists attempt to attack the cancer
aggressively, with as many therapies as available and with as high a dose as the
patient can tolerate. Since chemotherapy attacks both normal and cancerous
cells, treatment often tends to result in complicating side effects.
Additionally, cells which have been exposed to several rounds of chemotherapy
develop a resistance to the cancer drugs that are being administered. This is
known as “multi-drug resistance.” The side effects of chemotherapy often limit
the effectiveness of treatment. Cancers often recur and mortality rates remain
high. Despite large sums of money spent on cancer research, current treatments
are largely inadequate and improved anti-cancer agents are needed.




The
products we currently have under development potentially target a broad range of
solid tumors. The table below shows the incidence and mortality estimated for
the year 2008 for various types of solid tumor cancers that our products seek to
treat:




Cancer Indication
            
            
            
            New Cases
            
            DeathsBrain
            
            21,810
            
            13,070Breast
            
            184,450
            
            40,930Colorectal
            
            148,810
            
            49,960Lung
            
            215,020
            
            161,840Ovarian
            
            21,650
            
            15,520Prostate
            
            186,320
            
            28,660




Source:
American Cancer Society, 2008 Cancer Facts and Figures






We are
also exploring the use of  Cintredekin Besudotox, IL-13 PE 38 for the
treatment of IPF and Asthma.  IPF involves scarring of the
lung.  Gradually, the air sacs of the lungs become replaced by
fibrotic tissue.  When the scar forms, the tissue becomes thicker
causing an irreversible loss of the tissue’s ability to transfer oxygen into the
bloodstream.




According
to the Pulmonary Fibrosis Foundation, there are five million people worldwide
that are affected by this disease. In the United States there are over 200,000
patients with Pulmonary Fibrosis. As a consequence of misdiagnosis the actual
numbers may be significantly higher. Of these more than 40,000 expire annually.
This is the same as die from Breast Cancer. Typically, patients are in their
forties and fifties when diagnosed. However, diagnoses have ranged from age
seven to the eighties. Current research indicates that many infants are
afflicted by Pediatric Interstitial Lung Disease. At this time there is limited
data on prevalence for this group.




There are
currently no effective treatments or a cure for IPF.




BUSINESS
      STRATEGY




We are a
biopharmaceutical company focused on discovering, developing, and
commercializing innovative anti-cancer treatments. Our strategy consists of the
following key elements:




Focus
      on the growing cancer market




Cancer is
the second leading cause of death in the US, yet there remain unmet needs, and
current treatments remain ineffective and inadequate for some populations. The
FDA has procedures to accelerate the approval of drugs for serious or
life-threatening conditions, including cancer, when those drugs provide a
meaningful therapeutic benefit over existing treatments. We intend to continue
to use our expertise in the field of cancer research to target this significant
market opportunity for cancer drug development.




7




Develop
      our existing product
portfolio




We
currently have six clinical and pre-clinical stage anti-cancer drug product
candidates under development in cancer and certain other indications. We intend
to further develop these drug product candidates both by using our internal
resources and by continuing to collaborate with other companies and leading
governmental and educational institutions.  In 2007, we reassessed and
reprioritized our Cintredekin Besudotox and NeoLipid® platform
and strategy to focus our NeoLipid development efforts on LE-SN38, LEP-ETU,
LE-DT and LErafAON.  In addition we licensed Cintredekin Besudotox for
the treatment of interstitial pulmonary fibrosis, or IPF, and
asthma.




Create
      new products by capitalizing on our NeoLipid® drug delivery
      platform




We intend
to further explore the use of our proprietary NeoLipid®
liposomal drug delivery technology to create new products in two ways: life
cycle management, therefore extending the patent life and/or modifying the
pharmacokinetic profile of existing cancer drugs, and by utilizing our platform
to develop new drugs. We are aware of several widely used cancer drugs that are
nearing patent expiration, as well as other widely used cancer drugs with
patents that have expired. When a drug is combined with another agent or
delivery system in a novel way, its patent life may be extended. Secondly, while
many chemotherapeutic drugs have been effective for the treatment of cancer,
these drugs have been limited in their use because of adverse side effects and
difficulties in administration.  Our NeoLipid® drug delivery
technology, may increase the usefulness of these anti-cancer treatments.
Thirdly, we believe that our liposomal drug delivery technology may provide us
with a platform for the development of novel therapeutic agents for cancer drug
development.




Increase
      the potential for commercial success through
    diversification




We are
developing our drug product candidates simultaneously in an attempt to increase
our chances of commercial success through diversification as well as potential
partnerships with third parties.




Commercialize
      pharmaceutical products focused on cancer in selected
    markets




Our goal
is to bring to market novel drugs that address significant unmet needs in cancer
treatment. In North America, we may develop a specialized cancer sales and
marketing capability or work with third parties to market our future products to
specialty physicians. As appropriate, we may establish collaborations with
pharmaceutical companies, or others, to assist in the commercialization and
development of our drug product candidates outside of North
America.




DRUG
      PRODUCT CANDIDATES




Cintredekin
Besudotox


Cintredekin Besudotox
(GBM)




The drug
product candidate which we have advanced the farthest is Cintredekin Besudotox,
a tumor-targeting toxin being developed as a treatment for glioblastoma
multiforme, or GBM, a deadly form of brain cancer.




We have
exclusively licensed Cintredekin Besudotox from the NIH and the FDA, and have
been developing this drug product candidate under a Cooperative Research and
Development Agreement, or CRADA, with the FDA Center for Biologics Evaluation
and Research, or CBER. Cintredekin Besudotox has received orphan drug
designation in the US and Europe and FDA has designated it for the fast track
drug development program.  In addition, Cintredekin Besudotox has been
selected to participate in the FDA’s Continuous Marketing Application, CMA,
Pilot 2 program.  We also hold a non-exclusive license to utilize a
patented process owned by the U.S. government relating to convection enhanced
delivery, or CED, for use with drugs, including Cintredekin Besudotox in the
treatment of gliomas.




Conventional,
non-specific chemotherapeutic drugs attack cancer cells by stopping them from
dividing and reproducing, but can also damage normal healthy cells because they
do not discriminate between cancerous and healthy cells.  Furthermore,
standard chemotherapy drugs are usually administered systemically, which leads
to their distribution throughout the body rather than to one area, such as a
tumor in the brain.  Common side effects of chemotherapy that are
caused by damage to bone marrow include the body’s inability to produce enough:
red blood cells, causing weakness and fatigue; white blood cells, lowering the
body’s resistance to infections; or platelets, preventing blood from clotting
properly, which can lead to excessive bleeding.




Cintredekin
Besudotox is being developed as a highly specific tumor-targeting
agent.  Cintredekin Besudotox is a recombinant protein consisting of a
single molecule composed of two parts: a tumor-targeting molecule and a
cytotoxic agent.  The targeting component consists of
interleukin-13(IL-13), an immune regulatory cytokine.  Malignant
glioma cells, as compared to normal brain cells, express IL-13 receptors at a
higher density.  The cytotoxic agent is a potent bacterially derived
toxin called PE38.  Cintredekin Besudotox is designed to detect and
bind IL-13 receptors on the surface of malignant glioma cells and selectively
deliver PE38 to destroy tumor cells.  Cintredekin Besudotox is
administered by a technique known as convection-enhanced delivery, or CED, in
which the drug is delivered through catheters inserted in brain tissue
surrounding the tumor (peritumoral administration) or into the tumor
(intratumoral administration) following surgical resection of the
tumor.  CED is designed to infuse Cintredekin Besudotox directly to
the tumor site and adjacent brain tissue with the goal of killing resident tumor
cells and preventing recurrence of tumor cell growth.  We hope to show
that this method of delivery minimizes both damage to the surrounding cells and
toxicity from systemic drug exposure.




8




During
2006 and the first quarter of 2007, the Company primarily focused on completing
its Phase III testing and  commercialization strategy for Cintredekin
Besudotox, including the preparation of the corresponding BLA submission to the
FDA.  However, upon review of the PRECISE trial results with the
Company on March 28, 2007, the FDA concluded that an additional Phase III trial
would be required prior to acceptance of a potential BLA filing by the
Company.  This will substantially delay, and may even prevent, the
potential commercialization of the product.




The
Company is currently exploring the possibility of undertaking an initial Phase
III confirmatory trial with the primary objective of overall survival, with a
secondary objective of progression free survival for patients with recurrent GBM
against the standard of care.  If the results of such an initial
confirmatory trial were to be encouraging, the Company could elect to expand the
trial into a larger Phase III trial in order to support a possible BLA filing
for Cintredekin Besudotox with the FDA.  While the Company has
sufficient resources to fund the initial Phase III confirmatory trial, and
evaluate possible drug activity, additional funding from sources outside the
Company would be necessary to expand and then complete the necessary Phase III
trial, make the BLA filing and advance this drug product
candidate.  The Company does not currently have the financial reserves
to fully fund the testing and obtain approval for any of its drug product
candidates, including, but not limited to, Cintredekin
Besudotox.  Even if third party financing were to become available,
and at this time no assurance can be given that it would be, there can be no
assurance given that the terms of any proposed third party financing arrangement
would be acceptable to the Company.  The Company continues to explore
drug delivery improvements as well as the possibility of genetic testing to
identify patients that might be more responsive to treatment.  There
can be no assurance that these modifications will result in a positive outcome
in a second Phase III trial.  Further, there can be no assurances the
data from a second Phase III trial, whether or not these modifications were
made, would be deemed acceptable by the FDA or that the FDA would approve a BLA
for Cintredekin Besudotox based on such data.




The
Company continues to evaluate its options related to Cintredekin
Besudotox.  There can be no assurance that, if a second Phase III
trial were completed, data evidencing statistical superiority would be generated
and, even if such data were generated and produced to the FDA, there can be no
assurance that the FDA would accept or approve a BLA submission by the
Company.




Cintredekin Besudotox( IPF
and Asthma)




The
Company has recently licensed IL13-PE38 from NIH, FDA, and University of
Michigan as a potential therapeutic agent for the treatment of pulmonary
fibrosis and asthma. The Company’s collaborators have completed extensive
preclincal studies in animal models for the control and reversal of pulmonary
fibrosis with this agent. Preclinical studies relating to asthma have also been
performed.  Other preclincal toxicology studies are also
underway.  The Company plans to undertake additional detailed
preclinical evaluation of this product through nebulization in these studies and
to fully characterize the physio-chemical behavior of the nebulized
product.  The Company plans to submit an IND to the FDA in the last
half of 2008 or early in 2009 if those studies show that it is reasonably safe
to conduct clinical investigations in humans.  The preclinical testing
plan has been discussed with the FDA, and the agency has made it clear that
significant studies must be performed in animals to explore potential side
effects in humans, before the agency will permit testing in humans.




NeoLipid®
Platform




LE-SN38




LE-SN38 is
our NeoLipid® liposomal
formulation of SN-38, the active metabolite of Camptosar® (Pfizer Inc.), a
chemotherapeutic pro-drug, which is used as a first-line and second-line
colorectal cancer treatment. At the present time, without the NeoLipid® system,
SN-38 is insoluble and can only be used to treat cancer by administering the
pro-drug Camptosar®.  A pro-drug is a compound that is converted into
the active drug in the body. However, Camptosar® is converted into SN-38 in the
liver at different rates by different patients, and this variability in
conversion rates can result in suboptimal dosing and adverse side effects, such
as severe diarrhea.  We hope to show that our proprietary NeoLipid®
technology permits delivery of SN-38 to the tumor cells without the need for
conversion, therefore minimizing variability and optimizing dose with minimal
side effects.




Results
from our 2004 Phase I clinical trial provided evidence of the safety and
tolerability of LE-SN38 and established a maximum tolerated dose of 35 mg/m2  (MTD)
for all but a small subset of patients who metabolize SN-38
slowly.  Pharmacokinetic analysis of blood samples from patients
treated with LE-SN38 showed that blood levels and systemic drug exposure to
SN-38 were comparable to or greater than that expected from the marketed
Camptosar® dose based on previously published studies.




During the
second quarter of 2006, in conjunction with the Cancer and Leukemia Group B, or
CALGB, we initiated enrollment in a Phase II clinical trial with LE-SN38 in
metastatic colorectal cancer patients, and completed enrollment of the 21st
patient in December, 2006.




9




On March
30, 2007, the Company announced that the interim analysis of data following the
completion of treatment of the first 21 patients demonstrated disease
stabilization, but the study did not achieve the primary tumor response
endpoint.  The Company is reviewing the data and, in particular,
examining the patients’ demography, prior chemotherapy exposure, advanced stage
of the disease, and other related factors. It is possible that patients who were
enrolled in this trial were exposed to other chemotherapy regimens prior to
enrolling and that this prior exposure may be the reason the study did not
achieve its primary endpoint.  The Company is also assessing the
potential  next steps for this project which may include additional
data analyses and the possibility of other studies related to lung cancer and
breast cancer with LE-SN38.




LEP-ETU




LEP-ETU is
our NeoLipid® liposomal formulation of the widely used cancer drug,
paclitaxel.  Paclitaxel, also known as Taxol® (Bristol-Myers Squibb
Company), has been approved in the US for the treatment of ovarian, breast and
lung cancers.  Despite paclitaxel’s wide use and its tumor cytotoxic
characteristics, its effectiveness can be limited by its adverse side effects,
which can include nausea, vomiting, hair loss and nerve and muscle
pain.  Because of the chemical characteristics of paclitaxel, it
cannot be introduced into the body unless it is first formulated in a mixture of
castor oil (Cremophor®) and ethanol, which can lead to significant side effects
such as hypersensitivity reactions and cardiac toxicities.  We hope to
show that our proprietary NeoLipid® technology, which eliminates the need for
Cremophor and ethanol, permits delivery of paclitaxel treatment with fewer side
effects.




During
2004, we completed a Phase I clinical trial for LEP-ETU.  In this
study, LEP-ETU appeared to be well tolerated in the majority of patients, in
terms of typical paclitaxel side effects, including those patients receiving the
higher doses of drug, as well as those who were not premedicated with
antihistamines and steroids. Antitumor activity was observed, with 16% of
patients experiencing partial responses (shrinkage of tumor by 50% or
more).  Additionally, 44% of patients evidenced stable disease and
were able to complete 4 or more, 3-week cycles of LEP-ETU
treatment.  Patients previously treated with taxanes were among those
who partially responded to LEP-ETU.




The
Company expects to begin patient enrollment early in the second quarter of 2008
in  a Phase II trial designed to assess the efficacy and safety of
LEP-ETU in recurrent breast cancer patients in the first quarter of
2008.  Depending on the outcome of those clinical trials, we may
decide to undertake multicenter and multinational Phase III trials in this
indication after thorough discussions with FDA.





LE-DT




Pre-clinical
work has also advanced on our earlier stage liposomal formulation of the
anti-cancer agent docetaxel, LE-DT, which is the active ingredient in Sanofi
Aventis’ Taxotere® which is approved for use in certain breast cancer, non-small
cell lung cancer, gastric adenocarcinoma, head and neck cancer indications and
prostate cancer.  We filed the Investigational New Drug Application,
IND, to the FDA on December 28, 2007 and the IND became effective on January 30,
2008.  We currently expect to start a Phase I trial with LE-DT to
explore its toxicities, pharmacokinetics and maximum tolerated dose in the
second quarter of 2008.




LE-rafAON




Preclinical
work with the new formulation of LE-rafAON, which is expected to have minimal
infusion related toxicities, is ongoing and we expect to submit a revised IND to
FDA in the second or third quarter of 2008.  The antisense
oligonucleotide agent c-raf has shown significant down regulation of the gene in
Preclinical studies. Also, LE-rafAON has exhibited significant radiation
sensitization and chemo sensitization with other anticancer agents such as
Gemcitabine and Paclitaxel in human xenograft models in mice in Pancreatic and
Prostate tumors.  We plan to perform the bridging Phase I trial with
this newly formulated LE-rafAON and thereafter start Phase II trials in
pancreatic and prostate cancer models where this gene seems to be potentially
over expressed.










We intend
to further develop the NeoLipid® drug product candidates by using our internal
resources and by continuing to collaborate with other companies and leading
governmental and educational institutions.




In
addition, we intend to explore the use of our proprietary NeoLipid®
liposomal drug delivery technology to create new products in two ways: life
cycle management, therefore extending the patent life and/or modifying the
pharmacokinetic profile of existing cancer drugs, and by utilizing our platform
to develop new drugs.  We are aware of several widely used cancer
drugs that are nearing patent expiration, as well as other widely used cancer
drugs with patents that have expired.  When a drug is combined with
another agent or delivery system in a novel way, its patent life may be
extended.  Additionally, while many chemotherapeutic drugs have been
effective for the treatment of cancer, these drugs have been limited in their
use because of adverse side effects and difficulties in
administration.  Our NeoLipid® drug delivery technology may increase
the usefulness of these compounds as improved anti-cancer
treatments.  Finally, we believe that our liposomal drug delivery
technology may provide us with a platform for the development of novel
therapeutic agents for cancer drug development.




10




It is
difficult to predict with any certainty the timing of and total estimated costs
to complete development of drug product candidates in early stage, or Phase I,
clinical development, as well as the estimated date such drug product candidates
would be available for sale, if approved by the FDA.  A number of
factors contribute to this uncertainty, including: side effects encountered in
early stage clinical trials, ability to scale up manufacturing for commercial
supply, and the fact that the size and scope of pivotal Phase III clinical
trials are unknown until sufficient data is available to present a Phase III
plan to the FDA for approval.   In addition, our drug product
candidates require approval by the FDA after completing Phase III clinical
trials before we can sell the drugs to generate revenue and, potentially,
realize net cash inflows.  Substantial additional clinical trial
expenses are expected to be incurred for Cintredekin Besudotox before approval
can be sought again.




The table
below includes a summary of identified direct project costs incurred to date for
our clinical research and development projects.  Generally, identified
project costs include expenses incurred specifically for clinical trials and
pre-clinical studies we conduct, and exclude expenses incurred for salaries paid
to our professional staff, our Waukegan facility and the related depreciation of
equipment as well as  general laboratory supplies used in our
research, which are included with non-project specific costs.




Total
      Direct Costs IncurredResearch
      Project
              
              2007
              
              
              2006
              
              
              2005
              
              
              Since
      Beginning of ProjectCintredekin
      Besudotox
              
              $
              1,248,000
              
              
              $
              11,534,000
              
              
              $
              15,755,000
              
              
              $
              67,507,000LEP-ETU
              
              
              207,000
              
              
              
              876,000
              
              
              
              2,684,000
              
              
              
              7,790,000LE-SN38
              
              
              88,000
              
              
              
              254,000
              
              
              
              506,000
              
              
              
              5,316,000LE-DT
              
              
              545,000
              
              
              
              -
              
              
              
              -
              
              
              
              545,000LE-rafAON
              
              
              71,000
              
              
              
              -
              
              
              
              -
              
              
              
              71,000Non-project
      specific and other
              
              
              4,211,000
              
              
              
              8,535,000
              
              
              
              12,906,000
              
              
              
              N/ATotal
      research and development expenses
              
              $
              6,370,000
              
              
              $
              21,199,000
              
              
              $
              31,851,000
              
              
              
              N/A




Competition




Each of
the drug product candidates will face competition from products currently on the
market or under development. The following table lists our current principal
competitors and their products which would compete with our drug product
candidates in the future:




Our
      drug product candidate
            
            
            
            Principal
      competitor
            
            Competitor’s
      productCintredekin
      Besudotox (1)
            
            MGI
      Pharma, Inc.
            
            Gliadel®
      WaferLE-SN38
            
            Pfizer Inc.
            
            Camptosar®LEP-ETU
            
            Bristol-Myers
      Squibb Co.
              Abraxis
      BioScience, Inc.
            
            Taxol®(2)
              Abraxane®LE-DT
            
            Sanofi
      Aventis
            
            Taxotere®LE-rafAON
            
            ISIS
      Pharmaceutical
              Bayer
            
            In
      development
              In
      development





(1)
            In
      March 2007 the FDA indicated that it would not approve this drug without
      data from a second Phase III trial demonstrating the superior clinical
      activity of this drug in brain
tumors.




(2)
            This
      product is currently off-patent and generics are
  available.




We also
compete with drug development companies for access to novel technologies as well
as in potential collaborations with large pharmaceutical and other life sciences
companies.




RESEARCH
      AND DEVELOPMENT PROGRAM




We conduct
pre-clinical research to investigate other compounds that could potentially
benefit from our NeoLipid technology. Our pre-clinical research is generally
conducted in laboratories in our Waukegan, Illinois facility.  As of
December 31, 2007, we employed 10 individuals in research and development,
down from 30 individuals at December 31, 2006, as we have been aggressively
reprioritizing our workforce to better conserve our working capital. We have
incurred research and development expenses to advance our drug product
candidates and pre-clinical compounds totaling $6.4 million, $21.2 million and
$31.9 million in 2007, 2006 and 2005, respectively, with research and
development expenditures decreasing over time due to the timing of completion of
the PRECISE trial, advancement of other product candidates from the laboratory
toward clinical testing and the reprioritization of our NeoLipid development
efforts and resulting reduction in the number of persons working in this
area.




11




COLLABORATIVE
      RELATIONSHIPS AND LICENSES




License
      and Research Agreements




Nippon
      Kayaku Co. Ltd. License Agreement




In
December 2004, we signed a license agreement with Nippon Kayaku Co., Ltd.,
or NK, licensing them certain rights to develop and commercialize Cintredekin
Besudotox in Japan.  We received a $2 million non-refundable
up-front license fee in January 2005 and the right to receive royalties on
future commercial sales.  Under the license agreement, NK assumed
responsibility for, and the costs associated with, the development and testing
of Cintredekin Besudotox and obtaining regulatory approvals in Japan although we
were required to provide NK with supplies of Cintredekin Besudotox free of
charge to conduct pre-clinical and clinical testing.




The
initial term of the license agreement was ten years from the date of the first
commercial sale in Japan, and the agreement could be extended at the option of
NK, for a mutually agreed upon period. Under the terms of the license agreement,
each party could terminate the license agreement upon the occurrence of certain
defaults by the other.




On
September 11, 2007, NK notified us that they had elected to terminate the
Agreement effective June 2008. With the formal termination notice, development
efforts by NK have ceased and under terms of the Agreement, we will retain the
$2 million upfront license fee received from NK in 2005.  Accordingly,
in September 2007 the Company reversed the corresponding deferred revenue and
recognized the amount as other income.




Georgetown
      University Agreements




We
currently have two license agreements with Georgetown University relating to
various liposome-related products.




Under the
Georgetown licenses, and in return for sponsoring related research, we were
granted exclusive licenses to manufacture and sell liposome encapsulated
paclitaxel, or LEP, and liposome-encapsulated raf-antisense oligonuceotide, or
LE-rafAON. We are obligated to pay royalties to Georgetown on commercial sales
of these products. In addition, through December 31, 2007, we have paid an
up-front licensing fee and advance royalty payments (which may be credited
against future royalties) of $95,000. Additionally, we may be obligated to pay
$400,000 upon entering into any sublicense agreement and make milestone payments
upon achieving certain development objectives for these compounds. For LEP, we
have remaining potential maximum aggregate milestone payments remaining of
$250,000 and would pay a royalty rate of 1.25% to 2.50% on any commercial sales
of the product.  The Georgetown license for LEP expires in 2013 and
may also be terminated by either party in the event of a default by the other
party.




In
July 2007, we entered into an exclusive license to use certain antisense
technologies covered by certain US patents to support our LE-rafAON drug
candidate.  In exchange for the grant of this license, we paid
Georgetown a non-refundable license issue fee of $10,000 and are liable for
yearly maintenance fees of $20,000.  In addition, we agreed to pay
Georgetown a royalty of 2.75% of net sales from our products incorporating these
technologies and 50% of any royalties received from sublicensees.  We
may also be obligated to make milestone payments totaling $900,000 upon
achievement of certain objectives.  The Georgetown license for
LE-rafAON expires in 2022 and may be terminated by either party in the event of
a default by the other party.




National
      Institutes of Health




In
September 1997, we entered into an exclusive worldwide licensing agreement
with the NIH (an agency of the United States Public Health Service, or PHS,
within the Department of Health and Human Services, DHHS) whereby we were
granted the right to develop and commercialize Cintredekin Besudotox,
IL13-PE38QQR, for the treatment of cancer. The Cintredekin Besudotox license
required us to pay NIH an initial $75,000 non-refundable payment and requires
minimum annual royalty payments to NIH of $10,000 that increase to $25,000 after
the first commercial sale. The Cintredekin Besudotox license also requires us to
pay to NIH milestone payments of up to $585,000 upon completion of various
phases of development of Cintredekin Besudotox, and a maximum royalty of 3.5%
based on future product sales, if any. The license agreement terminates in 2018.
However, we have the unilateral right to terminate the license agreement at any
time upon 60 days written notice. The NIH may terminate the agreement upon
our default in performing any material obligations under the agreement or if
they determine that such action is necessary to meet the requirements for public
use specified by federal regulations and we were not reasonably satisfying such
requirements. While providing us with an exclusive license, it should be noted
that, as is typical in such agreements, the NIH does not make any
representations or warranties in the license agreement as to the validity or
enforceability of the licensed rights and does retain certain rights of use for
the government.




12




On May 30,
2006 we entered into a non-exclusive Patent License Agreement with the PHS
providing us with a non-exclusive license to utilize a patented process owned by
the U.S. government relating to convection enhanced delivery, or CED, for use
with drugs, including Cintredekin Besudotox, in the treatment of gliomas, in the
U.S., its territories and possessions.  Under the terms of this Patent
License Agreement, we have paid PHS a noncreditable, nonrefundable license issue
royalty of $5,000 and have agreed to pay a nonrefundable, minimum annual royalty
of $2,000, which will be credited against earned royalties, which are fixed at
0.5% on aggregate future product sales over $100 million.  An
additional benchmark royalty of $20,000 is payable within thirty days of
receiving approval from the FDA to use the licensed CED process in
administrating a drug for the treatment of gliomas.  Pursuant to an
amendment to this Patent License Agreement entered into in August 2006, we
expanded the field of use to cover the treatment of cancer, were given the right
to sublicense our rights and extended the time for us to reach certain
benchmarks.  In return for these additional rights, we agreed to pay
additional sublicensing royalties of 1.5%, to a maximum of $200,000, on the fair
market value of any upfront consideration received for granting a
sublicense.




In June
2007, we entered into an exclusive worldwide license agreement with the NIH to
develop and commercialize IL13-PE38QQR (Cintredekin Besudotox) for use in the
treatment of asthma and pulmonary fibrosis.  Upon entering the
contract, we paid NIH a non-refundable license issue royalty of $125,000 and
have agreed to pay an annual royalty of $20,000, which will be credited against
earned royalties, which are fixed at 4% of net sales, including those of
sublicensees.  In addition, we may be obligated to make milestone
payments totaling $1,410,000 upon achievement of certain
objectives.  We are required to pay the costs of filing and
maintaining product patents on the licensed patent applications. The agreement
extends to the expiration of the last to expire of the patents on the licensed
patent applications, if not terminated earlier. The agreement may be terminated
by mutual consent of NIH and us. Either party may terminate if the other party
breaches a material term or condition and such breach is not cured within a
certain period of time. Also, either party may unilaterally terminate by giving
advanced notice.




U.S.
      Food and Drug Administration




In 1997
the Company entered into a CRADA with the FDA. Pursuant to the CRADA, we
committed to work to commercialize the IL13-PE38QQR chimeric protein which we
licensed from NIH. The FDA agreed to collaborate on the clinical development and
commercialization of IL13-PE38QQR.   In September 2005, we and
the FDA agreed to extend the term and funding of the CRADA through July 2009 for
$165,000 per year.




In
summary, the amounts paid to our research and development collaborators under
our various agreements, as well as our potential aggregate future commitments
under these agreements, are included in the following table:




Research
and Development Collaboration Expenses




Aggregate Payments
              Made through
              December
      31, 2007
            
            Additional Aggregate
              Potential Payments(1)Georgetown
            
            $
            2,592,000
            
            
            $
            1,150,000NIH
            
            
            1,580,000
            
            
            
            1,410,000FDA
            
            
            2,240,000
            
            
            
            165,000Total
      Collaboration Expenses
            
            $
            6,412,000
            
            
            $
            2,725,000





(1)
            These
      amounts do not include potential sales-based royalty payments that may be
      required under the various license
agreements.




Manufacturing
Agreements




In order
to successfully commercialize our drug product candidates, we, or third parties
with whom we contract, must be able to manufacture products in commercial
quantities in compliance with the FDA’s current Good Manufacturing Practices, or
cGMP, at acceptable costs and in a timely manner. As we do not currently own a
cGMP manufacturing facility, we have contracted with third parties to provide us
with cGMP production capacity.




In
August 2002, we entered into an agreement with Diosynth RTP, Inc., or
Diosynth, to produce Cintredekin Besudotox for the PRECISE trial. In September
2005, we amended the Diosynth agreement to encompass work necessary to support a
potential Cintredekin Besudotox Biologics License Application, or BLA,
submission.  Further, in late 2006, to secure access to
manufacturing capacity for the potential manufacture, scale-up of manufacturing
and regulatory advancement of Cintredekin Besudotox, we entered into agreements
with Diosynth providing for payment of half of the processing costs, or
approximately $1.8 million at December 31, 2007, under certain
circumstances.  However, management does not feel that such
circumstances have taken place at December 31, 2007.  Refer to Note 13
for further discussion.  We have not yet secured potential longer-term
commercial manufacturing capacity for Cintredekin Besudotox, but believe that
there are acceptable sources of supply available to us, although securing such
alternative sources would significantly delay production.




13




Currently,
all of our liposome compounds are manufactured by Pharmaceutical Services
Division of the University of Iowa, or PSD.  The PSD has indicated
that it is currently able to meet our needs for research and clinical trials,
but we cannot offer any assurance that they will be able to do so in a timely
manner or on a cost effective basis in the future. We do not have a formal
manufacturing agreement with the PSD and, therefore, have a limited ongoing
obligation to manufacture our compounds at this facility.




Our
current laboratory facility generally provides us with the capacity to produce
the quantities of our compounds intended solely for our pre-clinical research
and development purposes.




We believe
there are other sources of raw materials and contract manufacturing that would
be acceptable to us and would comply with the requirements of the FDA. However,
there can be no assurances that we could enter into agreements with these
alternative suppliers or manufacturers on terms and conditions acceptable to us,
if at all or that having to obtain alternative sources of supply would not
substantially delay or curtail development or potential commercialization of our
drug candidates.




Patents
      and Proprietary Rights




We either
own or have in-licensed over 25 United States patents or patent applications
relating to our drug product candidates and compounds. We have also filed
applications in a number of foreign jurisdictions which are counterparts of our
issued United States patents and pending patent applications, many of which have
issued into patents in the respective countries. We believe all of our drug
product candidates and compounds under development are protected by patents
owned or licensed to us and that we will not be infringing upon anyone else’s
patented rights upon entry into the marketplace.




Patent
protection is important to our business. The patent position of companies in the
pharmaceutical field generally is highly uncertain, involves complex legal and
factual questions, and has recently been the subject of much litigation.
Therefore, we cannot assure you that any patent applications relating to our
products or processes will result in patents being issued, or that the resulting
patents, if any, will provide protection against competitors who successfully
challenge our patents, obtain patents that we may be found to infringe and,
therefore, adversely affect our ability to conduct business or are able to
circumvent our patent position by designing around our patented technology. It
is possible that other parties have invented compounds or processes that would
precede any of our discoveries in the United States. Finally, there can be no
assurance that others will not independently develop similar pharmaceutical
products which will compete against ours, or cause our drug product candidates
and compounds to become obsolete.




Our
competitive position is also dependent upon unpatented trade secrets. In an
effort to protect our trade secrets, we have a policy of requiring our
employees, consultants, and advisors to execute proprietary information and
invention assignment agreements upon commencement of employment or consulting
relationships with us. These agreements provide that all confidential
information developed or made known to the individuals during the course of
their relationship with us must be kept confidential, except in specified
circumstances. However, we cannot assure you that these agreements will provide
meaningful protection for our trade secrets or other proprietary information in
the event of unauthorized use or disclosure of confidential information.
Further, invention assignment agreements executed by consultants and advisors
may conflict with, or be subject to, the rights of third parties with whom such
individuals have employment or consulting relationships. In addition, we cannot
assure you that others will not independently develop equivalent proprietary
information and techniques or otherwise gain access to our trade secrets, that
such trade secrets will not be disclosed, or that we can effectively protect our
rights to unpatented trade secrets.




We may be
required to obtain licenses to patents or proprietary rights of others. We
cannot assure you that any licenses required under any such patents or
proprietary rights would be made available on terms acceptable to us or at all.
If we do not obtain such licenses, we could encounter delays in product market
introductions while we attempt to investigate any possible infringement upon or
design around such patents, or we could find that the development, manufacture,
or sale of products requiring such licenses could be foreclosed due to
infringement upon those rights. Litigation may be necessary to defend against or
assert claims of infringement, to enforce patents issued or exclusively licensed
to us, to protect trade secrets or know-how owned by us or to determine the
scope and validity of the proprietary rights of others. In addition, we may
become involved in oppositions in foreign jurisdictions or interference
proceedings declared by the United States Patent and Trademark Office to
determine the priority of inventions with respect to our patent applications or
those of our licensors. Litigation, opposition, or interference proceedings
could result in substantial costs to and diversion of effort by, and may have a
material adverse impact on, us. In addition, we cannot assure you that our
efforts will be successful. See Item 1A. - RISK FACTORS.




Government
Regulation





Regulation
by governmental authorities in the United States and foreign countries is a
significant factor in the development, manufacture, and marketing of our drug
product candidates and in our ongoing research and development
activities.  The nature and scope of this regulation will depend on
the nature of the products we develop.  We anticipate, however, that
each of our drug product candidates will be subject to extensive regulation
during the pre-approval research and development phase, and that each will
require approval by the Food and Drug Administration, or FDA, prior to
commercialization in the United States (and approval by comparable foreign
government authorities prior to commercialization in those
countries).  In particular, human therapeutic products are subject to
extensive oversight during the preclinical and clinical phases, as well as a
rigorous approval standard and elaborate approval procedures, both in the United
States and in foreign countries.  Various Federal statutes and
regulations also govern or influence the manufacturing, packaging, labeling, and
storing of human therapeutic products both during the pre-approval period and
after approval.  Various Federal statutes and regulations impose
record-keeping and reporting requirements with respect to these products both
before and after approval and regulate the promotion and marketing of these
products after approval.  State laws also apply, including state laws
relevant to promotion and marketing.  The process of obtaining
approval and compliance with the appropriate Federal statutes and regulations
both before and after approval requires substantial time and financial
resources.




14




The steps
ordinarily required before a new drug may be marketed in the United States,
which are similar to the steps required in most other countries,
include:




·
            preclinical
      laboratory tests, preclinical studies in animals, formulation studies, and
      the submission to FDA of an investigational new drug application, or
      IND;




·
            adequate
      and well-controlled clinical trials to establish the safety and efficacy
      of the drug for each indication
sought;




·
            the
      submission of a new drug application, or NDA, or biologics license
      application, or BLA, to FDA; and,




·
            FDA
      review and approval of the NDA or
BLA.




Preclinical
tests include laboratory evaluation of product chemistry, formulation, and
toxicity, as well as animal studies.  FDA regulates the laboratory
work and facilities through good laboratory practice, GLP,
regulations.  The results of preclinical testing are submitted to FDA
as part of an IND.  There is a 30-day waiting period after the filing
of each investigational new drug application before clinical testing in humans
may begin.  At any time during the 30-day period, FDA may place the
proposed study on clinical hold.  A clinical hold means that the trial
may not begin until FDA notifies the sponsor that it may begin.  FDA
may impose a clinical hold, for example, if it finds that human subjects will be
exposed to an unreasonable and significant risk of injury, or if the IND does
not contain sufficient information to assess the risks to subjects of the
proposed study.




Clinical
trials to support new drug applications are typically conducted in three
sequential phases, although the phases may overlap.  During Phase I,
clinical trials are conducted with a small number of subjects to assess the
metabolism, pharmacokinetics, and pharmacological actions of the drug, to
determine the side effects associated with increasing doses, and if possible to
gain early evidence of the drug's efficacy.  Phase II usually involves
studies in a limited patient population to assess the efficacy of the drug in
specific, targeted indications; assess dosage tolerance and optimal dosage; and
determine common short-term side effects and risks associated with the
drug.




If a
compound is found to be potentially effective and to have an acceptable safety
profile in Phase II evaluations, Phase III trials are undertaken to further
demonstrate efficacy and to further test for safety in an expanded patient
population at geographically dispersed clinical trial sites.  Phase
III trials are intended to gather the additional information about safety and
efficacy that is needed to support product approval.




Any
clinical trial conducted under an IND is subject to FDA regulations, including
its good clinical practices, GCP, requirements (which include safety reporting
requirements), informed consent requirements, and institutional review board,
IRB, requirements.  FDA may at any time halt an ongoing clinical
trial, if the agency believes that patients participating in the trial will be
or are being exposed to unacceptable health risks.  FDA may also
terminate an IND and require the sponsor to end all clinical trials under the
IND, if it finds deficiencies in the IND or in the conduct of the trial under
the IND.  The regulatory authorities of foreign countries have
comparable authority to regulate, suspend, and terminate clinical
trials.  The clinical trial process is extremely costly, and positive
results in the preclinical phase do not necessarily ensure positive results in
the subsequent clinical trials.




After
successful completion of the required clinical trials, a new drug application,
or NDA, or biologics license application, or BLA, (collectively an
"application") is generally submitted.  In order for a new drug to be
approved, the application must demonstrate that the product is safe and
effective and that the product is manufactured in compliance with current good
manufacturing practices, or cGMP.  FDA may request additional
information before accepting an application for filing, in which case the
application must be resubmitted with the additional information.  Once
an application has been accepted for filing, FDA reviews the application and
responds to the applicant.  FDA requests for additional information or
clarification often significantly extend the review process.  FDA may
refer the application to an appropriate advisory committee for review,
evaluation, and recommendation as to whether the application should be approved,
but FDA is not bound by the recommendations of its advisory
committees.  FDA will typically also inspect the manufacturing
facility to ensure cGMP compliance.




15




FDA review
of a BLA or NDA can take several years.  If FDA's evaluations of the
application and the manufacturing facilities are favorable, FDA may issue an
approval letter or an "approvable" letter.  An approvable letter will
usually contain a number of conditions that must be met in order to secure final
approval of the application and authorization to market the drug commercially
for the approved indications.   FDA may also refuse to approve
the application or issue a "not approvable" letter outlining the deficiencies in
the submission.  In this case, additional clinical testing may be
necessary before a new application will be ready for submission.




FDA has
the authority to expedite its review of a drug intended for the treatment of a
serious or life-threatening condition, if the sponsor demonstrates that the
product has the potential to address an unmet medical
need.   Such products are designated as "fast track
products."   An application for a fast track product may be
approved if FDA determines that the product has an effect on a surrogate
endpoint that is reasonably likely to predict clinical benefit.  This
means, for example, FDA has the authority to approve a cancer therapy not only
on the basis of patient survival rates and improved quality of life, but also
partial tumor shrinkage.  FDA's "fast track" authority can
significantly shorten the clinical trial process and regulatory review period
for new cancer therapies.  Approval of a fast track product may be
subject to the requirement that the sponsor conduct post-approval studies to
confirm the product's effect on a clinical endpoint.  Failure to
conduct these studies with due diligence, or a negative result in these studies,
can result in expedited withdrawal of product approval.  FDA often
asks the sponsor of a fast track product to agree to distribution restrictions
or a risk management plan.




Under the
Orphan Drug Act, FDA may designate a drug product as an “orphan drug” if there
is no reasonable expectation of recovery of the costs of research and
development from sales in the United States or if the drug is intended to treat
a rare disease or condition, which is defined as a disease or condition that
affects fewer than 200,000 persons in the United States.  If FDA
designates a drug product as an orphan drug, then once FDA approves the product
for marketing, it is entitled to seven years of market
exclusivity.  This means the agency may not approve another sponsor's
marketing application for the same drug for the same orphan indication for seven
years.  There are two exceptions to the bar on new
approvals.  Specifically, FDA may approve a second application for the
same orphan drug if (1) the first application holder consents, or (2) the first
application holder cannot assure the availability of sufficient quantities of
the drug to meet the needs of persons with the disease or
condition.   In addition, the market exclusivity provision does
not prevent FDA from approving a different orphan drug for the same use or the
same orphan drug for a different use.  The Orphan Drug Act has been
controversial, and legislative proposals have from time to time been introduced
in Congress to modify this law, particularly the market exclusivity
provisions.




Once a new
drug is approved for sale in the United States, the product and its manufacturer
continue to be subject to strict regulation by FDA.  FDA imposes
recordkeeping and reporting requirements, requires the manufacture of the
product to comply with CGMP, and reviews the manufacturer's promotional
activities.  The company is also subject to regular inspection by
FDA.  Serious unexpected adverse events after approval can result in a
change to the product's labeling, a new or expanded risk management plan, and,
in extreme situations, withdrawal of the product from the market and withdrawal
of the approved application.




Many of
the legal requirements described in the preceding paragraphs stem from the
Federal Food, Drug, and Cosmetic Act, FDCA.  Violation of the FDCA can
result in product seizure, injunctions against the company, civil penalties, and
criminal prosecution.




Sales of
new drug products outside the United States are regulated under comparable
laws.  The requirements vary from country to country, but typically
the pre-approval process takes several years, is heavily regulated, and requires
the investment of significant resources.  As in the United States,
manufacturing, labeling, distribution, and promotion continue to be regulated
after product approval.




In most
cases, if the FDA has not approved a product for sale in the United States, the
product may be exported for sale outside of the United States only if it
complies with the laws of, and has valid marketing authorization from the
appropriate authority in: the European Union, a country in the European Economic
Area, Australia, Canada, Israel, Japan, New Zealand, South Africa, or
Switzerland.  FDA regulations govern this process.




We are
also subject to various Federal, state, and local laws, regulations, and
recommendations relating to safe working conditions, laboratory and
manufacturing practices, and the use and disposal of hazardous or potentially
hazardous substances, including radioactive compounds and infectious disease
agents, used in connection with our research work.




Any of the
Federal and state laws, regulations, and requirements described in this section
may change at any time.




16




Employees




As of
December 31, 2007, we employed 17 people. Our employees are not represented
by any collective bargaining agreement and we believe our employee relations are
good.




Available
      Information




Copies of
our Annual Report on Form 10-K, Quarterly Reports on Form 10-Q,
Current Reports on Form 8-K and amendments to those reports filed or
furnished pursuant to Section 13(a) or 15(d) of the Securities
Exchange Act of 1934 are available free of charge through our website (www.NEOPHARM.com) as soon as
reasonably practicable after we electronically file the material with, or
furnish it to, the Securities and Exchange Commission, or the SEC. You may read
and copy any document we file with the SEC at the SEC’s Public Reference
Room at 450 Fifth Street, N.W., Washington, DC 20549. Please call the SEC
at 1-800-SEC-0330 for further information on the Public Reference Room. Our SEC
filings are also available to the public at the SEC’s website at http://www.sec.gov.
Additionally, we have also adopted a Code of Conduct and Business Ethics
applicable to all officers, directors, and employees, which is also available on
our website.




ITEM
1A.                      RISK
FACTORS




You should
carefully consider the following risk factors, in addition to the other
information set forth in this document as well as other information filed in
periodic reports we file with the SEC.  Each of these risk factors
could adversely affect our business, operating results and financial condition,
as well as the value of an investment in our common stock.






Cintredekin
      Besudotox, the drug product which we have developed more than any other,
      failed to meet the primary endpoint established in its Phase III PRECISE
      clinical trial and which, as a result, may never be approved for
      commercial use, or, even if approved, may not have the market potential
      which we had hoped for. If we are unable to successfully commercialize
      Cintredekin Besudotox, our ability to generate revenues would be impaired
      and our business would be harmed.




We have
invested a significant portion of our time and financial resources in the
development of Cintredekin Besudotox. In December 2006, we suffered a
significant setback with the results of our Phase III clinical trial of
Cintredekin Besudotox, the PRECISE trial, despite achieving potentially
promising results in earlier clinical trials. Patients in the PRECISE trial
received treatment either with Cintredekin Besudotox or with Gliadel® Wafers, a
product currently approved to treat this disease. The primary endpoint of the
study was to determine if there was a statistically significant overall patient
survival difference between patients treated with Cintredekin Besudotox and
patients treated with Gliadel® Wafers. Cintredekin Besudotox did not meet its
primary endpoint in the Phase III PRECISE trial.




In March
2007 the FDA Office of Oncology indicated that an additional Phase III
trial.  The Company is currently exploring the possibility of
undertaking an initial Phase III confirmatory trial with the primary objective
of overall survival, with a secondary objective of progression free survival for
patients with recurrent GBM against the standard of care.  If the
results of such an initial confirmatory trial were to be encouraging, the
Company could elect to expand the trial into a larger Phase III trial in order
to support a possible BLA filing with the FDA.  While the Company has
sufficient resources to fund the initial Phase III confirmatory trial, and
evaluate possible drug activity, additional funding from sources outside the
Company would be necessary to expand and then complete the necessary Phase III
trial, make the BLA filing and advance this drug product
candidate.  The Company does not currently have the financial reserves
to fully fund the testing and obtain approval for any of its drug product
candidates, including, but not limited to, Cintredekin
Besudotox.  Even if third party financing were to become available,
and at this time no assurance can be given that it would be, there can be no
assurance given that the terms of any proposed third party financing arrangement
would be acceptable to the Company.  The Company continues to explore
drug delivery improvements as well as the possibility of genetic testing to
identify patients that might be more responsive to treatment.  There
can be no assurance that these modifications will result in a positive outcome
in a second Phase III trial.  Further, there can be no assurances the
data from a second Phase III trial, whether or not these modifications were
made, would be deemed acceptable by the FDA or that the FDA would approve a BLA
for Cintredekin Besudotox based on such data.




Even if
the Company secures third party financing and conducts a second Phase III trial
that provides evidence of efficacy, before Cintredekin Besudotox can be marketed
in the United States the Company will have to submit, and the FDA will have to
approve, a BLA for the product.  A BLA is a lengthy, complex
submission to the FDA, which must comply in format and content with elaborate
and detailed FDA requirements.  We have never submitted a BLA
before.  The FDA may refuse to accept a BLA for filing if it is
incomplete.




Even if
the Company submits, and the agency accepts, a BLA for Cintredekin Besudotox,
the length and outcome of the FDA’s review of the BLA is
uncertain.  The FDA’s approval is contingent on many factors,
including its evaluation of our preclinical and clinical trial results, its
assessment of the manufacturing process we propose as well as the process
controls, its review of our drug substance specifications and proposed
analytical procedures, the data we provide on the drug stability, and its
inspection of the facilities where Cintredekin Besudotox is
manufactured.  The FDA may ask an advisory panel for its
recommendations on the BLA, and we cannot predict the outcome of the advisory
committee process.




17




Because
the PRECISE trial did not show that Cintredekin Besudotox is superior to
Gliadel, the medical community may be unwilling to accept Cintredekin Besudotox
as an alternative to Gliadel, or other treatment options.  This would
diminish the market potential for Cintredekin Besudotox.  In addition,
because the PRECISE trial did not show that Cintredekin Besudotox is superior to
Gliadel, public and private healthcare payors may not provide reimbursement for
the drug if it is more expensive than Gliadel.  This would also
diminish the market potential for Cintredekin Besudotox.




We rely
heavily on third parties with respect to, among other things, the production and
testing of Cintredekin Besudotox.  If, at some point in the future,
and no assurance can be given that such an event will ever take place, we are
able to submit a BLA for Cintredekin Besudotox, the failure of any of these
third parties to fulfill its contractual obligations, to perform key tasks
appropriately or in a timely manner, or to comply with applicable government
regulations, could require us to seek alternative third parties to fulfill these
functions.  This could significantly slow the filing of a BLA,
preclude its timely approval or even preclude its approval
altogether.  If FDA approval is delayed, or the FDA requires
additional clinical testing or other information, or the FDA does not approve a
BLA, our ability to achieve revenues from product sales would be impaired and
our stock price would be materially and adversely affected.




Even
though the FDA has awarded orphan drug designation to Cintredekin Besudotox, a
competitor could obtain orphan drug designation for another drug for the same
indication. The FDA could approve that competitor’s product first and give it
seven years of market exclusivity. In this case, even if the FDA were to accept
a BLA for Cintredekin Besudotox (and there is no assurance that it will) it
would not be able to approve the BLA for seven years. This would have a material
adverse effect on our business. The law would permit the FDA to approve our
product during the seven years if certain conditions were met, but there is no
assurance we could satisfy these conditions. We might be able to market the
product outside the United States, if certain conditions were met, but there is
no guarantee that we would be able to satisfy those conditions. The export
process can be complex, and there are no assurances that export would be
permitted or that another country would accept the product. Even if the FDA were
to approve Cintredekin Besudotox as an orphan drug, and there is no assurance at
this point that we will even be able to pursue such approval, and then award us
seven years of exclusivity in connection with its use, the law permits the FDA,
in certain situations, to approve a competitor’s product. This could have a
material adverse effect on the commercial success of our product.




If
      we are unable to successfully develop, obtain regulatory approval, cause
      to be manufactured and market our drug product candidates, our business
      would be harmed.




The
process for developing new therapeutic products is inherently long, complex, and
uncertain. We must make long-term investments and commit significant resources
before knowing whether our development programs will eventually result in
products that will receive regulatory approval and achieve market
acceptance.




We
currently have six drug product candidates in various stages of clinical and
pre-clinical development.  Each current drug product candidate in
clinical development is the subject of an effective Investigation New Drug
application, or IND, that we filed with FDA. The protocols for any clinical
trials we perform under these INDs must have institutional review board, or IRB,
approval, and the trials must comply with the FDA’s good clinical practices, or
GCP, and other regulations. There is no assurance that the clinical trials we
may seek to conduct under these INDs will obtain IRB approval. There is also no
assurance that FDA will allow us to continue the clinical trials that we have
begun. FDA may suspend a clinical trial at any time if the agency believes that
the patients participating in the study are or will be exposed to unacceptable
health risks. FDA may also terminate an IND and require the sponsor to end all
clinical trials under that IND, if it finds deficiencies in the IND or in the
conduct of a trial under the IND.  An IRB also may suspend or
terminate a clinical trial.  Some of our clinical trials are conducted
in foreign countries, and the regulatory authorities of those countries have
comparable authority to suspend and terminate clinical trials. Suspension or
termination of the clinical trials of our drug product candidates could
substantially delay or even prevent regulatory approval of the drug product
candidates.  There is no guarantee that clinical studies, if performed,
will demonstrate the safety and efficacy of any drug product candidate we have
in development.




Sales of
our drug product candidates would be subject to pre-market approval requirements
in the United States and in other countries. These requirements vary widely from
country to country.  We cannot assure you that we will receive approval to
market any of our drug product candidates in any country, or that any approval
we obtain will be on commercially viable terms. We have yet to submit an
application for marketing approval for any of the drug product candidates we
currently have under development. We cannot predict with certainty if or when we
might submit any of these drug product candidates for regulatory review. We
cannot assure you that once we submit a drug product candidate for review, the
FDA or any other regulatory agency will approve that product on a timely basis
or at all.




18




Approval
of our drug product candidates in the United States or a foreign country may
depend on our agreement to perform burdensome and expensive post-marketing
studies or our agreement to a burdensome risk management plan or
labeling  that could interfere with physician and patient acceptance
of our product. We cannot assure you that we will agree to perform such
additional studies or to accept such a risk management plan. If we agree to
perform post-market studies and then fail to conduct those studies with due
diligence, or if those studies fail to verify the product’s clinical benefit,
the FDA may withdraw its approval of the product.  The FDA may also
withdraw its approval of the product if it determines, based on other
information, that the product does not present an acceptable balance of benefits
and risks.




If the FDA
or a foreign regulatory authority approves one of our drug product candidates,
we will need to manufacture, or contract with third parties to manufacture, a
sufficient volume of that product to meet market demand. This will require
accurate forecasting of market demand. There is no guarantee that we will
accurately forecast the market demand for any of our drug product candidates or
that there will be any market demand. There is also no assurance that we will be
able to successfully manufacture, or find a third party to manufacture, adequate
quantities of any of our drug product candidates to meet any market
demand.




The drug
product candidate which we have advanced the farthest is Cintredekin Besudotox,
IL13-PE38QQR. In September 1997, we exclusively licensed worldwide rights
to Cintredekin Besudotox from the National Institute of Health, or NIH, and FDA.
In December 2006, we announced that the Phase III PRECISE Clinical trial of
Cintredekin Besudotox in the treatment of recurrent glioblastoma multiforme did
not meet the primary endpoint at 215 deaths, which was a statistically
significant difference, or separation, in the overall survival curves compared
with the Gliadel Wafer®, or
Gliadel.  There are no assurances that Cintredekin Besudotox will
prove to be safe and effective or receive regulatory approval for any
indication.




Two other
drug product candidates that we have in clinical development for the treatment
of various cancers are LE-SN38 and LEP-ETU.  We have completed
treatment of the first 21 patients in a Phase II clinical trial for LE-SN38 and
have completed two Phase I clinical trials and we are currently planning a Phase
II clinical trial for LEP-ETU.  We are in ongoing discussion with the
FDA on clinical and regulatory plans for LEP-ETU.There are no
assurances that any of these drug product candidates will proceed to the next
phase of clinical development, or prove to be safe and effective, or that any of
them will receive regulatory approval for the treatment of the indications which
we may pursue.




Even if we
receive regulatory approval for one of our drug product candidates in the United
States or a foreign country, there are no assurances that the product will prove
to be commercially successful or profitable.




We
      depend on third parties for a variety of functions, including the research
      and development, manufacturing, clinical testing, and regulatory
      compliance of our drug product candidates. No assurance can be given that
      these third party arrangements will allow us to successfully or timely
      develop, manufacture and market our drug product
    candidates.




We do not
have the internal infrastructure to conduct clinical trial management or certain
other aspects of clinical testing ourselves. On December 31, 2007, we had 17
full-time employees.  We therefore rely heavily on third parties to
perform a variety of functions with respect to the clinical development of our
drug product candidates, including clinical trial management and manufacturing
of our drug product candidates, manufacturing and testing of our drug product
candidates.  If we develop additional drug product candidates with
commercial potential, we will have to either hire additional personnel skilled
in clinical testing or engage third parties to perform such
services.




We depend
on these third parties to apply appropriate expertise and resources to
expeditiously and competently perform the services for which they have been
retained.  The failure of any of these third paries to fulfill their
contractual obligations or otherwise perform key tasks appropriately or in a
timely manner, or their failure to comply with applicable government
regulations, could require us to seek alternative third parties to fulfill these
functions and could potentially invalidate a clinical trial, significantly slow
the filing of a potential BLA, preclude its timely approval or even preclude its
approval altogether.




Although
we are currently aware of alternative manufacturers and service providers who
might be able to supply us with our requirements for our drug product
candidates, having to utilize alternative providers would result in significant
additional delays in the development, filing for approval, and potential
approval by the FDA of our drug product candidates.




We do not
currently have ourselves, or through third party contractors, commercial scale
cGMP compliant manufacturing ability with respect to Cintredekin
Besudotox.  However, given the delay in making a possible BLA
submission, the lack of commercial scale cGMP compliant manufacturing ability is
not considered critical to the present advancement of Cintredekin Besudotox and,
if necessary, it is believed that, given time, third party manufacturers could
be retained as needed, though this could be expected to further slow development
of this drug product candidate should the Company elect to pursue such further
development.






19




Manufacturing
establishments, including third party contract manufacturers, are subject to
inspections by the FDA for compliance with cGMP.  Any errors or
omissions in completing the process or method development or process validation,
if not promptly corrected by us/or the third party manufacturer, could
significantly delay, or even prevent, a potential BLA filing.  If FDA
approval is delayed, or the FDA requires additional clinical testing or other
information, or the FDA does not approve the BLA, our ability to achieve
revenues from product sales may be impaired and our stick price would be
materially and adversely affected.




We have
engaged other companies on a per study basis for assistance in the management
and testing for our Phase I and Phase II clinical trials. To oversee data
management in our clinical trials, we have contracted, on a per study basis,
with Advanced Clinical Services.  To conduct our large animal testing,
we have engaged, again on a per study basis, Charles Rivers
Laboratories.




We do not
currently have a commercial scale cGMP manufacturing capacity for any of our
liposome based drug product candidates we are developing.  All of our
liposome compounds are produced at the Pharmaceutical Services Division of the
University of Iowa (PSD).  PSD has indicated that it is currently able
to meet our needs for research and clinical trials, but we cannot be sure that
it will be able to meet our needs in a timely manner or on a cost-effective
basis in the future.  If PSD were unable to meet our needs in the
future, it is believed that, given time, alternative manufacturers could be
retained as needed, though this could be expected to further slow development of
these drug product candidates.




We also
in-license technology from governmental and academic institutions in order to
minimize our investment in basic research, and we enter into collaborative
arrangements with certain of these entities with respect to research and
development of our drug product candidates.  At this time we have a
research agreement in place with the FDA.  No assurance can be given
that we will enter into more of these relationships, that we will be able to
maintain or renew the research agreement with FDA, that this relationship will
provide benefits to us, or that we will be able to establish new relationships
on beneficial terms, without undue delays or expenditures.




Because
      all of our drug product candidates are in pre-clinical or clinical
      development, there is a high risk that further development and testing
      will demonstrate that our drug product candidates are not approvable or
      suitable for commercialization, which could cause our business to
      suffer.




None of
our drug product candidates has received regulatory approval for commercial
sale. Before we can obtain regulatory approval for the commercial sale of any of
our drug product candidates, we must demonstrate through pre-clinical testing
and clinical trials that the drug product candidate is safe and effective.
Conducting pre-clinical and clinical testing is a lengthy, expensive, and
uncertain process and may take several years or more. Success in pre-clinical
testing does not assure success in clinical trials, and positive results in
early phase clinical trials do not assure a positive outcome in later trials or
approval.




Clinical
development of any of our drug product candidates, including, but not limited
to, Cintredekin Besudotox, may be curtailed, redirected, delayed, or eliminated
at any time for any of the following reasons or for other reasons:




·
            our
      inability to demonstrate superiority to existing treatments for targeted
      diseases;




·
            our
      determination that the applicable market, or competition within the
      market, make competition
uneconomic;




·
            our
      inability to manufacture, or secure third party sources to manufacture,
      sufficient quantities of drug compounds for use in clinical
      trials;




·
            our
      inability to attract suitable and willing investigators for our
      trials;




·
            our
      inability to locate, recruit, and qualify a sufficient number of patients
      for our trials;




·
            negative
      or ambiguous results regarding the effectiveness of the drug product
      candidate;




·
            undesirable
      side effects that delay or extend the trials, or other unforeseen or
      undesirable safety issues that make the drug product candidate not
      approvable, or not medically or commercially
  viable;




20




·
            our
      failure, or the failure of any third party with whom we contract, to
      comply fully with the investigational new drug regulations and other
      regulations applicable to clinical
trials;




·
            delays,
      suspension, or termination of trials imposed by us or an independent
      institutional review board for a clinical trial site, or a clinical hold
      placed upon the trial by the FDA;




·
            regulatory
      delays or other regulatory actions, including changes in regulatory
      requirements;




·
            our
      inability to adequately follow patients after treatment;
    and




·
            delays
      in importing or exporting clinical trial
  materials.




A delay or
termination of any of our clinical trials would have an adverse effect on our
business. If any of our clinical trials is unsuccessful, this could preclude us
from obtaining regulatory approval, which would have an adverse effect on our
business. If any of our clinical trials is perceived as unsuccessful by the FDA
or physicians, our business, financial condition, and operations would be
harmed.




Our
      business is subject to extensive governmental regulation, and failure to
      comply with those regulations can lead to unanticipated delays in product
      development and approval and can prevent
  commercialization.




The FDA
regulates the research, development, and testing of our drug product candidates.
If any of our drug product candidates is approved for marketing and introduced
into the market, the FDA will continue to regulate the manufacturing, labeling,
distribution, marketing, and advertising activities of that product.
 Individual states also regulate distribution and marketing of drug
products.  Public health authorities in foreign countries have
comparable authority. Compliance with these requirements before and after
approval is expensive and time consuming. Failure to comply can lead to
regulatory action that would have a negative impact on our
business.




In order
to market a new therapeutic product in the United States, we must prove that the
product is safe and effective for its intended uses and that the product is
manufactured in compliance with current Good Manufacturing Practices, or cGMP.
Completing the pre-clinical and clinical testing necessary to prove the safety
and effectiveness of a new therapeutic product, and establishing the capability
to comply with cGMP, can take many years, be very costly, and still be
unsuccessful. The results of pre-clinical testing and Phase I and II studies are
not necessarily indicative of the results in larger patient populations, as
evaluated in Phase III studies.




In order
to market any of our drug product candidates, once this lengthy research and
development process is completed, we will need to submit a BLA or NDA to the
FDA. This will need to contain pre-clinical, clinical, manufacturing, labeling,
and other information, and it must demonstrate that the drug product candidate
is safe and effective for use in humans for each proposed indication. The FDA
may refuse to accept any of our applications if it views the application as
incomplete. The manufacturing facilities must also comply with cGMP, and FDA may
inspect the facility before it approves the application.




Even if we
complete the lengthy and expensive research and development process for one of
our drug product candidates and file a BLA or NDA seeking approval to market the
candidate, we do not know whether the FDA will approve the application on a
timely basis, on commercially viable terms, or at all. The FDA’s review of a BLA
or NDA that it accepts can take several years.  The FDA can delay, limit,
or deny approval for many reasons, including if:




·
            it
      determines that our drug product candidate is not safe or is not
      effective, or does not present an acceptable benefit-risk
      profile;




·
            it
      interprets the data from our pre-clinical testing and clinical trials
      differently than we do;




·
            it
      determines that our manufacturing processes or facilities, or the
      processes or facilities of third parties involved in the manufacture of
      our drug product candidates, do not comply with
  cGMP;




·
            it
      changes its approval policies or adopts new regulations;
  or




·
            Congress
      amends the Food, Drug and Cosmetics Act, the Public Health Service Act, or
      other applicable laws.




21




The
process of obtaining approvals in foreign countries is subject to uncertainty,
delay, and failure for similar reasons.




In
addition, the FDA (and foreign regulatory authorities) may approve a drug
product candidate for fewer than all the indications requested or require that
the drug product be labeled in a way that differs from our proposed labeling.
Even if the FDA (or a foreign regulatory authority) approves one of our drug
product candidates, it may require that we perform burdensome post-marketing
studies and it may impose other burdensome requirements, including the
requirement that we institute and maintain a special risk management plan to
monitor and manage potential safety issues. These requirements could reduce or
eliminate the drug product’s market potential.




A drug
product and its manufacturer are subject to strict regulation after product
approval by the FDA and comparable foreign authorities. The FDA regulates
manufacturing, labeling, distribution, and promotional activities after product
approval, as do comparable foreign regulatory agencies.  We must also
report certain adverse events and manufacturing issues involving our drug
products to these agencies.  Application holders must submit new or
supplemental applications and obtain FDA approval for certain changes to the
approved product, product labeling or manufacturing process.  In
addition to FDA requirements, sales, marketing and scientific/education grant
programs must comply with the anti-fraud and abuse provision of the Social
Security Act, the False Claims Act and similar state laws, each as
amended.  Pricing and rebate programs must comply with the Medicaid
rebate requirements of the Omnibus Budget Reconciliation Act of 1990, and the
Veteran’s Health Care Act of 1992, each as amended.  If products are
made available to authorized users of the Federal Supply Schedule of the General
Services Administration, additional laws and requirements apply.  All
of these activities are also potentially subject to federal and state consumer
protection and unfair competition laws.




Failure
to comply with applicable legal and regulatory requirements can result in, among
other things, product seizure, civil penalties, suspensions and withdrawals of
regulatory approvals, import and export problems, product recalls, operating
restrictions, and criminal prosecution. The restriction, suspension, or
revocation of regulatory approvals or other adverse action taken on the basis of
failure to comply with applicable regulatory requirements could have a material
adverse effect on our business, financial condition, and
operations.




Previously
unidentified adverse events or an increased frequency of adverse events that may
occur post-approval could result in the FDA, or other agencies, requiring us to
conduct further clinical research, which could be expensive and could lead to
new and unfavorable information about the safety or the effectiveness of our
product. New safety or effectiveness information after approval can result in a
change in the labeling of our drug products, new or more extensive distribution
restrictions, a new or expanded risk management program, product recalls,
withdrawal of the drug product from the market, or withdrawal of product
approval, any of which could materially affect the commercial success of the
product. Any unforeseen problems with one of our drug product candidates after
approval could preclude successful commercialization of that product and harm
our business and stock price.




We
      have a history of operating losses, expect to continue to incur losses for
      the foreseeable future, and may never be
  profitable.




We have a
limited operating history, and our operations consist primarily of the
development of our drug product candidates and the sponsorship of research and
clinical trials. Over the past three fiscal years ended December 31, 2007, we
have incurred aggregate net losses of $82.9 million, with aggregate net
losses since inception of $272.2 million. We expect to incur additional losses
and, as our development and commercialization efforts and clinical testing
activities continue, our losses can be expected to increase. We also expect to
experience negative cash flows for the foreseeable future as we fund our losses
and capital expenditures. Our losses have adversely impacted, and will continue
to adversely impact, our working capital, total assets and stockholders’ equity.
To date, we have not sold or received approval to sell any drug product
candidates, and it is possible that revenues from drug product sales will never
be achieved. In the past, we have generated only very limited revenue from
license fees and sales of products. We cannot at this time predict when or if we
will be able to develop sources of revenue or when or if our operations will
become profitable, even if we are able to commercialize some of our drug product
candidates.




Budget
      constraints have in the past,  and are expected to continue in
      the future, to force us to delay our efforts to develop certain drug
      product candidates in favor of developing others, which prevents us from
      commercializing all drug product candidates as quickly as
      possible.




Because we
are a small company with limited resources, and because research and development
is an expensive process, we must regularly assess the most efficient allocation
of our research and development budget. As a result, we have been forced to
prioritize development activities with the result that we will not be able to
fully realize the value of some of our drug product candidates in a timely
manner, as they will be delayed in reaching the market, if at all. In 2006 and
2007, we reprioritized the NeoLipid® program in an effort to substantially
decrease our expenses, including a reduction of our workforce and a reduction in
research and development spending. If we are not successful in maintaining the
planned level of spending, our efforts to commercialize our drug product
candidates will be seriously eroded. Additionally, the reduction in spending on
our drug product candidates will necessitate a delay in our commercialization
efforts and negatively impact our strategy to diversify our development risk
across our drug product candidates.




22




Competition
      in the biopharmaceutical field is intense and subject to rapid
      technological change. Our principal competitors have substantially greater
      resources to develop and market products that may be superior to
      ours.




If we
obtain regulatory approval for any of our drug product candidates, the extent to
which they achieve market acceptance will depend, in part, on competitive
factors. Competition in our industry is intense, and it is increased by the
rapid pace of technological development. Existing drug products or new drug
products developed by our competitors may be more effective or have fewer side
effects, or may be more effectively marketed and sold, than any that we may
develop. Many of our principal competitors have substantially greater research
and development capabilities and experience and greater manufacturing,
marketing, financial, and managerial resources than we do. Competitive drug
compounds may render our technology and drug product candidates obsolete or
noncompetitive prior to our recovery of research, development, or
commercialization expenses incurred through sales of any of our drug product
candidates. The FDA’s policy of granting “fast track” approval for drugs that
are intended to treat serious or life threatening conditions that offer a
meaningful therapeutic benefit over existing alternatives may also expedite the
regulatory approval of our competitors’ drug product candidates.




Each of
the drug product candidates currently in clinical development will face
competition from drug products currently on the market or under development. The
following table lists our current principal competitors and their products which
compete with the listed drug product candidates we currently have under
development:




Our
      drug product candidate
            
            
            
            Principal
      competitor
            
            Competitor’s
      productCintredekin
      Besudotox (1)
            
            MGI
      Pharma, Inc.
            
            Gliadel®
      WaferLE-SN38
            
            Pfizer Inc.
            
            Camptosar®LEP-ETU
            
            Bristol-Myers
      Squibb Co.
              Abraxis
      BioScience, Inc.
            
            Taxol®(2)
              Abraxane®LE-DT
            
            Sanofi
      Aventis
            
            Taxotere®LE-rafAON
            
            ISIS
      Pharmaceutical
              Bayer
            
            In
      development
              In
      development







(1)
            In
      March 2007 the FDA indicated that it would not approve this drug without
      data from a second Phase III trial demonstrating the superior clinical
      activity of this drug in brain
tumors.




(2)
            This
      product is currently off-patent and generics are
  available.




Additionally,
other drug companies are currently conducting clinical trials, which are in
various stages, for numerous drug compounds that, if ultimately approved for
marketing, could be competitive with our drug product candidates, including, but
not limited to, clinical trials involving drug compounds for the treatment of
glioblastoma multiforme which, if approved, could compete with Cintredekin
Besudotox, if development of that drug in the treatment of glioblastoma
multiforme is continued and if it then is eventually approved for the treatment
of that disease.




We also
compete with other drug development companies for licenses to novel technologies
as well as for collaborations with large pharmaceutical and other
companies.




The
      Nasdaq Global Market may cease to list our common stock, which may cause
      our stock price to suffer and adversely affect the market liquidity of our
      common stock.




The Nasdaq
Global Market upon which our common stock currently trades, imposes, among other
requirements, minimum bid requirements.  On December 26, 2007, we
received notice from the Nasdaq Stock Market (“Nasdaq”) advising us that for 30
consecutive trading days, the bid price of our common stock had closed below the
minimum $1.00 per share requirement for continued inclusion under Nasdaq
Marketplace Rule 4450(a)(5) (the “Rule”).  Pursuant to Nasdaq
Marketplace Rule 4450(e)(2), the Company has been provided  a
period of 180 calendar days, or until June 23, 2008, to regain compliance with
the Rule.  The notice states that the Nasdaq staff (the “Staff”) will
provide written notification that the Company has achieved compliance with the
Rule if at any time before June 23, 2008, the bid price of our common stock
closes at $1.00 per share or more for a minimum of ten consecutive business
days, although the notice also states that the Staff has the discretion to
require compliance for a period in excess of ten consecutive business days, but
generally no more than 20 consecutive business days, under certain
circumstances.




23




If the
Company does not regain compliance with the Rule by June 23, 2008, Nasdaq will
provide notice to the Company that its common stock will be delisted from the
Nasdaq Global Market.  If the Company receives such a letter, it will
have an opportunity to appeal the determination to Nasdaq’s Listing
Qualification Panel or to apply to transfer its common stock to the Nasdaq
Capital Market, if we satisfy the requirements for inclusion on the Nasdaq
Capital Market, other than the minimum bid price rule.  If the
application is approved, we would be afforded an additional 180 day
compliance period in order to regain compliance with the Rule while listed on
the Nasdaq Capital Market.  If we do not satisfy the requirements for
inclusion on the Nasdaq Capital Market, we would not be able to take advantage
of this additional 180 day period.  Even if we do satisfy the initial
listing requirements of the Nasdaq Capital Market, if we fail to return to
compliance during the second 180 day compliance period, Nasdaq will issue a
letter informing us that they will delist our common stock from the Nasdaq
Capital Market.  The Company may appeal such a determination by the
Staff to the Listing Qualification Panel at such time.




If our
common stock were to be delisted, the delisting could adversely affect the
market liquidity of our common stock and the market price of our common stock
could decrease.  Such a delisting could also adversely affect our
ability to obtain financing for the continuation of our operations and could
result in a loss of confidence by investors, suppliers and
employees.  In addition, your ability to trade or obtain quotations on
our shares could be severely limited because of lower trading volumes and
transaction delays.  These factors could contribute to lower prices
and larger spreads in the bid and ask price for our common stock.




Our
      stock price has been and is likely to continue to be volatile, and an
      investment in our common stock could decline in
  value.




The market
price of our common stock has been highly volatile and may continue to be
so.  For example, during 2007, the market price of our common stock
fluctuated between $0.58 and $2.37 per share and during 2006 the market price of
our common stock fluctuated between $1.66 and $12.67 per share.  As of
March 26, 2008 our stock closed at $0.70.




The
following factors, among others, could have a significant impact on the market
price of our stock:




·
            the
      success or failure of our clinical trials or those of our
      competitors;


·
            failure
      to maintain a listing of our common stock on
  Nasdaq;


·
            our
      ability to conserve our cash resources or to obtain financing, when
      needed;


·
            litigation,
      including, but not limited to, current class action
    lawsuits;


·
            actual
      or anticipated fluctuations in our financial
  results;


·
            economic
      conditions in the US and abroad;


·
            comments
      by or changes in Company assessments or financial estimates by securities
      analysts;


·
            adverse
      regulatory actions or decisions;


·
            losses
      of key management;


·
            changing
      governmental regulations;


·
            our
      ability to secure adequate third party reimbursement for products
      developed by us;


·
            developments
      or disputes concerning patents or other proprietary
  rights;


·
            product
      or patent litigation; and


·
            public
      concern as to the safety of products developed by
  us.




Additionally,
volatility or a lack of positive performance in our stock price may adversely
affect our ability to retain key employees, all of whom have been granted stock
options.




The
factors and fluctuations, as well as political and market conditions, may
materially adversely affect the market price of our common stock.




We
      will need to raise additional capital in the future. If additional capital
      is not available, or can not be obtained on favorable terms, we may have
      to curtail or cease operations.




We
estimate that as of December 31, 2007, our then existing cash reserves should be
sufficient to finance our operations at current and projected levels of
development and general corporate activity into 2009, contingent on our ability
to liquidate our investments held for sale.  The date that sufficient
funds continue to be available for operations, without additional financing, may
vary depending upon the timing and implementation of various strategies under
consideration by the Company.




24




While we
have sufficient resources to initiate a Phase III confirmatory trial, our
projection as to the date that sufficient funds continue to be available for
operations without additional financing does not contemplate the Company’s
independent completion of a second Phase III clinical trial of Cintredekin
Besudotox as currently required by the FDA in order for the FDA to accept a
BLA submission for that drug product candidate.  Completion of a full
second Phase III trial for Cintredekin Besudotox would require that substantial
additional financing be made available to the Company.  We do not
currently have such funds, nor have we received any offers from third parties to
make such financing available to us.




We do not
anticipate being able to generate revenues from product sales in the near term
at a rate sufficient to fund our operations.  We will need additional
future financing depending on a number of factors, including, but not limited
to, the following:




·
            a
      decision to pursue additional Phase III clinical testing for Cintredekin
      Besudotox;




·
            our
      degree of success in gaining approval for and thereafter successfully
      commercializing our drug product
candidates;




·
            the
      rate of progress and cost of research and development and clinical trial
      activities relating to our drug product
  candidates;




·
            a
      possible obligation to pay damages arising from the ongoing consolidated
      class action lawsuit, to the extent these possible damages exceed, or are
      not covered by, our insurance;




·
            the
      costs of preparing, filing and prosecuting patent applications,
      maintaining and enforcing our patent claims and other intellectual
      property rights and investigating and defending against infringement
      claims asserted against us by
others;




·
            emergence
      of competing technologies and other adverse market
      developments;




·
            changes
      in or terminations of our existing licensing
  arrangements;




·
            the
      amount of milestone payments we may receive from future collaborators, if
      any;




·
            the
      costs of acquiring or licensing new technology, products or businesses if
      we desire to expand our product portfolio;
and




·
            the
      cost of manufacturing scale-up and development of marketing operations, if
      we undertake those activities, or are required to pay for terminating such
      activities under existing
contracts.




Additional
financing may not be available when we need it or be on terms acceptable to
us.  If such financing is not available, our ability to liquidate our
auction rate securities could be limited if the present credit situation does
not improve (subsequent to year end, we are unable to liquidate a portion of the
securities as a result of the global credit crisis – refer to the Risk Factor
regarding the potential for our investments to lose market value
below.)  If adequate financing is not available, we may be required to
delay, scale-back, or eliminate certain of our research and development
programs, to relinquish rights to some of our technologies or products, or to
grant licenses to third parties to commercialize products or technologies that
we would otherwise seek to develop ourselves. We could also be required to cease
operations. If additional capital is raised through the sale of equity, our
stockholders’ ownership interest could be diluted and such securities may have
rights, preferences, or privileges superior to those of our other stockholders.
The terms of any debt securities we may sell to raise additional capital may
place restrictions on our operating activities. Failure to secure additional
financing may cause us to delay or abandon some or all of our development
programs.




If
      we, or our suppliers, fail to comply with FDA and other government
      regulations, our manufacturing operations could be interrupted, and our
      drug product development, future sales, and profitability would
      suffer.




All new
drugs, including our drug product candidates under development, are subject to
extensive and rigorous regulation by the FDA and comparable foreign authorities.
These regulations govern, among other things, the development, pre-clinical and
clinical testing, manufacturing, labeling, storage, pre-market approval,
advertising, promotion, sale, and distribution of our drug product candidates.
We rely on third parties to perform a variety of functions, including research
and development, clinical trial management and testing, and manufacturing of our
drug product candidates.  We currently obtain the necessary raw
materials for our drug product candidates, as well as certain services, such as
testing, from third parties. We currently contract with suppliers and service
providers that are required to comply with strict standards established by us.
Certain suppliers and service providers are required to follow good laboratory
practices, or GLP, good clinical practices, or GCP, and current good
manufacturing practices, or cGMP, requirements and are subject to routine
unannounced periodic inspections by the FDA and by certain state and foreign
regulatory agencies for compliance with those requirements and other applicable
regulations. There can be no assurance that the FDA and other regulatory
agencies will find the manufacturing process or facilities or other operations
of our suppliers and other service providers to be in compliance with GLP, GCP,
cGMP, or other applicable requirements.




25




While to
our knowledge none of our principal suppliers or service providers has been
found to be out of compliance with GLP, GCP, cGMP, or other applicable
requirements with respect to the goods or services they provide to us, failure
of any of our principal third party suppliers or service providers to maintain
satisfactory compliance with applicable requirements could have a material
adverse effect on our ability to develop, market, and distribute our drug
product candidates in the future and, in the most serious cases, could result in
the issuance of warning letters, seizure or recall of drug products, criminal
prosecution, civil penalties, or closure of such manufacturing facilities until
compliance is achieved.




We
      have no sales and marketing personnel and do not yet have distribution
      organizations, processes or capabilities in place, which means we must
      either enter into agreements with third parties to provide such
      capabilities or we must develop such capabilities
    ourselves.




We
currently have no internal sales and marketing, and do not have distribution
resources. If we were ever to receive the required regulatory approvals for one
of our drug product candidates, of which there can be no assurance, we could
elect to market and sell our drug product candidates through distribution,
co-marketing, co-promotion, or licensing arrangements with third
parties.  If we elect to market our drug product candidates directly,
significant additional expenditures and management resources will be required to
develop an internal marketing or sales force. We have no historical experience
in establishing or maintaining an effective sales or marketing effort. If we
were ever to develop and obtain approval of a drug, and we decided to perform
sales and marketing activities ourselves, we could face a number of additional
risks, including, but not limited to:




·
            the
      inability to attract and retain a marketing or sales force with relevant
      pharmaceutical experience;




·
            the
      costs of establishing a marketing or sales force may not be recoverable if
      product revenues are lower than expected;
and




·
            there
      could be delays in product launch due to the time needed to develop and
      train an effective marketing organization or sales
  force.




On the
other hand, to the extent that we elect to enter into arrangements with third
parties for the marketing and sale of our drug product candidates, any economic
benefit we received would depend primarily on the efforts of these third
parties, and the resulting economic benefit received may be lower than if we
marketed our drug products directly. In addition, we may not be successful in
entering into sales and distribution relationships with third parties and, even
if we are successful, we may not control the amount and timing of marketing
resources such third parties devote to our drug product candidates.




There can
be no assurance that we would be able to establish an effective marketing or
sales force should we choose to do so. The inability to successfully employ
qualified marketing and sales personnel or to develop other sales and marketing
capabilities through third parties would be harmful to our overall business
operations.




We
      are currently named as a defendant in a number of securities class action
      lawsuits. The volatility of our stock increases the risk that additional
      securities class action litigation could be instituted against us in the
      future.




Securities
class action litigation is often brought against a company following periods of
volatility in the market price of its securities. We, along with certain of our
former officers, are currently named as defendants in a number of class action
lawsuits which have been consolidated for trial and are currently pending in the
U.S. District Court for the Northern District of Illinois, and each of which
alleges various violations of the federal securities laws in connection with
certain of our public statements as they relate to our LEP drug product
candidate. We may be named as a defendant in similar litigation in the future.
While we are vigorously defending this litigation, this litigation has resulted,
and can be expected to continue to result, in substantial costs and in a
diversion of management’s attention and our resources, which could harm our
business and financial condition, as well as the market price of our stock.
Moreover, it may result in an adverse judgment against us or a settlement,
either of which could require us to make a payment to the plaintiffs to the
extent a possible payment exceeds or is not covered by our
insurance.




26




Our
lack of operating experience may cause us difficulty in managing any future
growth.




We have no
historical experience in selling pharmaceutical or other products or in
manufacturing or procuring drug products in commercial quantities in compliance
with FDA rules and we have only limited experience in negotiating, establishing
and maintaining collaborative relationships and conducting later stage phases of
the regulatory approval process. Our ability to manage our growth, if any, will
potentially require us to maintain, improve and expand our management and our
operational and financial systems and controls. If our management is unable to
manage growth effectively, our business and financial condition would be
adversely affected. In addition, if rapid growth occurs, it may strain our
operational, managerial and financial resources, which are
limited.




We
      depend on intellectual property rights licensed from third parties. If we
      fail to meet our obligations under our license agreements, or if
      technology licensed to us is subject to the rights of others, we could
      lose our rights of exclusivity of use to key technologies on which our
      business depends.




Our
business depends on our technology, which is based in part on patents and patent
applications licensed from third parties. Those third-party license agreements
impose obligations on us, such as payment obligations and obligations to
diligently pursue development of commercial products under the licensed rights.
The field of use of our license agreement regarding Cintredekin Besudotox is the
use of Cintredekin Besudotox to treat cancer.  Though the license
requires us to engage in clinical trials of the compound in patients with renal
cell carcinoma, previous trials demonstrated that Cintredekin Besudotox is toxic
in those patients. Therefore, we have instead focused on developing this
compound for treating patients with glioblastoma multiforme. We have informed
the governmental agency from which we licensed these patents of this change, and
we received no objections to it.




Because of
our dependence on intellectual property rights licensed to us by third parties,
any adverse development in our relationship with these licensors, including a
dispute regarding our rights under the agreements or the grant of rights by our
licensors to others, could materially and adversely affect our right to
commercialize the products we are developing or preclude others from
commercializing these products.




If a
licensor believes that we have failed to meet our obligations under a license
agreement, the licensor could seek to limit or terminate our licensed rights,
which could lead to costly and time-consuming litigation and, potentially, a
loss of the licensed rights. During the period of any such litigation, our
ability to carry out the development and commercialization of potential products
could be significantly and negatively affected. If our licensed rights were
restricted or ultimately lost, our ability to continue our business based on the
affected technology platform would be adversely affected.




We depend
in large part on our licensors to have and maintain the patent rights licensed
to us. Where our licensors cannot license technologies to us to the exclusion of
third parties, our competitive position could be impaired. In this regard, we
understand that co-rights to the technologies exclusively licensed to us by NIH
relating to Cintredekin Besudotox are claimed by one of the inventors, who has
subsequently entered into an agreement assigning such rights as he may have to a
third party. We are in the process of determining the nature of his claimed
rights and whether or not this assignment is valid.  We have
investigated the assignment and though it appears valid, an interinstitutional
agreement, or IIA, is in place between the third party and
NIH.  However, there is a risk that the IIA may be breached or is
invalid and the third party may then subsequently license the technology to
other parties.




We have
been granted “orphan drug” status with respect to the use of Cintredekin
Besudotox for malignant gliomas (a class of brain tumors which includes
glioblastoma multiforme), and we are thus potentially eligible to receive orphan
drug exclusivity upon approval.  In order to receive orphan drug
exclusivity, we must be the first CintredekinBesudotox product approved for
malignant glioma.  If we receive orphan drug exclusivity, it would
prevent the FDA for a period of seven years from approving another sponsor’s
marketing application for the same drug for the same indication, except that a
subsequent applicant with the same drug could be approved if it demonstrated its
product was clinically superior to our product or if we were unable to
manufacture sufficient supplies of product.   If it were
determined that we do not have exclusive rights to the technology licensed to us
by NIH, we might be unable to preclude third parties - during or after any
period of orphan drug exclusivity - from commercializing a drug based on
Cintredekin Besudotox for other indications.  Competing Cintredekin
Besudotox products, if suitable, could be prescribed by physicians for malignant
glioma, even though not FDA-approved for that use.  This could cause
our business to suffer.  Moreover, if it were determined that we do
not have exclusive rights to the technology licensed to us by NIH, a third party
might be able to develop a Cintredekin Besudotox based drug for the treatment of
malignant glioma.  If this competitor completed its clinical trials
before we complete ours, the FDA could approve that competitor’s product first
and give it seven years of market exclusivity.  In such a case, we
might not be allowed to market our product in the United States for seven
years.  Further, even if we receive seven years of market exclusivity,
other applicants could receive approval of compounds other than Cintredekin
Besudotox for malignant glioma, which would compete with our
product.






27




It should
be noted that, even if it were determined at a future date that we do not have
exclusivity with respect to the patents and patent applications licensed from
NIH, we have also filed various additional patent applications related to the
methods of administration and use of Cintredekin Besudotox which are not part of
the NIH patents. While we believe that patents that may eventually be granted
under these patent applications would provide us with additional exclusivity of
use for Cintredekin Besudotox, these patent applications are still pending, may
not be granted, and are subject to the risks described herein relating to
patents in general.




If
      we are unable to adequately protect our proprietary technologies this
      could harm our competitive position and have a material adverse effect on
      our business.




The
success of our business depends, in part, on our ability to obtain patents and
maintain adequate protection of our intellectual property for our proprietary
technology and products in the United States and other countries. The laws of
some foreign countries do not protect proprietary rights to the same extent as
the laws of the United States, and many companies have encountered significant
problems in protecting their proprietary rights in these foreign countries.
These problems can be caused, for example, by a lack of rules and processes
allowing for meaningful defense of intellectual property rights. If we do not
adequately protect our intellectual property, competitors may be able to use our
technologies and impair our competitive position, with the result that our
business and operating results could be harmed.




The patent
positions of pharmaceutical companies, including our patent positions, are often
uncertain and involve complex legal and factual questions. We will be able to
protect our proprietary rights from unauthorized use by third parties only to
the extent that our proprietary technologies are covered by valid and
enforceable patents or are effectively maintained as trade secrets. We apply for
patents covering our technologies and drug product candidates, as we deem
appropriate. Currently, we either own or have obtained licenses to more than 25
United States patents and patent applications relating to our technology,
compounds, and drug product candidates, many of which have foreign counterparts
either as issued patents or pending patent applications. However, we may not
obtain patents on all inventions for which we seek patents, and any patents we
obtain may be challenged and may be narrowed in scope or extinguished as a
result of such challenges. Our existing patents and any future patents we obtain
may not be sufficiently broad to prevent others from practicing our technologies
or from developing competing products. Others may independently develop similar
or alternative technologies or design around our patented technologies or drug
product candidates. These companies would then be able to develop, manufacture,
and sell products, which compete directly with our drug product candidates. In
that case, our revenues and operating results would decline.




We rely
upon trade secret protection for certain of our confidential information,
including certain of our trade secrets, know-how, technology advances and
processes. While we have taken measures to protect our confidential information,
and to date have not experienced any difficulties in maintaining the
confidentiality of our information, these measures may not provide adequate
protection for our trade secrets, know-how or other confidential information in
the future. We seek to protect our confidential information by entering into
confidentiality agreements with employees, collaborators, and consultants.
Nevertheless, employees, former employees, collaborators, or consultants may
still disclose or misuse our confidential information, and we may not be able to
meaningfully protect our trade secrets. In addition, others may independently
develop substantially equivalent information or techniques or otherwise gain
access to our trade secrets. Disclosure or misuse of our confidential
information would harm our competitive position and could cause our revenues and
operating results to decline.




We
      may be sued for infringing on the intellectual property rights of
      others.




Our
commercial success also depends in part on ensuring that we do not infringe the
patents or proprietary rights of third parties. The biotechnology industry has
produced a proliferation of patents, and it is not always clear to industry
participants, including us, which patents cover various types of products. The
coverage of patents is subject to interpretation by the courts, and the
interpretation is not always uniform. While we have not been sued for infringing
the intellectual property rights of others, there can be no assurance that the
drug product candidates that we have under development do not or will not
infringe on the patent or proprietary rights of others. Third parties may assert
that we are employing their proprietary technology without authorization. We
know of patents issued to third parties relating to antisense and
oligonucleotide technology, including patents about which such third parties
have communicated with us suggesting possible infringement, but the claims of
which we believe we do not infringe or are invalid. Moreover, United States
patent applications filed in recent years are confidential for 18 months,
while older applications are not published until the patent issues. Further,
some applications are kept secret during the entire length of their pendency by
request of the applicant in special circumstances. As a result, there may be
patents of which we are unaware, and avoiding patent infringement may be
difficult. Patent holders sometimes send communications to a number of companies
in related fields, suggesting possible infringement, and we, like a number of
biotechnology companies, have received this type of communication. If we are
sued for patent infringement, we would need to demonstrate that we either do not
infringe the patent claims of the relevant patent and/or that the patent claims
are invalid, which we may not be able to do. Proving invalidity, in particular,
is difficult since it requires a showing of clear and convincing evidence to
overcome the presumption of validity enjoyed by issued patents. Parties making
claims against us may be able to obtain injunctive or other equitable relief
that could effectively block our ability to further develop, commercialize and
sell products, and such claims could result in the award of substantial damages
against us. In the event of a successful claim of infringement against us, we
may be required to pay damages and obtain one or more licenses from third
parties. We may not be able to obtain these licenses at a reasonable cost, if at
all. In that event, we could encounter delays in product introductions while we
attempt to develop alternative methods or products or be required to cease
commercializing affected products, thereby harming our operating
results.




28




In the
future, others may file patent applications covering technologies that we may
wish to utilize with our proprietary technologies, or products that are similar
to products developed with the use of our technologies. If these patent
applications result in issued patents and we wish to use the claimed technology,
we would need to obtain a license from the third party, and this would increase
our costs of operations and harm our operating results.




We
      may in the future be a party to patent litigation, which could be
      expensive and divert our management’s
attention.




The field
of biotechnology has been characterized by extensive litigation regarding
patents and other intellectual property rights, and companies in the industry
have used intellectual property litigation to gain a competitive advantage. We
may become a party to patent infringement claims and litigation, re-examinations
of any of our issued patents at the U.S. Patent and Trademark Office that may
invalidate the patents or interference proceedings declared by the US Patent and
Trademark Office to determine the priority of inventions. The defense and
prosecution of these matters are both costly and time consuming. We may need to
commence proceedings against others to enforce our patents, trade secrets or
other know-how, to file requests for re-examination of others’ issued patents
that may interfere with our freedom to operate or defend against claims of
infringement asserted against us, which would require investigation and
determination of the enforceability, scope and validity of the respective
proprietary rights. These proceedings could result in substantial expense to us
and significant diversion of efforts by our technical and management
personnel.




We
      have lost key management personnel and may be unable to attract and retain
      the talent required for our business, and therefore our business could be
      harmed.




Since
January 1, 2007, we have had substantial turnover in our personnel at all
levels, but particularly among our senior management ranks, with all of the
named executive officers serving as of that date having either resigned or been
terminated.  With the exception of the position of President and Chief
Executive Officer, we have not yet filled several of these
positions.  At the present time, we are highly dependent on our
President and Chief Executive Officer, Mr. Laurence P. Birch, who is also
serving as our Acting Chief Financial Officer.  Our Chief Medical
Officer, Dr. Jeffrey W. Sherman left us effective June 18, 2007 and we are
postponing a search for a replacement until our clinical trial activity
necessitates full-time oversight.  Dr. Aquilur Rahman, one of the
founders of our Company, has been retained as an outside consultant and will
function as the Company’s Chief Scientific Officer and will work with the rest
of the team to oversee our clinical activities.  In September 2007,
Dr. Shahid Ali was appointed Executive Vice President, Research and
Development.  Dr. Ali will work in the area of preclinical activities
as well as being responsible for developing a pathway forward for the Company’s
drug portfolio.  Mr. Timothy Walbert’s position as Executive
VP-Commercial Operations was no longer considered vital to current operations of
the Company given the problems in the commercialization of Cintredekin Besudotox
and, as a result, the position was eliminated as part of the April 2007 cost
reduction initiative.  Mr. Walbert left us effective May 31,
2007.




Mr. Birch
has a written employment contract with us, which also provides post termination
benefits as described therein. We do not have key man insurance on any of our
management.  If we were to lose the services of Mr. Birch, or are
unable to replace other key members of our senior executive staff, including our
consultant, Dr. Rahman, our product development and achievement of our strategic
objectives could be delayed.  In addition, our success will depend on
our ability to attract and retain qualified commercial, scientific, technical,
and managerial personnel.  Given the large turnover in our employees,
and the recent set backs in our various clinical trials, it is expected that
recruiting additional personnel and retaining our existing personnel will be
more difficult,  No assurance can be given that we will be able to
retain existing personnel or attract and retain qualified staff in the
future.




29




The
      demand for our drug product candidates, if any, may be adversely affected
      by health care reform and potential limitations on third-party
      reimbursement.




In recent
years, there have been numerous proposals to change the health care system in
the U.S. Some of these proposals have included measures that would limit or
eliminate payments for medical procedures and treatments or subject the pricing
of pharmaceutical products to government control. We cannot predict the effect
that health care reforms may have on our business, and it is possible that such
reforms will hurt our business. In addition, in both the U.S. and elsewhere,
sales of prescription pharmaceutical products are dependent in part on the
availability of reimbursement to the consumer from third party payors, such as
government and private insurance plans. Third party payors are increasingly
challenging the prices charged for medical products and services with respect to
new drug products in particular. If we succeed in bringing any of our drug
product candidates to the market, we cannot be certain that our products will be
considered cost effective or that reimbursement to the consumer will be
available or will be sufficient to allow us or our collaborators to sell our
products on a competitive basis.




In
addition, many health maintenance organizations and other third party payors use
formularies, or lists of drugs for which coverage is provided under a health
care benefit plan, to control the costs of prescription drugs. Each payor that
maintains a drug formulary makes its own determination as to whether a new drug
will be added to the formulary and whether particular drugs in a therapeutic
class will have preferred status over other drugs in the same class. This
determination often involves an assessment of the clinical appropriateness of
the drug and sometimes the cost of the drug in comparison to alternative
products. We cannot be assured that:




·
            our
      future drug products, if any, will be added to payors’
      formularies;




·
            such
      future drug products will have preferred status to alternative therapies;
      or




·
            the
      formulary decisions will be conducted in a timely
  manner.




We may
also decide to enter into discount or formulary fee arrangements with payors,
which could result in us receiving lower or discounted prices for drug products
we may develop in the future.




Physicians,
      patients, payors, or the medical community in general may be unwilling to
      accept, utilize, or recommend any of our drug product candidates, and the
      failure to achieve market acceptance will harm our
    business.




Even if
approved for marketing, our drug product candidates may not achieve market
acceptance. The degree of market acceptance of our drug product candidates will
depend upon a number of factors, including:




·
            the
      establishment and demonstration in the medical community of the safety and
      clinical efficacy of our drug product candidates and their potential
      advantages over existing therapeutic products, including current
      treatments for GBM and  non-liposomal forms of the active agents
      included in our drug products; and




·
            pricing
      and reimbursement policies of government and third party payors such as
      insurance companies, health maintenance organizations and other plan
      administrators.




Material
      weaknesses or deficiencies in our internal control over financial
      reporting could harm stockholder and business confidence in our financial
      reporting, our ability to obtain financing, and other aspects of our
      business.




Our
management evaluated the effectiveness of the design and operation of our
disclosure controls and procedures as of the three months ended March 31, 2007,
June 30, 2007, and September 30, 2007 and concluded that our disclosure controls
and procedures were not effective as of those dates, because of the material
weakness in our internal control over financial
reporting.  Specifically, management had concluded that the Company’s
accounting staff did not have sufficient expertise in the area of U.S. GAAP and
SEC financial rules.  A material weakness is a control deficiency, or
combination of control deficiencies that results in more than a remote
likelihood that a material misstatement of the annual or interim financial
statements will not be prevented or detected.  A description of the
material weakness that existed as of those dates related to our inadequate
controls over financial reporting, and the various remedial measures that are
designed to improve our internal controls over financial reporting that have
been implemented, tested and deemed to be operating effectively as of December
31, 2007 is set forth above in Part I, Item 9A(T) “Controls and
Procedures”.




30




Internal
control over financial reporting can provide only reasonable and not absolute
assurance that deficiencies o r
weaknesses are identified. Additionally, potential control deficiencies that are
not yet identified could emerge and internal controls that are currently deemed
to be in place and operating effectively are subject to the risk that those
controls may become inadequate because of changes in conditions, or that the
degree of compliance with the policies or procedures may deteriorate.
Identification and corrections of these types of potential control deficiencies
could have a material impact on our business, financial position, results of
operations and disclosures and impact our ability to raise
funds.


Our
      investments could lose market value and consequently harm our ability to
      fund continuing operations.
  The
primary objective of our investment activities is to preserve principal while at
the same time maximizing yields without significantly increasing risk. To
achieve this objective, we maintain our portfolio of cash, cash equivalents and
short-term investments in a variety of securities, including auction rate
certificates, which are used by many student-loan providers, municipalities and
other governmental authorities to raise cash to fund projects or operations, and
money market funds. These auction rate certificates all have AAA/aaa credit
ratings, consistent with our investment policy guidelines, and have long-term
nominal maturities for which the interest rates are reset through periodic
auctions every 7 to 28 days.  The market values of these investments
may fluctuate due to market conditions and other conditions over which we have
no control. Fluctuations in the market price and valuations of these securities
may require us to record losses due to impairment in the value of the securities
underlying our investment. This could result in future charges to our earnings.
All of our investment securities are denominated in US dollars.
  All of the
auction rate certificates we held at December 31, 2007 experienced successful
auctions as of their initial reset dates in January and early February
2008.  As a result of the liquidity issues experienced in the global
credit and capital markets, some of the auction rate certificates held by the
Company in February 2008 have experienced failed auctions.  An auction
failure is not a default.  An auction failure means that the parties
wishing to sell securities could not because the number of sellers was greater
than the number of buyers on the reset dates.  Because the investments
typically have provisions such that the interest rates reset at higher
percentages upon failure in the auction market, the issuers have a strong
incentive to restructure and repurchase the underlying
bonds.  However, this process could take time and as a result, our
ability to liquidate our investment and fully recover the carrying value of the
investment in the near term may be limited or non-existent.  If the
issuers are unable to successfully close future auctions and their current AAA
credit rating deteriorates, we may in the future be required to record an
impairment charge on these investments.  If we are required to sell
these securities in order to meet cash needs in markets other than a successful
auction, we could be required to accept less than the face value and therefore,
recognize a loss.  In such an event, we may be required to seek
alternative funding if we are unable to liquidate our securities on a timely
basis.
  Investments
in both fixed-rate and floating-rate interest earning instruments carry varying
degrees of interest rate risk. Fixed-rate securities may have their fair market
value adversely impacted due to a rise in interest rates. In general, securities
with longer maturities are subject to greater interest rate risk than those with
shorter maturities. While floating-rate securities generally are subject to less
interest rate risk than fixed-rate securities, floating-rate securities may
produce less income than expected if interest rates decrease. Due in part to
these factors, our investment income may fall short of expectations or we may
suffer losses in principal if securities are sold that have declined in market
value due to changes in interest rates.
  We
      handle hazardous materials and must comply with environmental laws and
      regulations, which can be expensive and restrict how we do business. We
      could also be liable for damages, penalties, or other forms of censure if
      we are involved in a hazardous waste spill or other
    accident.
  Our
research and development processes involve the controlled storage, use, and
disposal of hazardous materials and biological hazardous materials. We are
subject to federal, state, and local laws and regulations governing the use,
manufacture, storage, handling, and disposal of hazardous materials and certain
waste products. Although we believe that our safety procedures for handling and
disposing of these hazardous materials comply with the standards prescribed by
law and regulation, the risk of accidental contamination or injury from
hazardous materials cannot be completely eliminated. In the event of an
accident, even by a third party, we could be held liable for any damages that
result, and such liability could exceed our current general liability insurance
coverage of $1,000,000 and our financial resources. In the future, we may not be
able to maintain insurance on acceptable terms, or at all. We could also be
required to incur significant costs to comply with current or future
environmental laws and regulations.
  We
      may have product liability exposure, and insurance against such claims may
      not be available to us at reasonable rates or at
  all.
  While we
maintain insurance to cover the use of our drug product candidates in clinical
trials, we currently do not have any product liability insurance for marketed
human therapeutic products. Although we plan to obtain product liability
insurance when and if any of our drug product candidates become commercially
available, we cannot assure you that we will be able to obtain or maintain this
insurance on acceptable terms or that any insurance we obtain will provide us
with adequate coverage against potential liabilities. Claims or losses in excess
of any liability insurance coverage we obtain could have a material adverse
effect on our business.
  31
  Anti-takeover
      provisions could make a third party acquisition of us or the removal of
      our board of directors or management more
  difficult.
  In
June 2003, we adopted a stockholder rights plan that provided for the
issuance of rights to purchase shares of our Series A Participating
Preferred Stock, the Series A Preferred. Under the plan, we distributed one
preferred share purchase right for each outstanding share of common stock. Each
purchase right entitles the holder to purchase from us one one-thousandth
(1/1000th) of a share of Series A Preferred at a price of $112.00 per
share, subject to adjustment. The rights become exercisable, with certain
exceptions, ten business days after any party, without prior approval of our
Board of Directors, acquires, or announces an offer to acquire, beneficial
ownership of 15% or more of our common stock. An exception to this policy exists
in the case of our largest shareholder, Dr. John N. Kapoor, who, along with
parties affiliated with him, is permitted to acquire up to 30% of our common
stock without triggering the rights issuance. In the event that any party
acquires 15% or more of our common stock (other than Dr. Kapoor for whom
the threshold is 30%), we are acquired in a merger or other business
combination, or 50% or more of our assets are sold after the time that the
rights become exercisable, the rights provide that each right holder will
receive, upon exercise, shares of the common stock of the surviving or acquiring
company, as applicable, having a market value of twice the exercise price of the
right. The stockholder rights plan may discourage or prevent certain types of
transactions involving an actual or potential change in control, which
transactions may be beneficial to our shareholders, by causing substantial
dilution to a party that attempts to acquire us on terms not approved by our
Board of Directors. In addition, Section 203 and other provisions of the
Delaware General Corporation Law as well as provisions of our charter and
by-laws could make a takeover of us or the removal of the members of the board
of directors or management more difficult.
  The
      issuance of preferred stock could adversely affect the holders of our
      common stock.
  Our board
of directors has the authority, without further stockholder approval, to issue
from time to time shares of preferred stock in one or more designated series or
classes. Depending upon the rights and preferences which may be granted to any
class of preferred shares which we may elect to issue, issuance of preferred
stock could adversely affect the voting power of holders of our common stock and
reduce the likelihood that our common stockholders will receive dividend
payments and payments upon liquidation. The issuance of preferred stock could
also decrease the market price of our common stock, or have terms and conditions
that could discourage a takeover or other transaction that might involve a
premium price for our shares or that our stockholders might believe to be in
their best interests.
  If
      there are substantial sales of common stock, the market price of our
      common stock could decline.
  Sales of
substantial numbers of shares of common stock could cause a decline in the
market price of our stock. We have filed Form S-8 registration statements
registering shares issuable pursuant to our equity compensation plans. Any sales
by existing stockholders or holders of options may have an adverse effect on our
ability to raise capital and may adversely affect the market price of our common
stock.
  ITEM 1B.
              UNRESOLVED
      STAFF COMMENTS
  None
  ITEM 2.
              PROPERTIES
  The
Company’s administrative offices and pre-clinical research and development
personnel are currently located in approximately 35,500 square feet of leased
space in Waukegan, Illinois.  With the lease on the present facility
expiring at March 31, 2008, the Company has signed a new lease for space in a
facility located in Lake Bluff, Illinois.  In the new facility, we
will have 12,600 square feet of space for our offices and research and
development laboratories.  We moved into the new facility in the first
quarter of 2008.
  ITEM 3.
              LEGAL
      PROCEEDINGS
  In
December 2006, we were advised by the staff of the U.S. Securities and Exchange
Commission, the SEC, that the SEC’s investigation of the Company, which the
Company believe concerned the Company’s disclosures regarding the development of
its LEP and LED drug product candidates, had been terminated and no enforcement
action had been recommended.  The decision by the SEC to terminate its
investigation is not a finding or judgment regarding the matters
investigated.
  32
 NeoPharm,
Inc. and certain of our former officers have been named in a consolidated
amended complaint, which alleges various violations of the federal securities
laws in connection with our public statements regarding our LEP drug product
candidate during the period from October 31, 2001 through April 19,
2002.  On November 4, 2002, we moved to have the complaint
dismissed. Our motion to dismiss was granted in part and denied in part in
February 2003.  In November 2004, the plaintiffs filed a
motion to amend and a motion for summary adjudication. The motion to amend seeks
to include certain pre-class period statements in the complaint. The motion for
summary adjudication asks the Court to rule that certain statements made in an
arbitration award regarding the LEP drug product candidate be deemed facts
established in this proceeding. On February 23, 2007, the Court entered an order
denying both the plaintiffs’ motion to amend and the plaintiffs’ motion for
summary adjudication.  Fact and expert discovery is closed and the
dispositive motion filing deadline was March 21, 2008.  No trial date
has yet been set.  We intend to vigorously defend each and every claim
in the complaint.  Management is unable to estimate the potential
outcome or range of possibilities, if any.  In addition, we maintain
insurance coverage to mitigate the financial impact of any potential
loss.
  The
employment of Mr. Guillermo Herrera, the former CEO of the Company, was
terminated effective March 23, 2007.  Since that date, he has
retained counsel and on May 7, 2007, Mr. Herrera’s attorney filed a suit
entitled Guillermo Herrera vs.
NeoPharm, Inc., Case No. 2007 L 004711 in the Circuit Court of Cook
County, Illinois, seeking payment of $212,500 for his 2006 bonus and $25,000 for
a salary increase for 2007.  Subsequent to this filing, the Company
determined that under the terms of his employment agreement the Company should
not be responsible for the payment of severance and terminated further
payments.  Mr. Herrera filed an Amended Complaint on February 21, 2008
alleging breach of his employment agreement with the Company, defamation, and
tortiously presenting him in a false light.  Mr. Herrera seeks an
additional $363,612 representing the remaining severance payments, plus
attorneys’ fees and costs.  Mr. Herrera also seeks unspecified
compensatory and punitive damages.  The Company is vigorously
defending this matter. We are unable at this time to make any prediction as to
the outcome of this litigation.
  ITEM 4.
              SUBMISSION
      OF MATTERS TO A VOTE OF SECURITY
HOLDERS
  No matters
were submitted to a vote of security holders during the quarter ended December
31, 2007.
  EXECUTIVE
OFFICERS OF NEOPHARM
  The
following persons were executive officers of NeoPharm as of March 14,
2008:
  Laurence P. Birch,48,  joined  NeoPharm in March 2007 as President,
Chief Executive Officer and as a director  and was appointed Acting
Chief Financial Officer in April 2007.  Prior to joining the Company,
Mr. Birch served as Sr. Vice President and CFO, and Interim President and CEO,
of AKSYS, Ltd., a hemodialysis developer and manufacturer from 2005 to
2006.  Prior to that, Mr. Birch served as co-founder and managing
director of Stratego Partners, a cost management consulting firm, from 2003 to
2005, Sr. Vice President — Business Development and CFO of Technology Solutions,
Inc., a systems integration and consulting company, from 2000 to
2002,  CFO of Brigade, Inc., an internet support company, from 1999 to
2000, and five years with MCI Systemhouse where he held a variety of senior
finance and general management positions.   Mr. Birch began his
career with Baxter Healthcare, a manufacturer and supplier of pharmaceuticals
and medical devices, where, over the course of 13 years, he held a variety of
positions.  Mr. Birch is a director of DataTrak International, Inc., a
provider of technology and services to the clinical trial industry. Mr. Birch
holds a Bachelor of Science-Finance from the University of Illinois and a MBA
from Northwestern University — Kellogg Graduate Business of
Management.  Mr. Birch is also a Certified Public
Accountant.
  Dr. Shahid Ali,57, Executive
Vice President, Research and Development, joined NeoPharm in January 2001, as
Associate Director of Research and Development. Since joining the Company, he
has held positions of increasing responsibility in Research and Development.
Previously, Dr. Ali was a Group Leader at EpiGenesis Pharmaceuticals Inc. where
he directed pre-clinical program for antisense oligonucleotide based therapeutic
intervention in pulmonary diseases including bronchial asthma. Prior to
EpiGenesis, Dr. Ali spent 10 years at School of Medicine, East Carolina
University, most recently serving as an Associate Research Professor in the
departments of Medicine/Pharmacology. Dr. Ali received his M.S and Ph.D degrees
from Lucknow University, Lucknow, India.
  Officers
are appointed to serve annually, subject to the discretion of the Board of
Directors, or until their successors are appointed. There are no family
relationships between any of our directors or executive officers.
  33
  PART II
  ITEM 5.
              MARKET
      FOR THE REGISTRANT’S COMMON EQUITY, RELATED STOCKHOLDER MATTERS, AND
      ISSUER PURCHASES OF EQUITY
SECURITIES
  The
Company’s common stock is listed on the NASDAQ Global Market under the symbol
NEOL. The following table provides the high and low sales prices as reported on
the exchange on which the Company’s stock was listed for the periods
indicated.
  2007
              
              High
              
              
              LowFirst
      Quarter
              
              $
              2.37
              
              
              $
              1.40Second
      Quarter
              
              
              1.87
              
              
              
              1.12Third
      Quarter
              
              
              1.47
              
              
              
              0.87Fourth
      Quarter
              
              
              1.64
              
              
              
              0.58
 
  2006
              
              High
              
              
              LowFirst
      Quarter
              
              $
              12.67
              
              
              $
              8.25Second
      Quarter
              
              
              8.51
              
              
              
              4.80Third
      Quarter
              
              
              5.61
              
              
              
              4.32Fourth
      Quarter
              
              
              8.49
              
              
              
              1.66
  As of
February 29, 2008, there were 50 holders of record of the common stock. The
calculation of holders of record was based on reports received from
Computershare Investor Services LLC, the Company’s transfer agent, based on
information provided by the holders of record, and maintained by the transfer
agent.
  Dividends
  The
Company has never paid a cash dividend on its common stock and has no present
intention of paying cash dividends in the foreseeable future. Any determination
in the future to pay cash dividends will depend on the Company’s financial
condition, capital requirements, results of operations, contractual limitations
and other factors deemed relevant by the Board of Directors.
  Equity
      Compensation Plan Information
  The
information called for by Item 5(a) relating to related stockholder information
is incorporated herein by reference to Item 12 – Security Ownership of Certain
Beneficial Owners and Management and Related Stock Matters.
  34
 Performance
      Graph
  The
following graph compares the percentage change in cumulative total stockholder
return on NEOPHARM’s Common Stock with the cumulative return on the NASDAQ Stock
Market Index and the NASDAQ Pharmaceutical Stock Index during the period
beginning December 31, 2002 through December 31, 2007.  The price of
the Common Stock as reflected in the graph has been adjusted to reflect a 15%
stock dividend paid in June 2003.  The below comparison assumes that
$100 was invested on December 31, 2002 in each of the Company’s Common Stock and
presented indices and assumes the reinvestment of dividends.
  Cumulative
      Total Return
  (in
dollars)
   
 Performance Information:
                12/31/2002
                12/31/2003
                12/31/2004
                12/31/2005
                12/31/2006
                12/31/2007NeoPharm,
      Inc.
                100
                207
                142
                122
                19
                7NASDAQ
      Market Index-U.S. Cos.
                100
                150
                163
                166
                183
                198NASDAQ
      Pharmaceutical Index
                100
                147
                156
                172
                168
                177
  35
  ITEM 6.
              SELECTED
      FINANCIAL DATA
  The
following selected three-year financial data is derived from our consolidated
financial statements included in Item 15 of Part IV of this Form
10-K.
  For
      the Years Ended December 31,2007
                
                
                2006
                
                
                2005Statement
      of Operations Data:Revenue
                
                $
                -
                
                
                $
                11,000
                
                
                $
                543,000Loss
      from operations
                
                
                (14,430,000
                )
                
                
                (35,735,000
                )
                
                
                (40,231,000
                )Other
      income
                
                
                2,000,000
                
                
                
                -
                
                
                
                -Interest
      income
                
                
                1,429,000
                
                
                
                2,527,000
                
                
                
                1,506,000Net
      loss
                
                $
                (11,001,000
                )
                
                $
                (33,208,000
                )
                
                $
                (38,725,000
                )Net
      loss per basic and diluted share
                
                $
                (0.39
                )
                
                $
                (1.20
                )
                
                $
                (1.64
                )As
      of December 31,2007
                
                
                2006
                
                
                2005Balance
      Sheet and Other Data:Cash,
      cash equivalents and short-term
      investments
                
                $
                20,781,000
                
                
                $
                38,587,000
                
                
                $
                30,262,000Working
      capital(1)
                
                
                17,279,000
                
                
                
                29,637,000
                
                
                
                21,608,000Total
      assets
                
                
                22,252,000
                
                
                
                40,689,000
                
                
                
                33,370,000Accumulated
      deficit
                
                
                (272,234,000
                )
                
                
                (261,233,000
                )
                
                
                (228,025,000
                )Total
      stockholders' equity
                
                
                18,253,000
                
                
                
                28,871,000
                
                
                
                21,945,000
  (1)
              Working
      capital is calculated as current assets minus current
      liabilities.
  ITEM 7.
              MANAGEMENT’S
      DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF
      OPERATIONS
  The
following discussion of our financial condition and results of operations should
be read together with our consolidated financial statements and notes to those
statements included in Item 15 of Part IV of this Form 10-K.
  Overview
  We are a
biopharmaceutical company engaged in the research, development, and
commercialization of drugs for the treatment of various cancers and other
diseases.  Our corporate office and research and development facility
is currently located in Waukegan, Illinois and we had 17 active employees as of
December 31, 2007.
  Since we
began business in June 1990, we have principally devoted our resources to
funding research and product development programs. To date, we have not received
United States Food and Drug Administration, or FDA, approval of any of our drug
product candidates. We expect to continue to incur losses for the foreseeable
future as we continue our research and development activities, which include the
sponsorship of human clinical trials for our drug product candidates. If and
until we are able to consistently generate profitable revenue through the sale
of drug or non-drug products, we anticipate that we will continue to be required
to fund the development of our pre-clinical compounds and drug product
candidates primarily by other means, including, but not limited to, selling
stock in the Company, licensing the development rights to some of our drug
product candidates to third parties, or collaborating with third parties to
develop formulations of their compounds using our technology.
  In
December 2006, we announced that the Phase III PRECISE trial of Cintredekin
Besudotox in the treatment of glioblastoma multiforme did not meet the primary
endpoint at 215 deaths, which was a statistically significant difference, or
separation, in the overall survival curves compared with the Gliadel Wafer®, or
Gliadel.
  In March
2007, the FDA concluded that an additional Phase III trial would be required
prior to acceptance of a potential BLA filing by the Company.  The
requirement to conduct a second Phase III trial will substantially delay, or
even prevent, the potential commercialization of the product.  The
Company is currently exploring the possibility of undertaking an initial Phase
III confirmatory trial for Cintredekin Besudotox with the primary objective of
overall survival and a secondary objective of progression free survival for
patients with recurrent GBM against the standard of care.  If
satisfactory results were obtained in such an initial Phase III confirmatory
trial, and additional resources to fund the project were secured, the Phase III
confirmatory trial might be expanded in the hope of obtaining results that would
support the submission of a BLA for Cintredekin Besudotox to the
FDA.  No prediction can be given as to the results of any initial
Phase III confirmatory trial that might be undertaken or the Company's ability
to secure additional financing to possibly expand such an initial trial if such
an expansion were to be warranted.
  36
 In 2007,
we reassessed and reprioritized our Cintredekin Besudotox and NeoLipid® platform
and strategy to focus our NeoLipid development efforts on LE-SN38, LEP-ETU,
LE-DT and LErafAON.  In addition we licensed Cintredekin Besudotox for
the treatment of interstitial pulmonary fibrosis, or IPF, and
asthma.
  LEP-ETU is
our NeoLipid® liposomal formulation of the widely used cancer drug,
paclitaxel.  Paclitaxel, also known as Taxol® (Bristol-Myers Squibb
Company), has been approved in the US for the treatment of ovarian, breast and
lung cancers.  The Company expects to initiate patient enrollment
early in the second quarter of 2008 in a Phase II trial designed to assess the
safety and efficacy of LEP-ETU in recurrent breast cancer patients in the first
quarter of 2008.  Depending on the outcome of those clinical trials,
we may decide to undertake multicenters and multinational Phase III trials in
this indication after thorough discussions with the FDA.
  LE-SN38 is
our NeoLipid® liposomal
formulation of SN-38, the active metabolite of Camptosar® (Pfizer Inc.), a
chemotherapeutic pro-drug, which is used as a first-line and second-line
colorectal cancer treatment.  On March 30, 2007, the Company announced
that the interim analysis of data following the completion of treatment of the
first 21 patients demonstrated disease stabilization, but the study did not
achieve its primary endpoint of tumor response endpoint.  The Company
is also assessing the potential  next steps for this project including
additional data analyses and the possibility of other studies related to lung
cancer and breast cancer with LE-SN38.
  Pre-clinical
work has also advanced on our earlier stage liposomal formulation of the
anti-cancer agent docetaxel, LE-DT, which is the active ingredient in Sanofi
Aventis’ Taxotere® which is approved for use in certain breast cancer, non-small
cell lung cancer, gastric adenocarcinoma, head and neck cancer indications and
prostate cancer. We intend to start a
Phase I trial with LE-DT to define the toxicities, pharmacokinetics and maximum
tolerated dose with this new modality of treatment in the second quarter of
2008.
  Preclinical
work with the new formulation of LE-rafAON, which is expected to have minimal
infusion related toxicities, is ongoing and we expect to submit a revised IND to
the FDA in the second or third quarter of 2008.
  The
Company has recently licensed Cintredekin Besudotox from NIH, FDA, and
University of Michigan as a potential therapeutic agent for the treatment of
pulmonary fibrosis and asthma.  We are currently conducting
preclinical studies, and we plan to submit an IND to the FDA in the second half
of 2008 .  The FDA has indicated it will require significant studies
in animals to explore potential side effects in humans, before the agency will
permit the clinical testing to begin.
  It
is difficult to predict with any certainty the timing of and total estimated
costs to complete development of drug product candidates in early stage, or
Phase I/II, clinical development, as well as the estimated date such drug
product candidates would be available for sale, if approved by the FDA or
foreign regulatory agencies. A number of factors contribute to this uncertainty,
including: side effects encountered in early stage clinical trials, ability to
scale up manufacturing for commercial supply, and the fact that the size and
scope of pivotal Phase III clinical trials are unknown until sufficient data is
available to present a Phase III plan to the FDA for approval. In addition, our
drug product candidates are required to be approved by the FDA after completing
Phase III clinical trials before we can sell the drugs to generate revenue and,
potentially, realize net cash inflows. Substantial additional clinical trial
expenses will also be incurred for Cintredekin Besudotox before approval can be
sought again because the FDA has concluded that an additional Phase III trial
will be required prior to acceptance of a potential BLA filing.
  37
  The table
below includes a summary of identified direct project costs incurred to date for
our major research and development projects. Generally, identified project costs
include expenses incurred specifically for clinical trials and pre-clinical
studies we conduct, and exclude expenses incurred for salaries paid to our
professional staff, facility overhead expenses and general laboratory supplies
used in our research, which are included with non-project specific.
  Total
      Direct Costs IncurredResearch
      Project
                
                2007
                
                
                2006
                
                
                2005
                
                
                Since
      Beginning of ProjectCintredekin
      Besudotox
                
                $
                1,248,000
                
                
                $
                11,534,000
                
                
                $
                15,755,000
                
                
                $
                67,507,000LEP-ETU
                
                
                207,000
                
                
                
                876,000
                
                
                
                2,684,000
                
                
                
                7,790,000LE-SN38
                
                
                88,000
                
                
                
                254,000
                
                
                
                506,000
                
                
                
                5,316,000LE-DT
                
                
                545,000
                
                
                
                -
                
                
                
                -
                
                
                
                545,000LE-rafAON
                
                
                71,000
                
                
                
                -
                
                
                
                -
                
                
                
                71,000Non-project
      specific and other
                
                
                4,211,000
                
                
                
                8,535,000
                
                
                
                12,906,000
                
                
                
                N/ATotal
      research and development expenses
                
                $
                6,370,000
                
                
                $
                21,199,000
                
                
                $
                31,851,000
                
                
                
                N/A
  Results
      of Operations
  Year
      Ended December 31, 2007 as compared to Year Ended December 31,
      2006
  There was
no product revenue for the year ended December 31, 2007, as compared to $11,000
for the year ended December 31, 2006.  The sole source of the $11,000 in
product revenue in 2006 was from sales of NeoPhectin and
NeoPhectin-AT.
  Research
and development, or R&D, expense for the year ended December 31, 2007
decreased by $14.8 million, to $6.4 million, compared to $21.2 million for the
same period in 2006.  The decrease is attributed to a $3.5 million
reduction in payroll and benefits expenses, primarily attributed to the
Company’s various cost reduction initiatives implemented during 2006 and 2007
and an $10.5 million decrease in overall project costs.  The decrease
in overall project costs is primarily attributed to decreases in the PRECISE
trial and Initial Diagnosis GBM Phase I trial expenditures and product
manufacturing costs in connection with decision to bring the phase III trial to
an early conclusion, and the advancement of our NeoLipid® products from a
pre-clinical status.  Product manufacturing costs decreased $4.8
million and sites costs, data management and third party contract services
decreased by a combined $6.5 million. Included in this decrease was a $0.9
million adjustment to reduce accrued clinical trial expenses for the PRECISE
trial from the estimated costs provided as patients were enrolled in the trial
to the actual final trial costs.  Included in accounts payable at
December 31, 2007 are $0.9 million in unpaid trial costs, which are expected to
be paid in the first half of 2008.
  Selling,
general, and administrative, or SG&A, expenses decreased $6.7 million, to
$7.4 million for the year ended December 31, 2007, compared to $14.1 million for
the same period in 2006.  The decrease is attributed to a $2.4 million
decrease in personnel costs, primarily attributed to the Company’s various cost
reduction initiatives implemented during 2006 and 2007.  With the
reduction in people and cost containment measures put into effect, the Company
has been able to realize reductions in spending in accounting, legal,
consulting, travel expenses, equipment lease costs, board of director
compensation, and office supplies totaling $4.3 million.
  The change
in fair value of derivative financial instruments of $(0.1) million during the
year ended December 31, 2007 was attributed to a decrease in valuation of stock
options granted to non-employee consultants prior to 2000 resulting from the
Company’s stock value declining to $0.59 per share at December 31, 2007 from
$1.67 per share at December 31, 2006.   Similarly, the Company
recorded a credit to earnings of  $(1.6) million in the year ended
December 31, 2006, resulting from a decrease in the Company’s stock price from
$10.79 at December 31, 2005 to $1.67 per share at December 31,
2006.
  38
 Following
the Company’s announcement on March 29, 2007 that an additional Phase III
clinical trial will be required before FDA will consider approving its drug
product candidate, Cintredekin Besudotox, the Company initiated an
organizational realignment in April 2007 which reduced the workforce by 16
employees to a total of 19 employees.  In the fourth quarter of 2007,
the workforce was further reduced by 1 more employee.  The Company’s
organizational realignment resulted in a total charge to earnings of $0.6
million for 2007.  At December 31, 2007, the Company had 17
employees.   Similarly the Company reduced its workforce at
various times during 2006 by a total of 40 employees.  Aggregate 2006
employee termination costs were $1.5 million.  The Company currently
has 17 employees.
  Facility
consolidation costs for the year ended December 31, 2007 were $0.5
million.  They resulted from an impairment charge to reduce the
carrying value of fixed assets, primarily furniture and fixtures to their
estimated net realizable value of $0.3 million and an additional $0.2 million
was recognized for the cost of restoration of our Waukegan facility to its
original condition.  In the year ended December 31, 2006, we recorded
$0.3 million as the remaining lease exposure on the Lake Forest, Illinois
facility that we had vacated and wrote off $0.1 million in related equipment and
leasehold improvements.
  The
Company sold computer and scientific equipment, which had minimal book value,
and realized a $0.3 million gain for the year ended December 31,
2007.
  The
Company recognized $2 million of other income in 2007 related to the reversal of
a deferred fee associated with the Nippon Kayaku Co, Ltd license
agreement.  As discussed in Note 1, in the Revenue Recognition
section,, the Company received notification on September 11, 2007 that Nippon
Kayaku had terminated the licensing agreement they had entered into with the
Company in 2004.  Accordingly, the non-refundable license fee of $2
million paid to the Company in 2005 and previously recorded as deferred revenue
was recognized as other income.
  The
Company generated interest income on cash and available for sale securities of
$1.4 million and $2.5 million for the years ended December 31, 2007 and 2006,
respectively.  The decrease in interest income during the period was
primarily due to a decrease in average short-term investment balances, which
were used to fund operations.
  Year
      Ended December 31, 2006 as compared to Year Ended December 31,
      2005
  The sole
source of product revenue in both 2006 and 2005 was from limited sales of our
NeoPhectin products and, in 2005, from recognition of $0.5 million in revenue
resulting from NeoPhectin collaboration fees.
  Generally,
our 2006 results of operations reflect the benefit of recent cost
rationalization initiatives, reduced clinical trial expense following the
December 2005 completion of enrollment in the Phase III PRECISE trial and our
activities, and the timing of those activities, to prepare Cintredekin Besudotox
for potential commercialization in the event the Company decides to seek
approval.  Accordingly, in 2006 the mix of expenses shifted from
Research and Development activities to Selling, General and Administrative
activities reflecting our focus during the year on preparing for the possibility
of launching our first product.
  Research
and development, or R&D, expense decreased by $10.7 million, to $21.2
million, in 2006 as compared to 2005 due primarily to reduced costs related to
the Cintredekin Besudotox Phase III PRECISE trial which completed patient
enrollment in December 2005, advancement of NeoLipid products from the lab into
the clinic and to the 2006 reprioritization of R&D spending and related
headcount reductions, partially offset by a $0.7 million increase in R&D
expense related to employee stock compensation due to our 2006 adoption of
Statement of Financial Accounting Standards, or SFAS, SFAS No. 123 (revised
2004), Share-Based Payment, or SFAS 123(R).
  Selling,
general and administrative, or SG&A, expenses increased $2.7 million, to
$14.1 million, in 2006 due primarily to initiation of exploratory
commercialization efforts for Cintredekin Besudotox and to $0.6 million in
share-based compensation expense resulting from our 2006 adoption SFAS 123(R),
partially offset by $0.5 million in 2005 expense related to our licensing of
Cintredekin Besudotox rights in Japan to Nippon.
  In 2006,
following our adoption of SFAS 123(R), we recorded a $1.6 million benefit, due
primarily to the impact of a decline in our stock price on the estimated fair
value of derivative financial instruments, relating to stock options previously
granted to non-employee consultants.
  Employee
termination, lease and fixed asset write-offs related to the 2006 organizational
changes and the July 2006 consolidation of our facilities resulted in a $2.0
million charge. During the first nine months of 2006, we reduced our workforce
by 26 associates under an organizational realignment initiative.  In
May 2006, Dr. Imran Ahmad resigned as the Company’s Executive Vice President and
Chief Scientific Officer and, in accordance with the terms of his original offer
letter, Dr. Ahmad received a twelve-month salary continuation and a separation
payment of $20,000.  Additionally, in June 2006, we entered into a
separation and consulting agreement with our former Chief Financial Officer, Mr.
Larry Kenyon which became effective August 31, 2006.  Under this
agreement, Mr. Kenyon received a nine-month salary continuation, reimbursement
of medical and dental coverage and his previously granted options continued to
vest during the consulting period.  In December 2006, we completed an
additional organizational realignment initiative which resulted in a workforce
reduction of 14 positions, or approximately 20% of the workforce at that
time.  Aggregate 2006 employee termination costs related to 2006
reorganization and separation agreements were $1.5 million.  Accrued
but unpaid employee termination costs at December 31, 2006 totaled $0.4 million
and were paid in 2007.
  39
 In May 2005, we accepted $2.5 million as
payment in full for all outstanding principal and interest due and owing on a
promissory note that we had previously assessed to be fully
impaired.  As a result of the payment, in 2005 we recorded a $2.5
million benefit as Recovery of Note Receivable.
  The Company generated interest income on
cash and investments of $2.5 million and $1.5 million in 2006 and 2005,
respectively.  The 2006 increase in interest income was primarily due
to an increase in average cash and short-term investment balances as a result of
a secondary public stock offering in January 2006 and to higher short-term
interest rates in 2006 than in 2005.
  Liquidity
      and Capital Resources
  Net cash
used in operating activities decreased $13.5 million from $31.2 million to $18.0
million for the year ended December 31, 2006 and 2007,
respectively.  The decrease in cash used by operations was primarily a
result of the lower net loss in the year ended December 31,
2007.  This was offset by a decrease in the deferred fee related to
the recognition of revenue for a non-refundable license fee that had been paid
to the Company in 2005, and by a significant reduction in accounts payable and
accrued expense balances which were paid down in 2007.
  In
January 2006, the Company completed the sale of 4,025,000 shares of our
common stock to the public. Proceeds to the Company were $39.0 million net of
underwriting fees but before expenses. The proceeds from this sale of stock were
invested in available for sale securities and are being used to fund clinical
trials of our drug product candidates; preclinical studies for other potential
drug product candidates; and for working capital, capital expenditures, and
other general corporate purposes.  The Company continues to draw down
proceeds from sales of these securities during both 2007 and 2006 to fund such
activities.
  Our
primary source of cash has been proceeds from issuance of our common shares and
interest earned on the investment of the stock issuance proceeds.  As
of December 31, 2007, we had $1.0 million in cash and cash equivalents and
$19.8 million in available for sale securities, consisting solely of
auction rate certificates, which have historically provided us liquidity
characteristics similar to cash equivalents.  Refer to the Risk Factor
regarding market value of investments.
  Our
primary use of cash over the next 12 to 18 months is expected to fund, in
addition to general and administrative expenses,  advancement of
Cintredekin Besudotox and our NeoLipid® clinical and pre-clinical research and
development efforts and our remaining Cintredekin Besudotox Phase III clinical
trial patient obligations.
  As a
result of the April 2007 cost reduction initiative coupled with other ongoing
cost-cutting initiatives, the Company was able to reduce selling, general and
administrative expenditures for 2007 as planned by $6.7 million compared to
2006.  The total cost reductions implemented and planned, before
consideration of project costs and certain legacy costs are expected to result
in annualized cash consumption rate of approximately $5.0 million. The Company
currently projects it has sufficient cash available to fund operations in 2008
and well into 2009 before requiring additional financing.  The date as
to which sufficient funds continue to be available for operations, without
additional financing, may vary depending upon the timing and implementation of
various strategies under consideration by the Company.
  Additionally,
due to the significant uncertainty in the credit markets subsequent to year end,
we are currently unable to liquidate some of our auction rate securities which
are collateralized by student loans.  We are unable at this time to
estimate the impact, if any, which emerging credit market conditions may have on
the liquidity of our auction rate certificates.
  We may
seek to meet future funding requirements through public or private offerings of
securities or with collaborative or other development or licensing arrangements
with corporate or private venture partners. Additional financing may not be
available when needed or on terms acceptable to us, if at all.  If
adequate financing is not available, we may be required to further delay, scale
back, or eliminate certain of our research and development programs, relinquish
rights to certain of our technologies, drugs or products, or license our
products or technologies to third parties that we would otherwise seek to
develop ourselves.
  40
  We have no
exposure to off-balance sheet arrangements, no special purpose entities, or
activities that include non-exchange-traded contracts accounted for at fair
value.
  The
following table summarizes our estimated contractual obligations as of December
31, 2007:
  Payments Due by PeriodContractual
      Obligations
                
                Total
                
                
                Less
      than one year
                
                
                1-3
      Years
                
                
                3-5
      Years
                
                
                More
      than five yearsOperating
      lease
                
                $
                2,201,000
                
                
                $
                348,000
                
                
                $
                644,000
                
                
                $
                550,000
                
                
                $
                659,000Capital
      lease
                
                
                117,000
                
                
                
                38,000
                
                
                
                79,000
                
                
                
                -
                
                
                
                -Manufacturing
      commitments (1)
                
                
                1,831,000
                
                
                
                -
                
                
                
                1,831,000
                
                
                
                -
                
                
                
                -License
      agreements—milestone based payments(2)(3)
                
                
                3,076,000
                
                
                
                556,000
                
                
                
                2,349,000
                
                
                
                114,000
                
                
                
                57,000Total
                
                $
                7,225,000
                
                
                $
                942,000
                
                
                $
                4,903,000
                
                
                $
                664,000
                
                
                $
                716,000
  (1)
              These
      amounts include guaranteed contractual commitments related to retaining
      our capability for the potential manufacture of Cintredekin
      Besudotox.
  (2)
              These
      amounts do not include potential sales-based royalty payments that may be
      required under the various license
agreements.
  (3)
              Milestone-based
      payment obligations are contingent upon successfully reaching objectively
      determinable stages in the development of drug product candidates. The
      Company has estimated the period the payments may be due, if at all, based
      upon its expectations of the timeline for continued successful development
      of the drug product candidates.
  Recent
      Accounting Pronouncements
  In
September 2006, the FASB issued SFAS No. 157, “Fair Value Measurements.”
SFAS No. 157 defines fair value, establishes a framework for measuring fair
value, and expands disclosures about fair value measurements.  SFAS
No. 157 is effective for financial statements issued for fiscal years
beginning after November 15, 2007.  In February of 2008, the FASB
issued FASB Staff position 157-2 which delays the effective date of SFAS 157 for
non-financial assets and liabilities which are not measured at fair value on a
recurring basis (at least annually) until fiscal years beginning after November
15, 2008.  The Company is currently evaluating the impact of the
adoption of SFAS No. 157 on its consolidated financial statements and note
disclosures.
  In
February 2007, the FASB issued SFAS No. 159, “The Fair Value Option for Financial
Assets and Financial Liabilities.”  SFAS No. 159 allows
entities the option to measure eligible financial instruments at fair value as
of specified dates.  Such election, which may be applied on an
instrument by instrument basis, is typically irrevocable once
elected.  SFAS No. 159 is effective for financial statements
issued for fiscal years beginning after November 15, 2007 and will become
effective for us beginning with the first quarter of 2008.   The
Company is currently evaluating the impact of the adoption of SFAS No. 157
on its consolidated financial statements and note disclosures.
  In
December 2007, the FASB issued SFAS No. 160, “Non-Controlling Interests in
Consolidated Financial Statements an amendment of ARB No. 51”
(“SFAS 160”).  SFAS 160 establishes new standards for the
accounting for and reporting of non-controlling interests (formerly minority
interests) and for the loss of control of partially owned and consolidated
subsidiaries.  SFAS 160 does not change the criteria for
consolidating a partially owned entity.  SFAS 160 is effective
for fiscal years beginning after December 15, 2008.  The
provisions of SFAS 160 will be applied prospectively upon adoption except
for the presentation and disclosure requirements which will be applied
retrospectively.  The Company does not expect the adoption of
SFAS 160 will have a material impact on its consolidated financial
statements.
  In
December 2007, the FASB issued SFAS No. 141(revised 2007)
(“SFAS 141R”), a revision of SFAS 141, “Business
Combinations.”  SFAS 141R establishes requirements for the
recognition and measurement of acquired assets, liabilities, goodwill, and
non-controlling interests.  SFAS 141R also provides disclosure
requirements related to business combinations.  SFAS 141R is
effective for fiscal years beginning after December 15,
2008.  SFAS 141R will be applied prospectively to business
combinations with an acquisition date on or after the effective
date.
  41
 Critical
      Accounting Policies
  In
preparing the Company’s financial statements in conformity with U.S. generally
accepted accounting principles, management must make a variety of decisions
which impact the reported amounts and related disclosures. Such decisions
include the selection of the appropriate accounting principles to be applied,
the assumptions on which to base accounting estimates and the consistent
application of those principles. Due to the type of industry in which we operate
and the nature of our business, the following policies are those that management
believes are the most important to the portrayal of our financial condition and
results and that require management’s most difficult, subjective or complex
judgments, often as a result of the need to make estimates about the effect of
matters that are inherently uncertain.
  Income
      Taxes
  In
assessing the realizability of deferred tax assets, management considers whether
it is more likely than not that some portion or all of the deferred tax assets
will not be realized. The ultimate realization of deferred tax assets is
dependent upon the generation of future taxable income during the periods in
which those temporary differences become deductible. Management considers the
scheduled reversal of deferred tax liabilities, projected future taxable income,
and tax planning strategies in making this assessment. Significant judgments are
required to estimate the generation of future taxable income and the timing of
the reversal of deferred tax liabilities.
  Contingencies
  To
properly account for and provide disclosure of loss contingencies, management
must apply judgment in determining whether a loss contingency is: probable,
reasonably possible, or remote. In instances where management has determined
that a loss contingency is probable, it must make use of estimates to determine
the amount of probable loss. Management must apply judgment in determining
whether or not it can make a reasonable estimate. Management must also apply
judgment in determining whether or not disclosure of loss contingencies that
have been accrued should be made for the consolidated financial statements not
to be misleading.
  Share-based
      Compensation
  We account
for share-based compensation in accordance with SFAS No. 123 (revised 2004),
Share-Based Payment, or
SFAS 123(R).  Under the provisions of SFAS 123(R), share-based
compensation cost is estimated at the grant date based on the award’s fair value
as calculated by the Black-Scholes option-pricing model and is recognized as
expense over the requisite service period.  We also use the
Black-Scholes model to estimate the fair value of non-employee options grants
that are revalued each quarter.  The Black-Scholes model requires
various highly judgmental assumptions including volatility and expected option
life.  If any of the assumptions used in the Black-Scholes model
change significantly, share-based compensation expense may differ materially in
the future from that recorded in the current period.
  Revenue
      Recognition
  We follow
the provisions as set forth by current accounting rules, which primarily include
Staff Accounting Bulletin, or SAB, 104, Revenue Recognition,and
Emerging Issues Task Force, or EITF, No. 00-21, Accounting for Revenue Arrangements
with Multiple Deliverablesin recognition of revenue.Generally, revenue is
recognized when evidence of an arrangement exists, delivery has occurred or
services have been rendered, the price is fixed and determinable, and
collectibility is reasonably assured.
  In the
past we have provided for general rights of return of products sold to our
distributors. Appropriately determining revenue recognition when the general
right of return exists requires the use of judgment in estimating the level of
returns. In certain circumstances, we may not be able to develop a reasonable
estimate of the level of returns. Making such a determination requires the use
of significant judgment. We have determined that given the limited sales history
of NeoPhectinTM, we are unable to develop a reasonable estimate of the level of
expected returns. Accordingly, we recognized revenue for products shipped to
distributors upon the expiration of the right of return, which occurred upon the
earlier of the shipment by the distributor to an end user or, depending on the
distributor, 60 to 180 days.
  We have
entered in collaboration and license agreements with third parties that contain
multiple deliverables. Under the provisions of EITF 00-21, a determination must
be made on each contract as to whether a deliverable constitutes a separate unit
of accounting. The amount of revenue to be recognized is based on the fair value
for each unit of accounting within the arrangement. Management’s judgment is
required to determine, based upon the facts and circumstances of each
arrangement, whether or not each deliverable has standalone value and whether or
not there exists a sufficient level of objective and reliable evidence of fair
value of the undelivered items.  Additionally, units of accounting may
be delivered over an indeterminate period of time.  Management
judgment is required to estimate the period over which recognition of allocated
revenue occurs.
  42
 Available
for Sale Securities
  Available
for sale securities consist of auction rate certificates that have scheduled
maturities greater than 90 days at the time of purchase.  We believe
the structural features of the auction rate certificates provide us with
liquidity characteristics similar to cash equivalents.  As provided by
Statement of Financial Accounting Standards, or SFAS, No. 115, Accounting for Certain Investment in
Debt and Equity Securities, we have elected to treat all of our
investments in marketable securities as “available-for-sale,” which requires
that these investments be recorded at fair market value. However, given the
interest rate reset features of our auction rate certificates, the carrying
value of our short-term investment represents their fair
value.  Dividend and interest income are recognized when
earned.
  The
auction rate certificates are used by many student-loan providers,
municipalities and other governmental authorities to raise cash to fund projects
or operations, and money market funds. These auction rate certificates all have
AAA/aaa credit ratings, consistent with our investment policy guidelines, and
have long-term nominal maturities for which the interest rates are reset through
periodic auctions every 7 to 28 days.  The market values of these
investments may fluctuate due to market conditions and other conditions over
which we have no control. Fluctuations in the market price and valuations of
these securities may require us to record losses due to impairment in the value
of the securities underlying our investment. This could result in future charges
to our earnings. All of our investment securities are denominated in US
dollars.
  All of the
auction rate certificates we held as of December 31, 2007 experienced successful
auctions as of their initial reset dates in 2008.  As a result of the
liquidity issues experienced in the global credit and capital markets, the
auction rate certificates currently held by the Company have experienced failed
auctions as there have been no purchasers as of the reset
dates.  Because these investments typically have provisions for their
interest rates to reset to high percentages upon failure in the auction market,
the issuers have a strong incentive to restructure and repurchase the underlying
bonds.  However, the time for new debt securities to be issued in place of
the auction rate certificates is unknown. A secondary market may also develop in
which certain investment firms would purchase these investments at some discount
from their par value, and be able to ride out their inability to liquidate them
in the short term.
  43
 ITEM 7A.
              QUANTITATIVE
      AND QUALITATIVE DISCLOSURES ABOUT MARKET
RISK
  As of
December 31, 2007, we did not own any derivative instruments, but we were
exposed to market risks, primarily the impact of changes in United States
interest rates on our short-term investments. As of December 31, 2007, we held
total cash and cash equivalents of $1,022,000 and available for sale securities
of auction rate certificates of $19,759,000.  All cash equivalents
have a maturity less than 90 days. Declines in interest rates over time would
reduce our interest income from our investments. Based upon our cash, cash
equivalents, and short-term investments as of December 31, 2007, a decrease in
interest rates of 1.0% would cause a corresponding decrease in our annual
interest income of approximately $200,000.
  The market
values of these available for sale securities may fluctuate due to market
conditions and other conditions over which we have no
control.  Fluctuations in the market price and valuations of these
securities may require us to record losses due to impairment in the value of the
securities underlying the investment.  This could result in future
charges to our earnings.  Refer to Note 14 of our financial statements
for further discussion regarding a failure of a portion of our available for
sale securities in the auction markets subsequent to year end.
  ITEM 8.
              FINANCIAL
      STATEMENTS AND SUPPLEMENTAL DATA
  The
Financial Statements are incorporated herein by reference to the Company’s
Consolidated Financial Statements included as follows:
  PageReports
      of Independent Registered Public Accounting Firms
              
              52Consolidated
      Balance Sheets
              
              54Consolidated
      Statements of Operations
              
              55Consolidated
      Statements of Stockholders’ Equity
              
              56Consolidated
      Statements of Cash Flows
              
              57Notes
      to Consolidated Financial Statements
              
              58
 
  ITEM 9.
              CHANGES
      IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL
      DISCLOSURES
  During
2007, the Company dismissed its independent accounting firm KPMG LLP (KPMG),
which became effective July 5, 2007.  As reported in the Company’s
Form 8-K filed on July 6, 2007, (1) there was no disagreement between the
Company and KPMG on any matter of accounting principles or practices, financial
statement disclosure, or auditing scope or procedure, which disagreement, if not
resolved to the satisfaction of KPMG would have caused it to make a reference to
the subject matter of the disagreement(s) in connection with its report, and (2)
the Company did not have any reportable events as described under Item 304
(a)(1)(iv) of Regulation 8-K.  On July 5, 2007, the Company engaged
BDO Seidman, LLP, as its independent registered public accounting firm for the
fiscal year ended December 31, 2007, as reported in the Company’s Form
8-K.
  There were
no disagreements with accountants on accounting or financial disclosures in the
past two fiscal years.
  ITEM 9A(T).
              CONTROLS
      AND PROCEDURES
  DISCLOSURE
      CONTROLS AND PROCEDURES
  Ourdisclosure
controls and procedures are designed to ensure that information required to be
disclosed in the reports that we file or submit under the Securities Exchange
Act of 1934, as amended, is recorded, processed, summarized and reported within
the time periods specified in the Securities and Exchange Commission’s rules and
forms, including ensuring that such information is accumulated and communicated
to management as appropriate to allow timely decisions regarding required
disclosure.  We necessarily apply judgment in assessing the costs and
benefits of such controls and procedures that, by their nature, can only provide
reasonable assurance regarding management’s control objectives.
  44
 Our
President and Chief Executive Officer/Acting Chief Financial Officer, has
carried out an evaluation, with the participation of our management and outside
consultants, of the effectiveness of the Company’s disclosure controls and
procedures (as defined in Rule 13a-15(e) of the Securities Exchange Act of
1934), as of the end of the period covered by this report, based on the
evaluation required by paragraph (b) of Rule 13a-15 under the Securities
Act of 1934.
  As of
September 30, 2007 and for the nine months then ended, management had concluded
that a material weakness in control over financial reporting existed because the
Company had not maintained sufficient staff with any consistency or appropriate
training in US GAAP and SEC financial rules and
regulations.  This deficiency resulted in the potential of material
misstatements and/or inadequate disclosures in the Company’s financial
statements.  As a result of this material weakness, management
concluded that internal controls over financial reporting were not effective as
of September 30 and for the nine months then ended, based on the criteria
identified above.
  Our
management has discussed the material weakness described above and other
potential deficiencies with our Audit Committee.  We have taken a
number of steps to improve our internal controls over financial reporting and
correct this material weakness.  We hired a full-time Controller in
November 2007 and are continuing to engage a third party financial advisory firm
to assist us in both the proper accounting and disclosures related SFAS 123R
Share-Based Payment as well as other  GAAP and SEC reporting matters
as necessary.  In addition, given the earlier reduction in force and
the depleted resources in the accounting function, the Company continued to
utilize outside consultants to assist with the financial accounting function and
to perform additional procedures as deemed necessary to compensate for the
deficiencies.
  At
December 31, 2007, these deficiencies were considered to be remediated as the
new internal controls were operational for a period of time , were tested, and
management concluded that the controls are operating effectively at that
time.
  INTERNAL
      CONTROL OVER FINANCIAL REPORTING
  Management’s
      Report on Internal Control over Financial
  Reporting
  The
management of NeoPharm, Inc. (the Company), including the Company’s
President and Chief Executive Officer, who is also the acting Chief Financial
Officer, is responsible for establishing and maintaining adequate internal
control over financial reporting.
  The
Company’s internal control over financial reporting is a process designed to
provide reasonable assurance to the Company’s management and Board of Directors
regarding the reliability and preparation of published financial statement in
accordance with U.S. generally accepted accounting principles.  All
internal control systems, no matter how well designed, have inherent
limitations.  Therefore, even those systems determined to be effective
can provide only reasonable assurance with respect to financial statement
preparation and presentation and may not prevent or detect
misstatements.  Also, projections of any evaluation of effectiveness
to future periods are subject to the risk that controls may become inadequate
because of changes in conditions, or that the degree of compliance with the
policies or procedures may deteriorate.
  The
Company’s management assessed the effectiveness of the company’s internal
control over financial reporting as of December 31, 2007.  In making
this assessment, the Company used the criteria set forth in Internal Control – Integrated
Framework issued by the Committee of Sponsoring Organization of the
Treadway Commission (“COSO”).  Based on management’s assessment, the
Company believes that as of December 31, 2007, the Company’s internal control
over financial reporting is effective based on the criteria established in Internal Control – Integrated
Framework.
  This
annual report does not include an attestation report of the Company's registered
public accounting firm regarding internal control over financial reporting.
Management's report was not subject to attestation by the Company's registered
public accounting firm pursuant to temporary rules of the Securities and
Exchange Commission that permit the company to provide only management's report
in this annual report.
  Changes
      in Internal Control over Financial
Reporting
  Our
management has discussed the material weakness described above and other
potential deficiencies with our Audit Committee.  We have taken a
number of steps to improve our internal controls over financial reporting and
correct this material weakness.  We hired a full-time Controller in
November 2007 and are continuing to engage a third party financial advisory firm
to assist us in both the proper accounting and disclosures related SFAS 123R
Share-Based Payment as well as other  GAAP and SEC reporting matters
as necessary.  In addition, given the earlier reduction in force and
the depleted resources in the accounting function, the Company continued to
utilize outside consultants to assist with the financial accounting function and
to perform additional procedures as deemed necessary to compensate for the
deficiencies.
  45
 ITEM 9B.
              OTHER
      INFORMATION
  None.
  PART III
  ITEM 10.
              DIRECTORS,
      EXECUTIVE OFFICERS AND CORPORATE
GOVERNANCE
  Information
regarding the Directors of the Company is incorporated by reference to the
information under the caption “Election of Directors” in the Company’s Proxy
Statement for the 2008 Annual Meeting of Stockholders, (the “2008 Proxy
Statement”) required to be filed within 120 days of the Company’s fiscal year
end of December 31, 2007.
  Information
regarding the Executive Officers of the Company can be found in Part I Item
4 of this annual report on Form 10-K.
  Information
regarding the Audit Committee Financial Expert is incorporated by reference to
the information under the caption “Report of the Audit Committee” in the 2008
Proxy Statement, required to be filed within 120 days of the Company’s fiscal
year end of December 31, 2007.
  Information
regarding the identification of the Audit Committee is incorporated by reference
to the information under the caption “Board of Directors and Its Committees” in
the 2008 Proxy Statement, required to be filed within 120 days of the Company’s
fiscal year end of December 31, 2007.
  Information
regarding compliance with Section 16(a) of the Exchange Act is
incorporated by reference to the information under the caption
“Section 16(a) Beneficial Ownership Reporting Compliance” in the 2008
Proxy Statement, required to be filed within 120 days of the Company’s fiscal
year end of December 31, 2007.
  Information
regarding the Company’s Code of Ethics that applies to the Company’s Chief
Executive Officer, Chief Financial Officer, and key financial and accounting
personnel is incorporated by reference to the information under the caption
“Corporate Governance Policies and Practices” in the 2008 Proxy Statement,
required to be filed within 120 days of the Company’s fiscal year end of
December 31, 2007.
  ITEM 11.
              EXECUTIVE
      COMPENSATION
  The
information required by this item as to executive compensation is hereby
incorporated by reference from the information appearing under the captions
“Executive Compensation,” “Compensation of Directors” and “Election of
Directors-Compensation Committee Interlocks and Insider Participation” in the
2008 Proxy Statement required to be filed with the Commission within 120 days of
the Company’s fiscal year end of December 31, 2007.
  ITEM 12.
              SECURITY
      OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED
      STOCKHOLDER MATTERS
  The
information required by this item as to the ownership of management and others
of securities of the Company is hereby incorporated by reference from the
information appearing under the caption “Security Ownership” in the 2008 Proxy
Statement, required to be filed with the Commission within 120 days of the
Company’s fiscal year end of December 31, 2007.
  46
  The
following table sets forth certain information as of December 31, 2007 with
respect to compensation plans under which shares of NEOPHARM’s common stock may
be issued:
  Plan category
                
                Number
      of securities to be issued upon exercise of outstanding stock
      options
                
                
                Weighted-average
      exercise price of outstanding options
                
                
                Number
      of securites remaining available for future issuanceEquity
      compensation plans approved by stockholders
                
                
                1,252,326
                
                
                $
                5.35
                
                
                
                2,260,139Equity
      compensation plans not approved by stockholders
                
                
                -
                
                
                
                -
                
                
                
                -Total
                
                
                1,252,326
                
                
                $
                5.35
                
                
                
                2,260,139
  ITEM 13.
              CERTAIN
      RELATIONSHIPS AND RELATED
TRANSACTIONS
  The
information required by this item as to certain business relationships and
transactions with management and other related parties of the Company is hereby
incorporated by reference from the information appearing under the caption
“Certain Relationships and Related Transactions” in the 2008 Proxy Statement,
required to be filed with the Commission within 120 days of the Company’s fiscal
year ended December 31, 2007.
  ITEM 14.
              PRINCIPAL
      ACCOUNTING FEES AND SERVICES
  The
information required by this item as to expenses for principal accounting fees
and services incurred by the Company is hereby incorporated by reference from
the information appearing under the caption “Ratification of the Appointment of
Independent Registered Public Accounting Firm” in the 2008 Proxy Statement
required to be filed with the Commission within 120 days of the Company’s fiscal
year ended December 31, 2007.
  PART IV
  ITEM 15.
              EXHIBITS,
      FINANCIAL STATEMENT SCHEDULES
  (a)       The
following documents are filed as part of this Annual Report on Form 10-K
beginning on the pages referenced below:
  (1)          Financial
Statements:
  PageReports
      of Independent Registered Public Accounting Firms
              
              52Consolidated
      Balance Sheets
              
              54Consolidated
      Statements of Operations
              
              55Consolidated
      Statements of Stockholders’ Equity
              
              56Consolidated
      Statements of Cash Flows
              
              57Notes
      to Consolidated Financial Statements
              
              58
 (2)
  47
  (2)          Exhibits
  Item
15(a)(2) Exhibit List
  Exhibit
      Number
              
              Description
 3.1
              
              Amended
      and Restated Certificate of Incorporation(1), incorporated by reference
      fom Exhibit 3.1in the Company’s registration statement on Form S-3/A filed
      on Sepember 6,2000 (File No.
333-44396).
 3.1.1
              
              Amendment
      to the Amended and Restated Certificate of Incorporation incorporated by
      reference from Exhibit 3.01 contained in the Company’s Quarterly
      Report on Form 10-Q for the quarter ended June 30, 2002. (File
      No. 001-12493).3.2
              
              Amended
      and Restated Bylaws of the Company incorporated by reference from
      Exhibit 3.2 contained in the Company’s Current Report on
      Form 8-K filed September 7, 2004 (File
      No. 001-12493).4.1
              
              Specimen
      Common Stock Certificate incorporated by reference from Exhibit 4.3 in the
      Company’s registration statement on Form S-3 filed on October 1, 2003
      (File No. 333-109340).4.1.1
              
              Preferred
      Stock Rights Agreement between NeoPharm, Inc. and Computershare
      Investor Services L.L.C. dated as of June 30, 2003, incorporated by
      reference from Exhibit 4.1 contained in the Company’s Current Report
      on Form 8-K filed July 7, 2003 (File
      No. 001-12493).4.1.2
              
              First
      Amendment to Rights Agreement between NeoPharm, Inc. and
      Computershare Investor Services L.L.C. dated as of September 10,
      2004, incorporated by reference from the Company’s Current Report on
      Form 8-K filed September 24, 2004 (File
      No. 001-12493).4.1.3
              
              Second
      Amendment to Rights Agreement between NeoPharm, Inc. and
      Computershare Investor Services, L.L.C. dated as of November 11,
      2004, incorporated by reference from the Company’s Current Report on
      Form 8-K filed November 17, 2004 (File
      No. 001-12493).10.1
              
              Cooperative
      Research and Development Agreement between the Company and the National
      Cancer Institute dated September 13, 1993, incorporated by reference
      from Exhibit 10.4 in the Company’s registration statement on Form S-1
      (File No. 33-90516).10.2
              
              License
      Agreement between the Company and Georgetown University dated
      July 1990, incorporated by reference from Exhibit 10.5 to the
      Company’s registration statement on Form S-1 (File No.
      33-90516).10.3
              
              License
      Agreement between the Company and Georgetown University dated
      April 18, 1994, incorporated by reference from Exhibit 10.6 to the
      Company’s registration statement on Form S-1 (File No.
      33-90516).10.4
              
              Cooperative
      Research and Development Agreement between the Company and the Food and
      Drug Administration dated August 27, 1997, incorporated by reference
      from Exhibit 10.11 of the Company’s Annual Report on Form 10-K for the
      calendar year ended December 31, 1998.10.5
              
              License
      Agreement between the Company and the National Institute of Health dated
      September 23, 1997, incorporated by reference from Exhibit 10.12 of
      the Company’s Annual Report on Form 10-K for the calendar year ended
      December 31, 1998 (File No. 001-12493).*10.6
              
              1998
      Equity Incentive Plan incorporated by reference from Exhibit 4.1 to the
      Company’s registration statement on Form S-8 filed on October 30,1995
      (File No. 333-66365).10.7
              
              Amendment
      No. 1 dated January 22, 1999 to the License Agreement between
      the Company and Georgetown University dated January, 1990, incorporated by
      reference from Exhibit 10.18 of the Company’s Annual Report on Form 10-K
      for the calendar year ended December 31, 1998 (File No.
      001-12493).10.8
              
              Amendment
      No. 1 dated January 22, 1999 to the License Agreement between
      the Company and Georgetown University dated April 18, 1994,
      incorporated by reference from Exhibit 10.19 of the Company’s Annual
      Report on Form 10-K for the calendar year ended December 31, 1998 (File
      No. 001-12493).10.9
              
              Promissory
      Note dated as of December 20, 2001 by and between the Company and
      Akorn, Inc., incorporated by reference from Exhibit 10.2 to the
      Company’s Annual Report on Form 10-K for the fiscal year ended
      December 31, 2001.10.10
              
              Processing
      Agreement dated as of December 20, 2001 by and between the Company
      and Akorn, Inc., incorporated by reference from Exhibit 10.3 to
      the Company’s Annual Report on Form 10-K for the fiscal year ended
      December 31, 2001.10.11
              
              Subordination
      and Intercreditor Agreement dated as of December 20, 2001 by and
      between the Company and John N. Kapoor, as Trustee under the John N.
      Kapoor Trust, dated September 20, 1989, incorporated by reference
      from Exhibit 10.4 to the Company’s Annual Report on Form 10-K
      for the fiscal year ended December 31,
  2001.
   48
  Exhibit
      Number
                
                Description
 10.12
              
              Subordination,
      Standby and Intercreditor Agreement dated as of December 20, 2001 by
      and between the Company and the Northern Trust Company, incorporated by
      reference from Exhibit 10.5 to the Company’s Annual Report on
      Form 10-K for the fiscal year ended December 31,
      2001.*10.13
              
              Amendment
      to the 1998 Equity Incentive Plan, incorporated by reference from Appendix
      A to the Company’s Definitive Proxy Statement on Schedule 14A for the
      Annual Meeting of Stockholders held June 6, 2002.10.14
              
              Form of
      Amendment to Processing Agreement dated as of October 7, 2003 by and
      between NeoPharm, Inc. and Akorn, Inc., incorporated by
      reference from Exhibit 10.30 to the Company’s Annual Report on
      Form 10-K for the fiscal year ended December 31, 2003 (File No.
      001-12493).10.15
              
              Form of
      Amended and Restated Promissory Note dated as of October 7, 2003 by
      and between the Company and Akorn, Inc., incorporated by reference
      from Exhibit 10.31 to the Company’s Annual Report on Form 10-K
      for the fiscal year ended December 31, 2003 (File No.
      001-12493).10.16
              
              Subordination
      and Intercreditor Agreement dated as of October 7, 2003 by and
      between the Company and LaSalle Bank National Association., incorporated
      by reference from Exhibit 10.32 to the Company’s Annual Report on
      Form 10-K for the fiscal year ended December 31, 2003 (File No.
      001-12493).*10.17
              
              Form of
      Director and Executive Officer Indemnification Agreement of
      NeoPharm, Inc., as adopted on September 20, 2004, incorporated
      by reference from Exhibit 10.01 to the Company’s Current Report on
      Form 8-K filed September 30, 2004 (File
      No. 001-12493).10.18
              
              Sublicense
      and License Agreement between Nippon Kayaku Co., Ltd. and
      NeoPharm, Inc. dated as of December 28, 2004, incorporated by
      reference from Exhibit 10.01 to the Company’s Current Report on
      Form 8-K filed January 4, 2005 (File
      No. 001-112493).10.19
              
              Note
      Repayment Agreement by and between NeoPharm, Inc. and Akorn, Inc. dated
      May 16, 2005, incorporated by reference from Exhibit 10.01 to the
      Company’s Current Report on Form 8-K filed on May 20, 2005 (File
      No. 001-12493).10.20
              
              Modification
      to CRADA No. 26-97 by and between the NeoPharm, Inc. and FDA dated July
      25, 2005 incorporated by reference from Exhibit 10.1 to the Company’s
      Current Report on Form 8-K filed on August 11, 2005 (File
      No. 001-12493).*10.21
              
              Employment
      Agreement by and between NeoPharm, Inc. and Guillermo A. Herrera dated
      October 28, 2005, incorporated by reference from Exhibit 10.01 to the
      Company’s Current Report on Form 8-K filed on November 1, 2005 (File
      No. 001-12493).10.22
              
              License
      Amendment (L-226-1996/1) dated May 30, 2006, between NeoPharm, Inc. and
      the National Institute of Health, on behalf of the Public Health Service,
      amending License Agreement (L-226-1996/0), incorporated by reference from
      Exhibit 10.1 to the Company’s Current Report on Form 8-K filed June 5,
      2006 (File No. 001-12493).10.23
              
              License
      Amendment (L-024-2006/0) dated May 30, 2006, between NeoPharm, Inc. and
      the National Institute of Health, on behalf of the Public Health Service,
      incorporated by reference from Exhibit 10.3 to the Company’s Current
      Report on Form 8-K filed June 5, 2006 (File No.
  001-12493).*10.24
              
              The
      NeoPharm, Inc. 2006 Employee Stock Purchase Plan, incorporated by
      reference from Exhibit 10.1 to the Company’s Current Report on Form 8-K
      filed June 21,2006 (File No. 001-12493).*10.25
              
              The
      NeoPharm, Inc. 2006 Equity Incentive Plan, incorporated by reference from
      Exhibit 10.2 to the Company’s Current Report on Form 8-K filed June
      21,2006 (File No. 001-12493).*10.26
              
              Specimen
      Form of Award Agreement used to award Stock Options under the NeoPharm,
      Inc. 2006 Equity Incentive Plan, incorporated by reference from Exhibit
      10.2 to the Company’s Current Report on Form 8-K filed June 21, 2006 (File
      No. 001-12493).*10.27
              
              Non-employee
      Director Compensation, incorporated by reference from Exhibit 10.4 to the
      Company’s Current Report on Form 8-K filed June 21, 2006 (File No.
      001-12493).*10.28
              
              Terms
      of Employment by and between NeoPharm, Inc. and Ronald E. Pauli dated
      August 4, 2006, incorporated by reference from Exhibit 10.1 to the
      Company’s Current Report on Form 8-K filed on August 9, 2006 (File No.
      001-12493).
   49
  Exhibit
      Number
                
                Description
 10.29
              
              License Amendment
      (L-024-2006/1) dated August 21, 2006, between NeoPharm, Inc. and the
      Natioanl Institutes of Health, on behalf of the Public Health Serviceand the Department of Health and Human Services, amending License
      Agreement L-024-2006/0, incorporated by reference from Exhibit 10-1 to the
      Company Current Report on Form 8-K filed on August 23, 2006 (File No.
      12493).10.30
              
              Amendment
      No. 5 to Cooperative Research and Development Agreement No 26-97
      incorporated by reference from Exhibit 10.1 to the Company’s Current
      Report on Form 8-K filed November 11, 2006 (File No.
      001-12493).*10.31
              
              Employment
      agreement by and between NeoPharm, Inc. and Laurence P. Birch dated as of
      March 23, 2007, incorporated by reference from Exhibit 10.1 to the
      Company’s Current Report on Form 8-K filed on March 27, 2007 (File No.
      001-12493).*10.32
              
              Separation
      Agreement and Mutual Release, dated May 10, 2007, by and between NeoPharm,
      Inc. and Timothy P. Walbert, incorporated by reference from Exhibit 10.1
      to the Company’s Current Report on Form 8-K filed May 16, 2007 (File No.
      001-12493).*10.33
              
              Separation
      Agreement and General Release, dated May 24, 2007, by and between
      NeoPharm, Inc. and Jeffrey W. Sherman, incorporated by reference from
      Exhibit 10.1 to the Company’s Current Report on Form 8-K filed May 29,
      2007 (File No. 001-12493).*10.34
              
              NeoPharm,
      Inc. 2006 Equity Incentive Plan, as amended, incorporated by reference
      from Appendix A to the Company Proxy Statement on Schedule 14A filed on
      July 6, 2007 (File No. 001-12493).*10.35
              
              Non-employee
      Director Compensation, incorporated by reference from Exhibit 10.2 to the
      Company’s Current Report on Form 8-K filed on August 21, 2007 (File No.
      001-12493).**23.1
              
              Consent
      of Independent Registered Public Accounting Firm-BDO Seidman,
      LLP.**23.2
              
              Consent
      of Independent Registered Public Accounting Firm-KPMG
  LLP.**31.1
              
              Certification
      of Chief Executive Officer.**31.2
              
              Certification
      of Acting Chief Financial Officer.**32.1
              
              Certification
      pursuant to Section 906 of the Sarbanes-Oxley Act.**32.2
              
              Certification
      pursuant to Section 906 of the Sarbanes-Oxley Act.
 *
              Denotes
      management contract or compensatory plan or
  arrangement.
  **
              Filed
      herewith
  All
schedules and exhibits, other than those listed above, are omitted as the
information is not required or are furnished elsewhere in the financial
statements or the notes thereto.
   50
 
  SIGNATURES
  PURSUANT
TO THE REQUIREMENTS OF SECTION 13 OR 15(d) 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.
 NeoPharm, Inc.By:
              /s/
      LAURENCE P. BIRCHLaurence
      P. BirchPresident
      and Chief Executive Officer(Principal Executive Officer) and Acting Chief
      Financial Officer (Principal Financial
Officer)
 
  PURSUANT
TO THE REQUIREMENTS OF THE SECURITIES EXCHANGE ACT OF 1934, THIS ANNUAL REPORT
HAS BEEN SIGNED BY THE FOLLOWING PERSONS IN THE CAPACITIES AND ON THE DATES
INDICATED.
  Signature
              
              
              
              
              Title
              
              
              
              Date/s/
      JOHN N. KAPOOR
              
              Director,
      Chairman of the Board
              
              March
      27, 2008John
      N. Kapoor/s/
      LAURENCE P. BIRCH
              
              Director,
      President and Chief Executive Officer (Principal Executive Officer) and
      Acting Chief Financial Officer (Principal Financial
    Officer)
              
              March
      27, 2008Laurence
      P. Birch/s/
      FRANK C. BECKER
              
              Director
              
              March
      27, 2008Frank
      C. Becker/s/
      Bernard A. Fox
              
              Director
              
              March
      27, 2008Bernard
      A. Fox/s/
      Paul E. Freiman
              
              Director
              
              March
      27, 2008Paul
      E. Freiman
 
  
 51
 
 Report
of Independent Registered Public Accounting Firm
 
 
 The Board
of Directors and Stockholders
 NeoPharm,
Inc.
 Waukegan,
Illinois
 
 We have
audited the accompanying consolidated balance sheet of NeoPharm, Inc. and
subsidiary as of December 31, 2007 and the related consolidated statements of
operations, stockholders’ equity, and cash flows for the year then
ended.  These financial statements are the responsibility of the
Company’s management.  Our responsibility is to express an opinion on
these financial statements based on our audit.
  We
conducted our audit in accordance with the standards of the Public Company
Accounting Oversight Board (United States).  Those standards require
that we plan and perform the audit to obtain reasonable assurance about whether
the financial statements are free of material misstatement. The Company is not
required to have, nor were we engaged to perform, an audit of its internal
control over financial reporting. Our audit included consideration of internal
control over financial reporting as a basis for designing audit procedures that
are appropriate in the circumstances, but not for the purpose of expressing an
opinion on the effectiveness of the Company’s internal control over financial
reporting. Accordingly, we express no such opinion. An audit also includes
examining, on a test basis, evidence supporting the amounts and disclosures in
the financial statements, assessing the accounting principles used and
significant estimates made by management, as well as evaluating the overall
financial statement presentation.  We believe that our audit provides
a reasonable basis for our opinion.
  In our
opinion, the consolidated financial statements referred to above present fairly,
in all material respects, the financial position of NeoPharm, Inc. and
subsidiary at December 31, 2007 and the results of its operations and its cash
flows for the year then ended, in conformity with accounting principles
generally accepted in the United States of America.
  
 /s/ BDO
Seidman, LLP
 
 Chicago,
Illinois
 March 26,
2008
 
  52
 
 Report
of Independent Registered Public Accounting Firm
 
 
 Board of
Directors and Stockholders
  NeoPharm,
Inc.:
  We have
audited the accompanying consolidated balance sheets of NeoPharm, Inc. and
subsidiary as of December 31, 2006 and 2005, and the related consolidated
statements of operations, stockholders’ equity, and cash flows for each of the
years in the two-year period ended December 31, 2006.  These
consolidated financial statements are the responsibility of the Company’s
management.  Our responsibility is to express an opinion on these
consolidated financial statements based on our audits.
  We
conducted our audits in accordance with the standards of the Public Company
Accounting Oversight Board (United States).  Those standards require
that we plan and perform the audit to obtain reasonable assurance about whether
the financial statements are free of material misstatement.  An audit
includes examining, on a test basis, evidence supporting the amounts and
disclosures in the financial statements.  An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement
presentation.  We believe that our audits provide a reasonable basis
for our opinion.
  In our
opinion, the consolidated financial statements referred to above present fairly,
in all material respects, the financial position of NeoPharm, Inc. and
subsidiary as of December 31, 2006 and 2005, and the results of their operations
and their cash flows for each of the years in the two-year period ended December
31, 2006, in conformity with U.S. generally accepted accounting
principles.
  As
discussed in Note 1 to the consolidated financial statements, the Company, as of
January 1, 2006, changed its method of accounting for share-based
awards.
  /s/ KPMG
LLP
  Chicago,
Illinois
  March 16,
2007
  
 53
 
  NEOPHARM, INC.
AND SUBSIDIARY
  CONSOLIDATED
BALANCE SHEETS
  December
      31,2007
                
                
                2006ASSETSCurrent
      assets:Cash
      and cash equivalents
                
                $
                1,022,000
                
                
                $
                1,852,000Available
      for sale securities
                
                
                19,759,000
                
                
                
                36,735,000Prepaid
      expenses and other
                
                
                417,000
                
                
                
                627,000Total
      current assets
                
                
                21,198,000
                
                
                
                39,214,000Fixed
      assets, net of accumulated depreciation
                
                
                395,000
                
                
                
                1,266,000Other
      assets
                
                
                659,000
                
                
                
                209,000Total
      assets
                
                $
                22,252,000
                
                
                $
                40,689,000LIABILITIES
      AND STOCKHOLDERS’ EQUITYCurrent
      liabilities:Accounts
      payable
                
                $
                1,340,000
                
                
                $
                4,575,000Accrued
      clinical trial expenses
                
                
                278,000
                
                
                
                2,272,000Accrued
      compensation
                
                
                1,042,000
                
                
                
                811,000Accrued
      manufacturing expenses
                
                
                739,000
                
                
                
                646,000Obligations
      under capital lease
                
                
                32,000
                
                
                
                30,000Other
      accrued expenses
                
                
                488,000
                
                
                
                1,243,000Total
      current liabilities
                
                
                3,919,000
                
                
                
                9,577,000Obligations
      under capital lease
                
                
                74,000
                
                
                
                105,000Deferred
      revenue
                
                
                -
                
                
                
                2,000,000Deferred
      rent
                
                
                -
                
                
                
                35,000Derivative
      financial instruments
                
                
                6,000
                
                
                
                101,000Total
      liabilities
                
                
                3,999,000
                
                
                
                11,818,000Commitments
      and contingenciesStockholders’
      equity:Preferred
      stock, $0.01 par value; 15,000,000 shares authorized:none
      issued and outstanding
                
                
                -
                
                
                
                -Common
      stock, $0.0002145 par value; 50,000,000 sharesauthorized: 28,488,550
      and 28,080,408 shares issued andoutstanding,
      respectively
                
                
                6,000
                
                
                
                6,000Additional
      paid-in capital
                
                
                290,481,000
                
                
                
                290,098,000Accumulated
      deficit
                
                
                (272,234,000
                )
                
                
                (261,233,000
                )Total
      stockholders’ equity
                
                
                18,253,000
                
                
                
                28,871,000Total
      liabilities and stockholders’ equity
                
                $
                22,252,000
                
                
                $
                40,689,000
  The
accompanying notes to consolidated financial statements are an integral part of
these financial statements.
 54
  NEOPHARM, INC.
AND SUBSIDIARY
  CONSOLIDATED
STATEMENTS OF OPERATIONS
  For
      the Years Ended December 31,2007
                
                
                2006
                
                
                2005Collaboration
      revenue
                
                $
                -
                
                
                $
                -
                
                
                $
                500,000Product
      revenue
                
                
                -
                
                
                
                11,000
                
                
                
                43,000Total
      revenue
                
                
                -
                
                
                
                11,000
                
                
                
                543,000Expenses:Cost
      of product revenue
                
                
                -
                
                
                
                1,000
                
                
                
                2,000Research
      and development
                
                
                6,370,000
                
                
                
                21,199,000
                
                
                
                31,851,000Selling,
      general, and administrative
                
                
                7,363,000
                
                
                
                14,136,000
                
                
                
                11,421,000Change
      in fair value of derivativefinancial
      instruments
                
                
                (95,000
                )
                
                
                (1,551,000
                )
                
                
                -Employee
      termination costs
                
                
                598,000
                
                
                
                1,528,000
                
                
                
                -Facility
      consolidation costs
                
                
                496,000
                
                
                
                433,000
                
                
                
                -Gain
      on sale of equipment
                
                
                (302,000
                )
                
                
                -
                
                
                
                -Recovery
      of note receivable
                
                
                -
                
                
                
                -
                
                
                
                (2,500,000
                )Total
      expenses
                
                
                14,430,000
                
                
                
                35,746,000
                
                
                
                40,774,000Loss
      from operations
                
                
                (14,430,000
                )
                
                
                (35,735,000
                )
                
                
                (40,231,000
                )Other
      income
                
                
                2,000,000
                
                
                
                -
                
                
                
                -Interest
      income
                
                
                1,429,000
                
                
                
                2,527,000
                
                
                
                1,506,000Net
      loss
                
                $
                (11,001,000
                )
                
                $
                (33,208,000
                )
                
                $
                (38,725,000
                )Net
      loss per share —Basic
      and diluted
                
                $
                (0.39
                )
                
                $
                (1.20
                )
                
                $
                (1.64
                )Weighted
      average shares outstanding —Basic
      and diluted
                
                
                28,264,727
                
                
                
                27,782,074
                
                
                
                23,601,643
 The
accompanying notes to consolidated financial statements are an integral part of
these financial statements.
 55
 NEOPHARM, INC.
AND SUBSIDIARY
  STATEMENT
OF STOCKHOLDERS’ EQUITY
  
 Shares
      of Preferred Stock
                
                
                Shares
      of Common Stock
                
                
                Par
      Value
                
                
                Additional
      Paid-in Capital
                
                
                Accumulated
      Deficit
                
                
                Total
      Stockholders' EquityBalance
      at December 31, 2004
                
                
                -
                
                
                
                23,372,755
                
                
                $
                5,000
                
                
                $
                247,525,000
                
                
                $
                (189,300,000
                )
                
                $
                58,230,000Issuance
      of common stock pursuant to exercise of stock options
                
                
                -
                
                
                
                285,519
                
                
                
                -
                
                
                
                1,494,000
                
                
                
                -
                
                
                
                1,494,000Issuance
      of restricted common stock to non-employee directors
                
                
                -
                
                
                
                36,010
                
                
                
                -
                
                
                
                305,000
                
                
                
                -
                
                
                
                305,000Employee
      common stock-based compensation
                
                
                -
                
                
                
                22,075
                
                
                
                -
                
                
                
                217,000
                
                
                
                -
                
                
                
                217,000Non-employee
      common stock option compensation
                
                
                -
                
                
                
                -
                
                
                
                -
                
                
                
                236,000
                
                
                
                -
                
                
                
                236,000Issuance
      of common stock in lieu of cash payment
                
                
                -
                
                
                
                23,692
                
                
                
                -
                
                
                
                188,000
                
                
                
                -
                
                
                
                188,000Net
      loss
                
                
                -
                
                
                
                -
                
                
                
                -
                
                
                
                -
                
                
                
                (38,725,000
                )
                
                
                (38,725,000
                )Balance
      at December 31, 2005
                
                
                -
                
                
                
                23,740,051
                
                
                $
                5,000
                
                
                $
                249,965,000
                
                
                $
                (228,025,000
                )
                
                $
                21,945,000Issuance
      of common stock pursuant to public offering
                
                
                -
                
                
                
                4,025,000
                
                
                
                1,000
                
                
                
                38,738,000
                
                
                
                -
                
                
                
                38,739,000Issuance
      of common stock pursuant to exercise of stock options
                
                
                -
                
                
                
                217,950
                
                
                
                -
                
                
                
                856,000
                
                
                
                -
                
                
                
                856,000Issuance
      and compensation associated with restricted common stock issued to
      non-employee directors
                
                
                -
                
                
                
                58,083
                
                
                
                -
                
                
                
                368,000
                
                
                
                -
                
                
                
                368,000Employee
      common stock-based compensation
                
                
                -
                
                
                
                -
                
                
                
                -
                
                
                
                1,633,000
                
                
                
                -
                
                
                
                1,633,000Issuance
      of common stock to employees stock purchase plan
                
                
                -
                
                
                
                39,324
                
                
                
                -
                
                
                
                190,000
                
                
                
                -
                
                
                
                190,000Reclassification
      of derivative instrument to liabilities
                
                
                -
                
                
                
                -
                
                
                
                -
                
                
                
                (1,652,000
                )
                
                
                -
                
                
                
                (1,652,000
                )Net
      loss
                
                
                -
                
                
                
                -
                
                
                
                -
                
                
                
                -
                
                
                
                (33,208,000
                )
                
                
                (33,208,000
                )Balance
      at December 31, 2006
                
                
                -
                
                
                
                28,080,408
                
                
                $
                6,000
                
                
                $
                290,098,000
                
                
                $
                (261,233,000
                )
                
                $
                28,871,000Employee
      common stock-based compensation
                
                
                -
                
                
                
                -
                
                
                
                -
                
                
                
                73,000
                
                
                
                -
                
                
                
                73,000Issuance
      and compensation associated with restricted common stock issued to
      non-employee directors
                
                
                -
                
                
                
                213,196
                
                
                
                -
                
                
                
                251,000
                
                
                
                -
                
                
                
                251,000Issuance
      of restricted common stock to CEO
                
                
                -
                
                
                
                180,665
                
                
                
                -
                
                
                
                33,000
                
                
                
                -
                
                
                
                33,000Issuance
      of common stock to employees stock purchase plan
                
                
                -
                
                
                
                14,281
                
                
                
                -
                
                
                
                26,000
                
                
                
                -
                
                
                
                26,000Net
      loss
                
                
                -
                
                
                
                -
                
                
                
                -
                
                
                
                -
                
                
                
                (11,001,000
                )
                
                
                (11,001,000
                )Balance
      at December 31, 2007
                
                
                -
                
                
                
                28,488,550
                
                
                $
                6,000
                
                
                $
                290,481,000
                
                
                $
                (272,234,000
                )
                
                $
                18,253,000
 The
accompanying notes to consolidated financial statements are an integral part of
these financial statements.
 56
 
 NEOPHARM, INC.
AND SUBSIDIARY
  CONSOLIDATED
STATEMENTS OF CASH FLOWS
  For
      the Years Ended December 31,2007
                
                
                2006
                
                
                2005Cash
      flows from operating activities:Net
      loss
                
                $
                (11,001,000
                )
                
                $
                (33,208,000
                )
                
                $
                (38,725,000
                )Adjustments
      to reconcile net loss to net cash used in operating
      activities:Depreciation
                
                
                651,000
                
                
                
                1,153,000
                
                
                
                1,300,000Stock-based
      compensation expense
                
                
                368,000
                
                
                
                2,059,000
                
                
                
                758,000Change
      in fair value of financial instruments
                
                
                (95,000
                )
                
                
                (1,551,000
                )
                
                
                -Loss
      on retirement of fixed assets
                
                
                1,000
                
                
                
                11,000
                
                
                
                25,000Gain
      on sale of fixed assets
                
                
                (302,000
                )
                
                
                -
                
                
                
                -Writedown
      of fixed assets
                
                
                307,000
                
                
                
                -
                
                
                
                -Non-cash
      reorganization costs
                
                
                -
                
                
                
                94,000
                
                
                
                -Provision
      for losses on accounts receivable
                
                
                -
                
                
                
                -
                
                
                
                10,000Recognition
      of deferred fee
                
                
                (2,000,000
                )
                
                
                -
                
                
                
                -Changes
      in assets and liabilities:Decrease
      (increase) in interest receivable on short-term
investments
                
                
                26,000
                
                
                
                (9,000
                )
                
                
                (55,000
                )Decrease
      (increase) in trade accounts receivable
                
                
                -
                
                
                
                1,000
                
                
                
                (1,000
                )Decrease
      in inventories
                
                
                -
                
                
                
                6,000
                
                
                
                -(Increase)
      decrease in prepaid expenses and other
                
                
                (240,000
                )
                
                
                101,000
                
                
                
                473,000(Decrease)
      increase in accounts payable
                
                
                (3,235,000
                )
                
                
                4,402,000
                
                
                
                285,000(Decrease)
      increase in accrued expenses
                
                
                (2,425,000
                )
                
                
                (4,250,000
                )
                
                
                91,000(Decrease)
      increase in deferred revenue
                
                
                -
                
                
                
                -
                
                
                
                1,997,000(Decrease)
      increase in deferred rent
                
                
                (35,000
                )
                
                
                9,000
                
                
                
                36,000Net
      cash and cash equivalents used in operating activities
                
                
                (17,980,000
                )
                
                
                (31,182,000
                )
                
                
                (33,806,000
                )Cash
      flows from investing activities:Proceeds
      from sales and maturities of marketable securities
                
                
                16,950,000
                
                
                
                32,850,000
                
                
                
                59,100,000Purchase
      of marketable securities
                
                
                -
                
                
                
                (40,800,000
                )
                
                
                (77,450,000
                )Proceeds
      from sales of fixed assets
                
                
                303,000
                
                
                
                -
                
                
                
                -Purchase
      of equipment and furniture
                
                
                (89,000
                )
                
                
                (204,000
                )
                
                
                (588,000
                )Net
      cash and cash equivalents provided by (used in) investing
      activities
                
                
                17,164,000
                
                
                
                (8,154,000
                )
                
                
                (18,938,000
                )Cash
      flows from financing activities:Proceeds
      from issuance of common stock, net
                
                
                -
                
                
                
                38,739,000
                
                
                
                -Proceeds
      from exercise of stock options
                
                
                -
                
                
                
                856,000
                
                
                
                1,494,000Proceeds
      from employee stock purchase plan
                
                
                16,000
                
                
                
                133,000
                
                
                
                -Repayment
      of capital lease obligation
                
                
                (30,000
                )
                
                
                (26,000
                )
                
                
                -Net
      cash and cash equivalents (used in) provided by financing
      activities
                
                
                (14,000
                )
                
                
                39,702,000
                
                
                
                1,494,000Net
      (decrease) increase in cash and cash equivalents
                
                
                (830,000
                )
                
                
                366,000
                
                
                
                (51,250,000
                )Cash
      and cash equivalents, beginning of year
                
                
                1,852,000
                
                
                
                1,486,000
                
                
                
                52,736,000Cash
      and cash equivalents, end of year
                
                $
                1,022,000
                
                
                $
                1,852,000
                
                
                $
                1,486,000Supplemental
      schedule of non-cash financing activities:Issuance
      of common stock in satisfaction of liability
                
                $
                -
                
                
                $
                -
                
                
                $
                188,000Capital
      lease of office equipment
                
                $
                -
                
                
                $
                161,000
                
                
                $
                -Supplemental
      disclosure of cash paid for:Interest Provision
      for losses on accounts receivable
                
                $
                -
                
                
                $
                -
                
                
                $
                -Income
      taxes
                
                $
                -
                
                
                $
                -
                
                
                $
                -
  The
accompanying notes to consolidated financial statements are an integral part of
these financial statements.
 57
 NEOPHARM,
INC. AND SUBSIDIARY
  NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS
  1. NATURE
      OF OPERATIONS AND PRINCIPAL ACCOUNTING
POLICIES
  Nature of
Operations—NeoPharm, Inc. (“we”,
“us, “our”, or the “Company”), a Delaware corporation, was incorporated on
June 15, 1990, under the name of OncoMed, Inc. In March 1995, we
changed our name to NeoPharm, Inc. During 2004, we established a
wholly-owned subsidiary, NeoPharm EU Limited, to comply with regulatory
requirements enacted for clinical trials conducted in the European Union. All of
our assets are located in the United States.
  We are a
biopharmaceutical company engaged in the research, development, and
commercialization of drugs for the treatment of various cancers and other
diseases.  Our corporate office and research and development facility
is located in Waukegan, Illinois and we had 17 active employees as of December
31, 2007.
  Since we
began business in June 1990, we have principally devoted our resources to
funding research and product development programs. To date, we have not received
United States Food and Drug Administration, or FDA, approval of any of our drug
product candidates. We expect to continue to incur losses for the foreseeable
future as we continue our research and development activities, which include the
sponsorship of human clinical trials for our drug product candidates. If and
until we are able to consistently generate profitable revenue through the sale
of drug or non-drug products, we anticipate that we will continue to be required
to fund the development of our pre-clinical compounds and drug product
candidates primarily by other means, including, but not limited to, selling
stock in the Company, licensing the development rights to some of our drug
product candidates to third parties, or collaborating with third parties to
develop formulations of their compounds using our technology.
  Two of our
drug product candidates have been licensed from the National Institutes of
Health, or NIH, and one of which is the subject of a Cooperative Research and
Development Agreement, or CRADA, with the FDA. We also have rights to drug
product candidates developed under license and contract research agreements with
Georgetown University, or Georgetown.
  We are
continuing to develop our drug product candidates, which requires substantial
capital for research, product development and market development activities. We
have not yet obtained approval of, or initiated marketing of a commercial drug
product. Future product development will require clinical testing, regulatory
approval, and substantial additional investment prior to commercialization. Our
future success is dependent on our ability to make progress in the development
of our drug product candidates and, ultimately, upon our ability to attain
future profitable operations through the successful manufacturing and marketing
of those drug product candidates. There can be no assurance that we will be able
to obtain the necessary financing or regulatory approvals to be able to
successfully develop, manufacture, and market our drug product candidates, or
attain successful future operations. Insufficient funds could require us to
delay, scale back, or eliminate one or more of our research and development
programs or to license third parties to commercialize drug product candidates or
technologies that we would otherwise seek to develop without relinquishing our
rights thereto. Accordingly, the predictability of our future success is
uncertain.
  Our rights
to our drug product candidates are subject to the terms of our agreements with
NIH, FDA, and Georgetown. Termination of any, or all, of these agreements could
have a material adverse effect on our business, financial position and results
of operations. In addition, uncertainty exists as to our ability to protect our
rights to patents and proprietary information. There can also be no assurance
that research and discoveries by others will not render some or all of our
technology or drug product candidates noncompetitive or obsolete. Nor can there
be any assurance that unforeseen problems will not develop with our technologies
or applications, or that we will be able to successfully address technological
challenges we encounter in our research and development programs. While we
maintain insurance to cover the use of our drug product candidates in clinical
trials, we do not yet maintain insurance covering the potential sales of our
products nor is there any assurance that we will be able to obtain or maintain
such insurance on acceptable terms or with adequate coverage against potential
liabilities.
  Basis of
Presentation—The
consolidated financial statements include the accounts of NeoPharm, Inc.
and its wholly-owned subsidiary, NeoPharm EU Limited. As of and through December
31, 2007, the subsidiary had nominal assets and had not conducted any business.
All significant intercompany accounts and transactions have been eliminated in
consolidation.
  Amounts
presented have been rounded to the nearest thousand.
  Use of
Estimates—The
preparation of financial statements in conformity with U.S. generally accepted
accounting principles 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 consolidated financial
statements and the reported amounts of revenue and expense during the reporting period.
Actual results could differ from those estimates.
 58
  Cash and
Cash Equivalents—We consider all highly
liquid investments purchased with an original maturity of three months or less
to be cash equivalents. Included with cash are cash equivalents of $669,000 and
$593,000 as of December 31, 2007 and 2006, respectively. The carrying value of
these investments approximates their fair market value due to their short
maturity and liquidity.
  Available for
Sale Securities –Available for sale securities consist of auction rate
certificates that have scheduled maturities greater than 90 days at the time of
purchase.  We believe the structural features of the auction rate
certificates provide us with liquidity characteristics similar to cash
equivalents.  As provided by Statement of Financial Accounting
Standards, or SFAS, No. 115, Accounting for Certain Investment in
Debt and Equity Securities, we have elected to treat all of our
investments in marketable securities as “available-for-sale,” which requires
that these investments be recorded at fair market value. However, given the
interest rate reset features of our auction rate certificates, the carrying
value of our short-term investment represents their fair
value.  Dividend and interest income are recognized when
earned.  Realized gains on investments sold in the periods presented
were immaterial.
  Refer to
Note 3 for further discussion regarding the available for sale securities held
at December 31, 2007 and Note 14 for further discussion regarding a failure of a
portion of the Company’s available for sale securities in the auction markets
subsequent to year end.
  Fixed
Assets—Fixed
assets are recorded at cost and depreciated using the straight-line method over
their estimated useful lives. Maintenance and repairs that do not extend the
life of assets are charged to expense when incurred. When properties are
disposed of, the related costs and accumulated depreciation are removed from the
accounts and any gain or loss is reported in the period the transaction takes
place. Total depreciation expense for the years ended December 31, 2007, 2006
and 2005, was $651,000, $1,153,000 and $1,300,000, respectively.
  Long-lived
assets are reviewed for impairment whenever events or changes in circumstances
indicate the carrying amount of an asset may not be recoverable. Recoverability
of assets to be held and used is measured by a comparison of the carrying amount
of an asset to estimated undiscounted cash flows expected to be generated by the
asset. If the carrying amount exceeds its estimated future cash flows, an
impairment charge is recognized by the amount by which the carrying amount
exceeds the fair value of the asset.  In connection with the corporate
headquarters move in the first quarter of 2008, as more fully discussed in Note
11, the Company wrote down assets by $296,000 to reduce their carrying value to
estimated fair value.
  As a
result of the cost reduction actions that the Company has implemented in 2006
and 2007, and with the move to a smaller corporate headquarters facility in the
first quarter of 2008, the Company identified fixed assets that have been
classified as held for sale assets.  As a result, these assets, with a
net book value of $11,000, have been moved out of fixed assets and into held for
sale assets which have been included on the balance sheet as prepaid expenses
and other.
  Other
Assets—Other
assets as of December 31, 2007 consist of cash held by a bank as collateral for
two standby letters of credit issued by the bank in favor of the
Company.  The cash held by the bank is restricted as to use for the
term of the standby letter of credit.  One letter of credit for
$189,000 is for the capitalized lease on office equipment and the other letter
of credit for $470,000 is for the lease on the facility into which the Company
has  moved in the first quarter of 2008.
  Accrued
Compensation—Accrued compensation
consists of accrued severance of $374,000, accrued bonuses of $512,000, accrued
401(k) expenses of  $99,000 and other accrued compensation of $57,000
at December 31, 2007.  At December 31, 2006 the accrued compensation
consisted of accrued bonuses of $415,000, accrued 401(k) expenses of $284,000
and other accrued compensation of $112,000.
  Income
Taxes—We account for income taxes under the asset and liability method in
accordance with SFAS No. 109 Accounting for Income Taxes.
Deferred tax assets and liabilities are recognized for the future tax
consequences attributable to differences between the financial statement
carrying amounts of existing assets and liabilities and their respective tax
bases and operating loss and tax credit carryforwards. Deferred tax assets and
liabilities are measured using enacted tax rates expected to apply to taxable
income in the years in which those temporary differences are expected to be
recovered or settled. The effect on deferred tax assets and liabilities of a
change in tax rates is recognized in income in the period that includes the
enactment date. We provide valuation allowances against the deferred tax asset
for amounts which are not considered “more likely than not” to be
realized.  In July 2006, the Financial Accounting Standards Board
issued Interpretation No. 48 (“FIN 48”), Accounting for Uncertainty in Income
Taxes—An Interpretation of FASB Statement No. 109.  The
Company adopted the provisions of FIN 48 on January 1, 2007.  FIN 48
clarifies the accounting for uncertainty in income taxes recognized in the
financial statements
in accordance with FASB Statement No. 109.  FIN 48 also
prescribes a recognition threshold and measurement model for the financial
statement recognition of a tax position taken, or expected to be taken, in a tax
return penalties and provides guidance on derecognition, classification,
interest and penalties, accounting in interim periods, disclosure and
transition.
 59
  Revenue
Recognition—We
recognize revenue when persuasive evidence of an arrangement exists, delivery
has occurred or services have been rendered, the price is fixed or determinable,
and collectibility is reasonably assured.
  For
product sales not subject to unconditional rights of return, we recognize
revenue upon shipment as title and risk of loss has passed to the customer. For
product sales subject to unconditional rights of return, we recognize revenue
upon shipment when we can reasonably estimate the level of returns at the time
of shipment. Given the limited sales history of our products, we are currently
unable to reasonably estimate the level of returns at the time of shipment.
Accordingly, revenue related to shipments to distributors that have been granted
an unconditional right of return is currently being recognized when the right of
return has expired, which occurs upon the earlier of shipment of the product by
the distributor to an end user or expiration of the right of return, which is
60-180 days depending upon the distributor. The Company warrants its products in
a manner consistent with industry standards and has not incurred any warranty
costs related to the sale of NeoPhectin.
  We enter
into collaboration and technology licensing arrangements, which contain multiple
deliverables. Under the provisions of Emerging Issues Task Force (EITF)
No. 00-21, Accounting for
Revenue Arrangements with Multiple Deliverables, we evaluate whether
these deliverables constitute separate units of accounting to which total
arrangement consideration is allocated. A deliverable qualifies as a separate
unit of accounting when the item delivered to the customer has standalone value,
there is objective and reliable evidence of fair value of items that have not
been delivered to the customer, and, if there is a general right of return for
the items delivered to the customer, delivery or performance of the undelivered
items is considered probable and substantially in our control. Arrangement
consideration is allocated to units of accounting on a relative fair-value basis
or the residual method if we are unable to determine the fair value of all
deliverables in the arrangement. Consideration allocated to a unit of accounting
is limited to the amount that is not contingent upon our future performance.
Upon determination of separate units of accounting and allocated consideration,
the general criteria for revenue recognition are applied to each unit of
accounting.
  We have
entered into collaboration and license agreements with third
parties.  The terms of one of our collaboration agreements provided
for an upfront nonrefundable payment to the Company of $150,000 as well as an
additional $350,000 upon delivery of a customized formulation for NeoPhectin to
the customer.  We delivered the customized formulation in June 2005 at
which time we recognized the full contract amount as revenue.
  On
December 28, 2004, a Sublicense and License Agreement was entered into between
the Company and Nippon Kayaku Co, Ltd (NK) for NK to develop and commercialize
in Japan a product developed by us.  Upon execution of this agreement,
NK paid us a one-time, non-refundable license fee of US
$2,000,000.  We recorded this payment as Deferred Revenue on the
balance sheet until  September 11, 2007, when NK notified us that they
had elected to terminate the Agreement effective June, 2008.  With the
formal termination notice, development efforts by NK have ceased and, in
accordance with the terms of the Agreement, we will retain the upfront license
fee received from NK.  Accordingly, in September 2007 the Company
reversed the deferred revenue and recognized the amount as other
income.
  Research and
Development—Research and development, or
R&D, costs are expensed when incurred. These costs include, among other
things, consulting fees and costs reimbursed to third parties under license and
research agreements described in Note 12, Commitments.  Payments
related to the acquisition of technology rights, for which development work is
in process, are expensed as incurred and are considered a component of R&D
costs. We charge the indirect cost of administering R&D activities to
R&D expense.
  Share-based
Compensation— We
adopted the provisions of SFAS No. 123 (revised 2004), Share-Based Payment, or SFAS
123(R), effective January 1, 2006.  SFAS 123(R) requires the financial
statement recognition of compensation expense related to the fair value of our
share-based compensation awards.  Prior to our adoption of SFAS
123(R), we accounted for share-based awards to directors, officers, and
employees using the intrinsic value method in accordance with Accounting
Principles Board Opinion No. 25, or APB No. 25, under SFAS No. 123, Accounting for Share-based
Compensation, or SFAS 123. Under the intrinsic value method, compensation
expense is measured on the date of grant if the current market price of the
underlying stock exceeded the exercise price or when the number of shares and
exercise price are known, if both are not determinable at the date of
grant.  Compensation expense for fixed awards was recognized ratably
over the vesting period.  SFAS 123 also established accounting and
disclosure requirements using a fair-value method of accounting for share-based
employee compensation plans.
  We adopted
SFAS 123(R) using the modified prospective method.  Under this
transition method, compensation cost recognized in the 2007 and 2006
consolidated statements of operations includes: a) compensation cost for the
fair value of the remaining portion of the requisite service period for all
share-based awards granted prior to, but not vested as of January 1, 2006, and
b) compensation cost for the fair value for all share-based awards granted or
modified subsequent to January 1, 2006.  We recognize such
compensation cost on a straight-line basis.  Under the pro forma
disclosure requirements of SFAS 123, in prior periods, we recognized costs on a
straight-line basis and considered the effect of forfeitures as
incurred.
 60
  Leases—With respect to its
operating leases, we apply the provisions of FASB Technical Bulletin, or FTB,
85-3, Accounting for Operating
Leases with Scheduled Rent Increases, to scheduled rent increase
provisions contained in lease agreements by recognizing rent expense on a
straight-line basis over the lease term.  Our capital lease is
accounted for under the provision of SFAS No. 13: Accounting for
Leases.
  Contingencies—Liabilities for loss
contingencies arising from claims, assessments, litigation, fines, and penalties
and other sources are recorded when it is probable that a liability has been
incurred and the amount of the assessment can be reasonably estimated.
Recoveries from other parties are recorded when realized.
  Fair Value of
Financial Instruments—Financial instruments consist of cash, cash
equivalents, short-term investments, accounts receivable, accounts payable and
derivative financial instruments, see Note 3. The carrying value of these
financial instruments is a reasonable estimate of fair value.
  Recent Accounting
Pronouncements—In September 2006, the FASB issued SFAS
No. 157, “Fair Value
Measurements.” SFAS No. 157 defines fair value, establishes a
framework for measuring fair value, and expands disclosures about fair value
measurements.  SFAS No. 157 is effective for financial statements
issued for fiscal years beginning after November 15, 2007.  In
February of 2008, the FASB issued FASB Staff position 157-2 which delays the
effective date of SFAS 157 for non-financial assets and liabilities which are
not measured at fair value on a recurring basis (at least annually) until fiscal
years beginning after November 15, 2008.  The Company is currently
evaluating the impact of the adoption of SFAS No. 157 on its consolidated
financial statements and note disclosures.
  In
February 2007, the FASB issued SFAS No. 159, “The Fair Value Option for Financial
Assets and Financial Liabilities.”  SFAS No. 159 allows
entities the option to measure eligible financial instruments at fair value as
of specified dates.  Such election, which may be applied on an
instrument by instrument basis, is typically irrevocable once
elected.  SFAS No. 159 is effective for financial statements
issued for fiscal years beginning after November 15, 2007 and will become
effective for us beginning with the first quarter of 2008.   The
Company is currently evaluating the impact of the adoption of SFAS No. 157
on its consolidated financial statements and note disclosures.
  In
December 2007, the FASB issued SFAS No. 160, “Non-Controlling Interests in
Consolidated Financial Statements an amendment of ARB No. 51”
(“SFAS 160”).  SFAS 160 establishes new standards for the
accounting for and reporting of non-controlling interests (formerly minority
interests) and for the loss of control of partially owned and consolidated
subsidiaries.  SFAS 160 does not change the criteria for
consolidating a partially owned entity.  SFAS 160 is effective
for fiscal years beginning after December 15, 2008.  The
provisions of SFAS 160 will be applied prospectively upon adoption except
for the presentation and disclosure requirements which will be applied
retrospectively.  The Company does not expect the adoption of
SFAS 160 will have a material impact on its consolidated financial
statements.
  In
December 2007, the FASB issued SFAS No. 141(revised 2007)
(“SFAS 141R”), a revision of SFAS 141, “Business
Combinations.”  SFAS 141R establishes requirements for the
recognition and measurement of acquired assets, liabilities, goodwill, and
non-controlling interests.  SFAS 141R also provides disclosure
requirements related to business combinations.  SFAS 141R is
effective for fiscal years beginning after December 15,
2008.  SFAS 141R will be applied prospectively to business
combinations with an acquisition date on or after the effective
date.
  Reclassifications—
Certain reclassifications have been made to conform prior period consolidated
financial statements and notes to the current period presentation.
  61
  2.
      NET
      LOSS PER SHARE
  The
following table sets forth the computation of the basic and diluted net loss per
share for the years ended December 31:
  For
      the Years Ended December 31,2007
                
                
                2006
                
                
                2005Numerator:Net
      loss
                
                $
                (11,001,000
                )
                
                $
                (33,208,000
                )
                
                $
                (38,725,000
                )Denominator:Weighted
      average shares outstanding
                
                
                28,264,727
                
                
                
                27,782,074
                
                
                
                23,601,643Loss
      per share - basic and diluted
                
                $
                (0.39
                )
                
                $
                (1.20
                )
                
                $
                (1.64
                )Potential
      common share equivalents:
                
                
                1,646,187
                
                
                
                2,765,808
                
                
                
                3,805,157
  As the
Company has incurred a net loss for all periods presented, basic and diluted per
share amounts are the same, since the effect of potential common share
equivalents is anti-dilutive.
  3.
              CASH
      AND CASH EQUIVALENTS AND AVAILABLE FOR SALE
  SECURITIES
  We
consider all highly liquid investments purchased with an original maturity of
three months or less to be cash equivalents.  Included with cash are
cash equivalents of $669,000 and $593,000 as of December 31, 2007 and 2006,
respectively. The carrying value of these investments approximates their fair
market value due to their short maturity and liquidity.
  Available
for sale securities consist of auction rate certificates with scheduled
maturities greater than 90 days at the time of purchase.  We believe
the structural features of the auction rate certificates, including an interest
rate reset feature which adjusts the rate typically every 7 to 28 days, provide
us with liquidity characteristics similar to cash equivalents. As provided by
Statement of Financial Accounting Standards, or SFAS, No. 115, Accounting for Certain Investments
in Debt and Equity Securities,we have elected to treat all of our
investments in marketable securities as “available-for-sale,” which requires
that these investments be recorded at fair market value.  However,
given the interest rate reset features of our auction rate certificates, the
carrying value of these available for sale securities represents their fair
value.  The market values of these investments may fluctuate due to
market conditions and other conditions over which we have no
control.  Fluctuations in the market price and valuations of these
securities may require us to record losses due to impairment in the value of the
securities underlying our investment.
  The
auction rate certificates are used by many student-loan providers,
municipalities and other governmental authorities to raise cash to fund projects
or operations, and money market funds. These auction rate certificates all have
AAA/aaa credit ratings, consistent with our investment policy guidelines, and
have long-term nominal maturities for which the interest rates are reset through
periodic auctions every 7 to 28 days.  The market values of these
investments may fluctuate due to market conditions and other conditions over
which we have no control. Fluctuations in the market price and valuations of
these securities may require us to record losses due to impairment in the value
of the securities underlying our investment. This could result in future charges
to our earnings.
  As of
December 31, 2007, our investments in auction rate certificates have maturities
ranging from 17 to 38 years.  Despite the long-term nature of their
stated contractual maturities, the Company has demonstrated the ability to
liquidate these securities as needed and intends to liquidate them in
2008.  Accordingly, as these securities represent the investment of
cash, which is available for operations, they have been classified as a current
asset on the accompanying Consolidated Balance Sheets.  Refer to Note
14 for further discussion regarding a failure of a portion of the Company’s
available for sale securities in the auction markets subsequent to year
end.
  Included
with the carrying value of the available for sale securitieswas accrued interest
income receivable of $59,000 and $85,000 as of December 31, 2007 and 2006,
respectively.
  Available
for sale securities, stated at cost, which approximates fair market value,
include the following at December 31, 2007 and 2006:
  2007
                
                
                2006State
      government agencies
                
                $
                19,700,000
                
                
                $
                36,650,000Total
      available for sale securities
                
                $
                19,700,000
                
                
                $
                36,650,000
  62
  4.
                FIXED
      ASSETS
  Fixed
assets are comprised of the following as of December 31:
 EstimatedUseful
      Life(years)
                
                
                2007
                
                
                2006Computer
      equipment
                
                
                3
                
                
                $
                1,447,000
                
                
                $
                1,452,000Scientific
      equipment
                
                
                5
                
                
                
                3,223,000
                
                
                
                3,967,000Furniture
                
                
                7
                
                
                
                349,000
                
                
                
                780,000Equipment
      under capital lease
                
                
                5
                
                
                
                43,000
                
                
                
                161,000Leasehold
      improvements
                
                
                *
                
                
                
                533,000
                
                
                
                908,000Less
      accumulated depreciation
                
                
                **
                
                
                
                (5,200,000
                )
                
                
                (6,002,000
                )Fixed
      assets, net
                
                
                
                
                
                $
                395,000
                
                
                $
                1,266,000
 * -The
estimated useful life of leasehold improvements is the lesser of the lease term
or five years.
  ** -
Amortization expense related to assets under capital lease is included in
depreciation expense and accumulated depreciation.
  In
connection with the corporate headquarters move in the first quarter of 2008, as
more fully discussed in Note 11, the Company wrote down assets by $296,000 to
reduce their carrying value to estimated fair value.  These assets are
recorded at their estimated fair value with their initial cost and related
accumulated depreciation  written off.
  In
addition to the write down of assets mentioned above, the Company has identified
fixed assets that it has classified as held for sale assets.  Due to
the cost reduction initiatives that the Company implemented in 2006 and 2007,
and with the move to a smaller corporate headquarters facility in the first
quarter of 2008, these assets are no longer being effectively
utilized.  The held for sale assets have a value at December 31, 2007
of $11,000 which represents the lower of their carrying value or their estimated
fair value less costs to sell.  These assets held for sale are
included with prepaid expenses and other assets on the balance sheet at December
31, 2007.  If not sold during 2008, they will be disposed
of.  During the fourth quarter of 2007, equipment, primarily computer
and scientific equipment, with a net book value of $1,000 was sold in several
transactions with a resulting gain on sale of equipment of
$302,000.
  5.
              STOCKHOLDERS’
      EQUITY
  On January
10, 2006, we issued 4,025,000 shares of our common stock in a public offering,
which resulted in net proceeds of $39,002,000, after underwriting discounts and
commissions of $2,053,000 and before expenses of $263,000.
  In
June 2003, our Board of Directors adopted a stockholder rights plan that
provided for the issuance of rights to purchase shares of Series A
Participating Preferred Stock, or Series A Preferred, of the Company. Under
the plan, one preferred share purchase right was distributed for each
outstanding share of common stock. Each purchase right entitles the holder to
purchase from the Company one one-thousandth (1/1000th) of a share of
Series A Preferred at a price of $112.00 per share, subject to adjustment.
The rights become exercisable, with certain exceptions, ten business days after
any party, without prior approval of our Board of Directors, acquires, or
announces an offer to acquire, beneficial ownership of 15% or more of our common
stock (with the exception of our largest shareholder, Dr. John N. Kapoor, who,
along with parties affiliated with him, is permitted to acquire up to 30% of our
common stock without triggering the rights issuance), we are acquired in a
merger or other business combination, or 50% or more of our assets are sold
after the time that the rights become exercisable, the rights provide that each
right holder will receive, upon exercise, shares of the common stock of the
surviving or acquiring company, as applicable, having a market value of twice
the exercise price of the right. The rights expire on July 28, 2013, unless
they are earlier redeemed or exchanged by the Company. No rights had been
exercised as of December 31, 2007.
  We
maintain a Stockholder Rights Plan whereby rights to purchase shares of Series A
Participating Preferred Stock become exercisable by our stockholders in the
event a non-excluded party acquires, or attempts to acquire, 15% or more of our
outstanding common stock.
  63
  6.
              SHARE-BASED
      COMPENSATION
  We
currently sponsor the following share-based payment plans:
  2006
Plan
  In June
2006, our stockholders approved the NEOPHARM, Inc. 2006 Equity Incentive Plan,
or the 2006 Plan.  The 2006 Plan provides for the issuance of stock
options, non-vested stock, restricted stock, performance units or performance
share awards to employees, directors and consultants convertible to up to
1,000,000 shares of our common stock. During the second quarter of 2007, the
Board of Directors approved a resolution to increase the total shares available
for issuance under the 2006 Plan to 3,400,000 shares.  In addition,
the Board approved an increase in the number of shares of Common Stock that may
be granted to any Grantee during any calendar year, or earned by any Grantee
under any performance based award during any calendar year, from 500,000 to
750,000 shares.  Each of these Board resolutions were approved by the
shareholders at the Annual Meeting of Stockholders held on August 16,
2007.  Awards under the 2006 Plan generally consist of stock options
having an exercise price equal to the average of the lowest and highest reported
sale prices of our common stock on the date of grant; vest ratably over four
years; have a 10 year term; and are subject to continuous
employment.  Stock awards granted to our non-employee directors under
the 2006 Plan typically vest one year from the date of grant.  Awards
under the 2006 Plan vest immediately upon a change in control, as defined in the
2006 Plan.  Although the 2006 Plan provides for the issuance of
performance units and performance shares, we have not made grants of these types
of awards.  The 2006 Plan limits to 500,000 the shares of common stock
which may be issued pursuant to restricted stock or bonus stock
awards.  As of December 31, 2007, 2,260,139 shares were available for
issuance under the 2006 Plan.
  2006
Employee Stock Purchase Plan
  In June
2006, our shareholders also approved the 2006 Employee Stock Purchase Plan, or
the Purchase Plan, under which eligible employees may purchase shares of common
stock quarterly through payroll deductions. An aggregate of 100,000 shares of
common stock may be issued under the Purchase Plan.  The price per
share under the Purchase Plan is 85% of the lower of the closing price of the
common stock on (i) the first business day of the plan period or
(ii) the purchase date. The Purchase Plan imposes a limitation upon a
participant’s right to acquire common stock if immediately after or prior to
purchase the employee owns 5% or more of the total combined voting power or
value of the our common stock.  During 2007 and 2006, 14,281 and
39,234 shares were issued under the Purchase Plan resulting in compensation
expense of $10,000 and $54,000, respectively.  At December 31, 2007,
46,395 shares remained available for issuance.
  The
1998 Plan
  Our 1998
Equity Incentive Plan, or the 1998 Plan, provided for the grant of awards,
primarily stock options, to employees, directors, and consultants to acquire up
to 4,600,000 shares of our common stock.  Following the June 2006
shareholder approval of the 2006 Plan, no further awards have been or will be
made under the 1998 Plan.  Option awards under the 1998 Plan were
generally granted with an exercise price equal to the closing price of our
common stock on the date of grant, but may have been granted with an exercise
price of not less than 85% of the fair market value of our common
stock.  Option awards under the 1998 Plan typically had a 10-year life
and vested ratably on the first four anniversaries of the grant, subject to
continuous employment.  Stock awards granted to our non-employee
directors under the 1998 Plan typically vest one year from the date of
grant.  Outstanding awards issued under the 1998 Plan vested
immediately upon a change in control, as defined in the 1998 Plan.
  Amounts
recognized in the consolidated financial statements with respect to our share
based compensation plans (including options and restricted stock) were as
follows:
  Year
      Ended December 31,2007
                
                
                2006
                
                
                2005Research
      and development
                
                $
                37,000
                
                
                $
                722,000
                
                
                $
                -Selling,
      general and administrative
                
                
                331,000
                
                
                
                1,337,000
                
                
                
                758,000Total
      cost of share-based payment plansduring
      period
                
                $
                368,000
                
                
                $
                2,059,000
                
                
                $
                758,000
  We have
never capitalized, or recognized an income tax benefit from, share-based
compensation.
  64
  For fiscal
periods prior to our January 2006 adoption of SFAS 123(R), we used the APB 25
intrinsic-value method of accounting for share-based
compensation.  The following table illustrates the effect on our net
loss in prior year periods as if the SFAS 123 fair-value method of accounting
had been applied:
  2005Net
      loss as reported
                
                $
                (38,725,000
                )Add:
      stock-based employee compensationexpense
      included in reported net loss (1)
                
                
                758,000Less:
      total stock-based employee compensationexpense
      determined under fair-value basedmethod
      for all awards
                
                
                (1,647,000
                )Pro
      forma net loss
                
                $
                (39,614,000
                )Basic
      and diluted loss per common shareAs
      reported
                
                $
                (1.64
                )Pro
      forma
                
                $
                (1.68
                )
  (1)
              Value
      of restricted stock granted to non-employee directors in 2005,
      compensation expense relating to options granted to an executive at 85% of
      fair value in 2005 and the grant of common stock to an executive in
      2005.
  During
2004, the Company awarded its then newly-hired CEO, Mr. Gregory P.
Young, the right to receive up to 350,000 common stock options, which would be
granted at the then fair market value upon the Company’s common stock reaching
certain price levels for defined periods of time.
  In
March 2005, Mr. Young, resigned as CEO and a Director and became a
consultant to the Company. Under the terms of the consulting agreement,
Mr. Young agreed to serve as a consultant to the Company for a period of up
to 12 months or until the termination of the Separation Agreement, whichever was
earlier, during which time all options previously granted to Mr. Young
continued to vest and remained exercisable until 90 days after termination as a
consultant, resulting in the vesting of 62,500 options. All other options
granted to Mr. Young were forfeited. For the year ended December 31,
2005, the Company recorded compensation expense of $236,000 related to the
options granted to Mr. Young that continued to vest during the term of the
consulting agreement.
 65
  The following
table summarizes employee and non-employee director stock option awards during
the year ended December 31, 2007, 2006, and 2005:
  Shares
                
                
                Weighted
      Average Exercise Price / Fair Value
                
                
                Weighted
      Average Remaining Contractual Term
                
                
                Aggregate
      Intrinsic ValueOutstanding
      at December 31, 2004
                
                
                3,713,376
                
                
                $
                13.17
      / $9.38Granted
                
                
                960,875
                
                
                $
                8.55
      / $5.56Exercised
                
                
                (285,519
                )
                
                $
                5.23
      / $2.30Forfeited,
      expired and or cancelled
                
                
                (583,575
                )
                
                $
                13.02
      / $10.54Outstanding
      at December 31, 2005
                
                
                3,805,157
                
                
                $
                12.99
      / $8.82Granted
                
                
                929,400
                
                
                $
                8.42
      / $5.73Granted
      out of the money
                
                
                30,000
                
                
                $
                6.51
      / $3.46Exercised
                
                
                (180,000
                )
                
                $
                3.75
      / $3.22
                
                
                
                
                
                $
                225,000Forfeited,
      expired and or cancelled
                
                
                (2,052,774
                )
                
                $
                13.82
      / $10.43Outstanding
      at December 31, 2006
                
                
                2,531,783
                
                
                $
                11.28
      / $8.29
                
                
                
                7.33
                
                
                $
                -Granted
                
                
                698,000
                
                
                $
                1.38
      / $1.02Exercised
                
                
                -Forfeited,
      expired and or cancelled
                
                
                (1,977,457
                )
                
                $
                11.52
      / $8.43Outstanding
      at December 31, 2007
                
                
                1,252,326
                
                
                $
                5.35
      / $3.82
                
                
                
                6.85Exercisable
      at December 31, 2007
                
                
                497,275
                
                
                $
                10.56
      / $7.52
                
                
                
                3.00
                
                
                $
                -
  We expect
to recognize $869,000 of unrecognized share-based compensation at December 31,
2007, for our outstanding options over a weighted average period of 2.1
years.  The following table summarizes information about our stock options
outstanding at December 31, 2007:
  Options
      Outstanding
                
                
                
                
                Options
      ExercisableWeighted-Average
                
                Weighted-
                
                
                
                Weighted-Range
      of
                
                
                Options
                
                Remaining
      Life
                
                Average
                
                Options
                
                AverageExercise
      Prices
                
                
                Outstanding
                
                (in
      years)
                
                Exercise
      Price
                
                Exercisable
                
                Exercise
      Price$
                0.00
      - $5.17
                
                
                
                792,875
                
                8.42
                
                $
                1.43
                
                94,875
                
                $
                1.78$
                5.73
      - $8.60
                
                
                
                153,000
                
                7.33
                
                $
                7.66
                
                110,125
                
                $
                7.77$
                8.60
      - $11.46
                
                
                
                108,525
                
                2.00
                
                $
                9.36
                
                107,625
                
                $
                9.37$
                11.46
      - $14.33
                
                
                
                51,912
                
                3.89
                
                $
                13.06
                
                38,636
                
                $
                13.27$
                14.33
      - $17.19
                
                
                
                82,225
                
                1.66
                
                $
                16.54
                
                82,225
                
                $
                16.54$
                17.19
      - $20.06
                
                
                
                23,340
                
                6.18
                
                $
                19.12
                
                23,340
                
                $
                19.12$
                20.06 -
      $22.92
                
                
                
                40,449
                
                2.02
                
                $
                22.19
                
                40,449
                
                $
                2.02Total
      Options
                
                
                
                1,252,326
                
                6.85
                
                $
                5.35
                
                497,275
                
                $
                10.56
  In June
2005, we granted 36,010 shares of non-vested common stock to non-employee
directors with a weighted average fair value of $9.76, all shares of which
vested on June 16, 2006.  In June 2006, we granted 58,083 non-vested
shares of common stock to non-employee directors with a weighted average fair
value of $6.37 and one year vesting.  In June 2007, we granted 180,665
restricted shares of common stock to our chief executive officer with a weighted
average fair value of $1.36 per share and a four year vesting
period.  In August 2007, we granted 213,196 restricted shares of
common stock to non-employee directors with a weighted average fair value of
$0.99 and a one year vesting period.  As of December 31, 2007,
there was a total of 393,861 restricted shares of common stock outstanding
with unearned compensation of $345,000 which is expected to be earned within 8
months for the non-employee directors and 42 months for the chief executive
officer.  No stock options were granted to non-employee directors
during 2007.
  66
  Stock
Option Valuation Information
  We have
estimated the fair value of our stock option compensation using the
Black-Scholes option-pricing model.  This model requires the use of
subjective assumptions that have a significant impact on the fair value
estimate.  The weighted-average estimated fair value of employee stock
options granted as calculated using the Black-Scholes model and the related
weighted-average assumptions follow:
  2007
                
                
                2006
                
                
                2005Expected
      volatility
                
                
                79.9
                %
                
                
                67.9
                %
                
                
                70.5
                %Risk-free
      interest rate
                
                
                4.0
                %
                
                
                4.5
                %
                
                
                4.3
                %Expected
      term (in years)
                
                
                7.00
                
                
                
                6.25
                
                
                
                6.25Expected
      dividend yield
                
                
                0.0
                %
                
                
                0.0
                %
                
                
                0.0
                %Weighted
      average estimatedfair
      value of employee stockoptions
      granted
                
                $
                1.02
                
                
                $
                5.73
                
                
                $
                5.56
  We have based
our assumptions regarding expected volatility on the historic volatility of our
common stock, the risk-free interest rate on the U.S. Treasury yield curve in
effect at the time of grant, and the expected term of options using the
“Simplified Method” in accordance with SEC Staff Accounting Bulletin, or SAB,
No. 107, Share Based
Payment.
  Derivative
Financial Instruments
  Prior to
2000, we granted common stock options to certain non-employee consultants as
compensation related to research and development activities.  As of
January 1, 2006, the effective date of SFAS123(R), options granted to certain
non-employees to purchase 234,025 shares of our common stock were vested and
outstanding.  Upon adoption of SFAS 123(R), these non-employee common
stock options were accounted for as derivative instruments in accordance with
SFAS 133,Accounting for Derivative
Instruments and Hedging Activities, and recorded as a
liability.
  In August
2006, we entered into a separation agreement with Lawrence A. Kenyon, our former
Chief Financial Officer, under which Mr. Kenyon’s employment status changed from
employee to consultant reflecting his continued service to the
Company.  Under the agreement, at that time 40,300 options were
forfeited and 17,025 unvested employee stock options were reclassified to
non-employee option grants which would vest through May 31, 2007 and were
exercisable until August 29, 2007.  No grants were
exercised.  We have recognized the expense for these non-employee
grants accordingly.
  We
calculated the estimated fair value of the outstanding options granted to
non-employees as of January 1, 2006 to be $1,652,000 and reclassified this
amount from additional paid-in-capital to a liability.  The estimated
fair value of the non-employee options is remeasured each reporting period with
any change in estimated fair value recorded as a component of loss from
operations in the accompanying Consolidated Statements of
Operations.  As of December 31, 2007, 158,125 non-employee options
were outstanding.  During 2007 and 2006, we recorded the benefit of
the change in fair value of $95,000 and $1,551,000, respectively which resulted
primarily from a decline in our stock price.
  We use the
Black-Scholes option-pricing model to estimate the fair value of the
non-employee option grants over the remaining contractual terms of the
outstanding options, which ranged from 8 months to 25 months at December 31,
2007.
 
 67
  7.
              INCOME
      TAXES
  From
inception through October, 1995, we operated as an S Corporation for income tax
purposes. Losses incurred during this period were reported on the stockholders’
tax returns, and are not available to the Company as a net operating loss carry
forward. Since that time, losses incurred result in net operating loss carry
forwards which could be used to offset possible future taxable
income.
  The net
operating loss carry forwards will expire as follows:
   Year of Expiration2011
                
                $
                1,882,0002012
                
                
                1,969,0002018
                
                
                3,122,0002020
                
                
                3,296,0002021
                
                
                12,500,0002022
                
                
                35,488,0002023
                
                
                52,200,0002024
                
                
                57,597,0002025
                
                
                40,990,0002026
                
                
                33,073,0002027
                
                
                11,916,000Total
      net operating loss carryforwards
                
                $
                254,033,000
  We have
general business credit carry forwards of approximately $6,476,000 which expire
in the period 2011-2027, and an alternative minimum tax credit of approximately
$40,000 which can be carried forward for an indefinite period.  At
December 31, 2007, excess tax benefits related to employee stock options of
$225,000 are not yet reflected in deferred tax assets, the related tax benefit
of $88,000 would be recorded in Additional Paid in Capital when it reduces
income taxes payable.
  Under
Section 382 of the Internal Revenue Code, if an ownership change of more than
50% occurs there are annual limitations on the amount of net operating loss and
other deductions which would be available to us.  Accordingly, our
ability to offset any future federal taxable income with net operating loss
carryforwards arising before any such ownership changes may be
limited.  The Company has not completed a formal analysis of ownership
change and, thus, does not know the impact of such changes.  However,
such limitations would not have a material impact on the financial statements as
the net operating losses are fully reserved.  Our federal statutory
tax rate is 35% while our effective tax rate is 0%.  Differences
between the federal statutory and effective tax rates result from the
establishment of a valuation allowance to reduce the carrying value of deferred
tax assets to zero.
  Significant
components of the Company’s deferred tax assets and (liabilities) as of
December 31 are as follows:
  2007
                
                
                2006
                
                
                2005Net
      operating loss carry forwards
                
                $
                99,070,000
                
                
                $
                94,324,000
                
                
                $
                81,540,000General
      business credit carry forwards
                
                
                6,476,000
                
                
                
                6,340,000
                
                
                
                5,790,000Charitable
      contribution carry forwards
                
                
                283,000
                
                
                
                375,000
                
                
                
                418,000Alternative
      minimum tax credit carry forwards
                
                
                40,000
                
                
                
                40,000
                
                
                
                40,000Deferred
      revenue
                
                
                -
                
                
                
                780,000
                
                
                
                780,000Depreciation
                
                
                47,000
                
                
                
                (169,000
                )
                
                
                (292,000
                )Non-deductible
      stock compensation expense
                
                
                762,000
                
                
                
                744,000
                
                
                
                233,000Expense
      not currently deductible for tax purposes
                
                
                290,000
                
                
                
                149,000
                
                
                
                172,000Total
      deferred tax assets
                
                
                106,968,000
                
                
                
                102,583,000
                
                
                
                88,681,000Valuation
      allowance
                
                
                (106,968,000
                )
                
                
                (102,583,000
                )
                
                
                (88,681,000
                )Net
      deferred tax assets
                
                $
                -
                
                
                $
                -
                
                
                $
                -
 
  68
  The
valuation allowance increased by $4,385,000, $13,902,000 and $16,296,000 in each
of the years ended December 31, 2007, 2006, and 2005, respectively. In assessing
the realizability of deferred tax assets, we consider whether it is more likely
than not that some portion or all of the deferred tax assets will not be
realized. The ultimate realization of deferred tax assets is dependent upon the
generation of future taxable income during the periods in which those temporary
differences become deductible. We also consider the scheduled reversal of
deferred tax liabilities, projected future taxable income or losses, and tax
planning strategies in making this assessment. Based upon our history of tax
losses and projections for future taxable income over the periods in which the
deferred tax assets are deductible, we do not believe realization of these tax
assets is more likely than not. As such, we have established full valuation
allowances for the deferred tax assets.
  In
July 2006, the Financial Accounting Standards Board issued Interpretation
No. 48 (“FIN 48”), Accounting for Uncertainty in Income
Taxes—An Interpretation of FASB Statement No. 109.  The
Company adopted the provisions of FIN 48 on January 1, 2007.  FIN 48
clarifies the accounting for uncertainty in income taxes recognized in the
financial statements in accordance with FASB Statement
No. 109.  FIN 48 also prescribes a recognition threshold and
measurement model for the financial statement recognition of a tax position
taken, or expected to be taken, in a tax return and provides guidance on
derecognition, classification, interest and penalties, accounting in interim
periods, disclosure and transition.  The adoption of FIN 48 did not
have an effect on the results of operations or financial position of the
Company.   When applicable, the Company classifies interest on
tax settlements as a component of interest expense and penalties on tax
settlements as a component of administrative expense in its financial
statements.
  8.
              TRANSACTIONS
      WITH RELATED PARTIES
  In
December 2001, NeoPharm entered into a transaction whereby NeoPharm loaned
to Akorn, Inc. $3,250,000 to assist Akorn in the completion of its
lyophilized products manufacturing facility in Decatur,
Illinois.  Dr. Kapoor, our current Chairman of the Board of
Directors and at that time a member of the Company’s Board of Directors, is also
Chairman of the Akorn Board of Directors and holds a substantial stock position
in both companies.  As of December 31, 2002, the Company
determined the Promissory Note was impaired and recorded a charge to fully
reserve for the Promissory Note and related accrued interest. On August 18,
2003, NeoPharm presented Akorn with a formal “Notice of Default” on the
Promissory Note.  Because the carrying value of the Promissory Note
was zero, there was no financial statement impact as a result of any event of
default under, or non-payment of, the Promissory Note.  On May 16,
2005, the Company and Akorn entered into a Note Repayment Agreement (“Repayment
Agreement”), whereby the Company agreed to accept $2,500,000 as payment in full
for all outstanding principal and interest due and owing under the Promissory
Note, which was paid in 2005.  In addition, the parties mutually
agreed to terminate the Processing Agreement.  As a result of the
Repayment Agreement, the Company recorded a $2,500,000 benefit which was
recorded as “Recovery of Note Receivable” in the Company’s Consolidated
Statement of Operations for the year ended December 31, 2005.
  9.
              REDUCTION
      IN CLINICAL TRIAL EXPENSES
  Prior to
2007, the Company had focused primarily on completing its Phase III PRECISE
clinical trial.  In December 2006 ,we suffered a setback with the
results of our PRECISE Trial.  As a result of the FDA’s conclusion
that an additional Phase III trial would be required prior to acceptance of a
potential biologics license application, or BLA, filing by the Company and
potential commercialization, the Company brought the PRECISE Trial to an early
conclusion.  As a result, a number of sites at which the trial was
being conducted stopped their investigations at that time.  A final
reconciliation of the services performed prior to 2007 and thereafter and
determination of the remaining liability was completed in the fourth quarter of
2007.  The Company did not incur all the costs which had been
anticipated and accrued at end of 2006.  As a result, the Company
recorded a reduction in research and development expenses relating to the
PRECISE Trial of $900,000 in the fourth quarter of 2007 to adjust the accrual
for clinical trial expenses to the balance remaining to be paid.
  10.
              EMPLOYEE
      TERMINATION COSTS
  Following
the Company’s announcement on March 29, 2007 that an additional Phase III
clinical trial will be required  before the FDA will consider
approving its drug product candidate, Cintredekin Besudotox, the Company
initiated an organizational realignment in April 2007 which reduced the
workforce from 36 to 20 employees.   The reorganization included
the agreement of Dr. Jeffrey Sherman, the Company’s Executive VP-Chief Medical
Officer and Mr. Timothy Walbert, the Company’s Executive VP-Commercial
Operations, to step down, which occurred in June 2007 and  May 2007,
respectively.   In connection with the original terms of
employment, the Company was obligated to pay these Executives continued salary
equal to $137,500 and $120,000, respectively.  The Company recorded a
total charge of $598,000 related to these two executives and severance related
costs for 14 employees that were part of the Company’s reduction in
workforce.  All payments were made in 2007 with no accrued employee
termination costs carried forward into 2008.
  69
 The
employment of Mr. Guillermo Herrera, the former CEO of the Company, was
terminated effective March 23, 2007.  Since that date, he has
retained counsel and on May 7, 2007, Mr. Herrera’s attorney filed a suit
entitled Guillermo Herrera vs.
NeoPharm, Inc., Case No. 2007 L 004711 in the Circuit Court of Cook
County, Illinois.  See Note 13 “Contingencies” for further
discussion.
  During
2006, we reduced our workforce by 40 associates under an organizational
realignment initiative.   In May 2006, Dr. Imran Ahmad resigned
as the Company’s Executive Vice President and Chief Scientific Officer and, in
accordance with the terms of his original offer letter, Dr. Ahmad received
a  twelve-month salary continuation and a separation payment of
$20,000.  Additionally, in June 2006, we entered into a separation and
consulting agreement with our former Chief Financial Officer, Mr. Larry Kenyon
which became effective August 31, 2006.  Under this agreement, Mr.
Kenyon received a nine-month salary continuation, reimbursement of medical and
dental coverage and his previously granted options continued to vest during the
consulting period.  In December 2006, we completed an additional
organizational realignment initiative which resulted in a workforce reduction of
14 positions, or approximately 20% of the workforce at that time and recorded
related expense of $230,000.  Aggregate 2006 employee termination
costs related to 2006 reorganization and separation agreements were
$1,528,000.  Accrued but unpaid employee termination costs included in
other accrued expenses at December 31, 2006, totaled $415,000 and were paid in
the first half of 2007.
  The
employee termination costs over the past two years are summarized in the
following table:
  Employee
      Termination Costs2007
                
                
                2006Beginning
      Accrual Balance
                
                $
                415,000
                
                
                $
                -Accrued
      costs
                
                
                598,000
                
                
                
                1,528,000Payments
                
                
                (1,013,000
                )
                
                
                (1,113,000
                )Ending
      Accrual Balance
                
                $
                -
                
                
                $
                415,000
   11.
              FACILITY
      CONSOLIDATION COSTS
  During the
third quarter of 2007, the Company recorded an impairment charge totaling
$296,000 to reduce the carrying value of fixed assets, primarily furniture and
fixtures, to their estimated net realizable value.  With the lease on
the Company’s corporate headquarters expiring at March 31, 2008, the Company has
signed a lease for a new facility into which it has moved in the first quarter
of 2008.  As the new space is significantly smaller than the current
space, the Company will be required to sell excess furniture and
equipment.  This charge reduces the carrying value to its estimated
net realizable value upon disposal.
  The lease
on our Waukegan facility, from which we are moving to the new facility in Lake
Bluff, expires on March 31, 2008.  In this lease there is an
obligation for us to restore the facility to its original condition when we
moved into the facility.  As a result, for the year ended December 31,
2007, we have accrued an estimated cost of our restoration obligation of
$200,000.
  In 2006,
in connection with our facility consolidation, we vacated our office space in
Lake Forest, Illinois and have included $5,000 and $238,000 in other accrued
expenses as the remaining estimated lease exposure at December 31, 2007 and
December 31, 2006, respectively.  In 2006, we recorded a $339,000
charge for estimated lease exposure related to our former Lake Forest, Illinois
office space and wrote off $94,000 in related equipment and leasehold
improvements.  This office space has been sublet through March 31,
2008, the end of the lease period.
  70
  12.
              COMMITMENTS
  Manufacturing
Commitment--To secure access to manufacturing capacity for the potential
manufacture, scale-up of manufacturing and regulatory advancement of Cintredekin
Besudotox, we entered into agreements with a contract manufacturing
organization.  Under the terms of the agreements, we may be obligated
to pay half of the committed processing costs, or approximately $1.8 million,
should we elect not to utilize such capacity.   However, at
December 31, 2007, management does not feel that there is an obligation to pay
this amount.  Refer to Note 13 for further discussion.
  License and
Research Agreements—From time to time we enter into license and research
agreements with third parties. As of December 31, 2007, we had significant
agreements with three parties, as described below.
  Georgetown
University—We have entered into two license agreements with Georgetown
whereby we obtained an exclusive worldwide license to use certain technologies.
In exchange for the grant of one of these exclusive licenses that is related to
taxane derivatives, we agreed to pay Georgetown a royalty, ranging from 1.25% to
2.50% of any net sales from our products incorporating such technologies as
covered by the licensed patents. The royalty will be payable for the life of the
related patents. Additionally, we may be obligated to pay $400,000 upon entering
into any sublicense agreement and $250,000 upon approval of a New Drug
Application, or NDA.
  In July
2007, we entered into an exclusive license to use certain antisense technologies
covered by certain US patents.  In exchange for the grant of this
license, we paid Georgetown a non-refundable license issue fee of $10,000 and
are liable for yearly maintenance fees of $20,000.  In addition, we
agreed to pay Georgetown a royalty of 2.75% of net sales from our products
incorporating these technologies and 50% of any royalties received from
sublicensees.  We may also be obligated to make milestone payments
totaling $900,000 upon achievement of certain objectives.
  National
Institutes of Health—We entered into an exclusive worldwide licensing
agreement with the NIH in 1997 to develop and commercialize IL13-PE38QQR
(Cintredekin Besudotox). The agreement required us to pay NIH a $75,000
non-refundable license issue payment and minimum annual royalty payments of
$10,000, which increase to $25,000 after the first commercial sale. The
agreement further provides for us to make milestone payments to NIH of up to
$585,000 and royalties of up to 3.50% based on any future product
sales.  We made the first milestone payment of $25,000 to NIH in
November 1999 after the filing of the U.S. Investigational New Drug IND
application for IL13-PE38QQR.  We are required to pay the costs of
filing and maintaining product patents on the licensed patents. The agreement
extends to the expiration of the last to expire of the patents on the licensed
patents, if not terminated earlier. The agreement may be terminated by mutual
consent of NIH and us. Either party may terminate if the other party breaches a
material term or condition and such breach is not cured within a certain period
of time. Also, either party may unilaterally terminate by giving advanced
notice.
  On May 30,
2006 we entered into a non-exclusive Patent License Agreement with the NIH
providing us with a non-exclusive license to utilize a patented process owned by
the U.S. government relating to convection enhanced delivery, or CED, for us to
use with drugs, including Cintredekin Besudotox in the treatment of gliomas, in
the U.S., its territories and possessions.  Under the terms of this
Patent License Agreement, we have paid NIH a noncreditable, nonrefundable
license issue royalty of $5,000 and have agreed to pay a nonrefundable, minimum
annual royalty of $2,000, which will be credited against earned royalties, which
are fixed at one-half of one percent (0.5%) on aggregate future product sales
over $100 million.  An additional benchmark royalty of $20,00 is
payable within thirty (30) days of receiving approval from the U.S. FDA of
approval to use the licensed CED process in administrating a drug for the
treatment of gliomas.  Pursuant to an amendment to this Patent License
Agreement entered into in August 2006, we expanded the field of use to cover the
treatment of cancer, were given the right to sublicense our rights and extended
the time for us to reach certain benchmarks.  In return for these
additional rights, we agreed to pay additional sublicensing royalties one and
one-half percent (1.5%), to a maximum of $200,000, on the fair market value of
any upfront consideration received for granting a sublicense.
  In June
2007, we entered into an exclusive worldwide license agreement with the NIH to
develop and commercialize IL13-PE38QQR (Cintredekin Besudotox) for use in the
treatment of asthma and pulmonary fibrosis.  Upon entering the
contract, we paid NIH a non-refundable license issue royalty of $125,000 and
have agreed to pay an annual royalty of $20,000, which will be credited against
earned royalties, which are fixed at four percent (4%) of net sales, including
those of sublicensees.  In addition, we may be obligated to make
milestone payments totaling $1,410,000 upon achievement of certain
objectives.  We are required to pay the costs of filing and
maintaining product patents on the licensed patents. The agreement extends to
the expiration of the last to expire of the patents on the licensed patents, if
not terminated earlier. The agreement may be terminated by mutual consent of NIH
and us. Either party may terminate if the other party breaches a material term
or condition and such breach is not cured within a certain period of time. Also,
either party may unilaterally terminate by giving advanced notice.
  71
 U.S. Food and
Drug Administration—In 1997 the Company entered into a Cooperative
Research and Development Agreement, or CRADA, with the FDA. Pursuant to the
CRADA, we committed to work to commercialize the IL13-PE38QQR chimeric protein
which we licensed from NIH. The FDA agreed to collaborate on the clinical
development and commercialization of IL13-PE38QQR.   In September
2005, we and the FDA agreed to extend the term and funding of the CRADA through
July 2009 for $165,000 per year.
  Clinical Trial
Commitment—In August 2007, the Company entered into an agreement with
Excel Life Science for the completion of Phase II clinical trials with the use
of LEP-ETU for the treatment of metastatic breast cancer.  The
agreement contains milestone payments which are based upon stages of completion
of the phase II clinical trials.  The total of these payments is
potentially $349,000 for the clinical trials which began in the first quarter of
2008.
  Lease
Commitments—We have noncancelable operating leases, for office space and
research and development facility, which expire in March 2008 and require us to
pay all executory costs such as maintenance and insurance.  A sublease
on the Lake Forest facility was effected for the period from July 2007 through
March 2008.  The Company has signed a new lease for seven years for
space in a facility to replace the expiring leases.  Rental payments
include minimum rentals plus contingent rentals based on common area maintenance
expenses and property taxes.
  Rental
expense, net of the 2007 sublease receipts for the Lake Forest facility of
$40,000, for the three most recent fiscal years consisted of the
following:
  2007
                
                
                2006
                
                
                2005Minimum
      rentals
                
                $
                206,000
                
                
                $
                395,000
                
                
                $
                541,000Contingent
      rentals
                
                
                138,000
                
                
                
                244,000
                
                
                
                194,000Rental
      Expense
                
                $
                344,000
                
                
                $
                639,000
                
                
                $
                735,000
  In October
2007, the Company signed a three year lease for information technology network
equipment for the Company’s information services applications.  The
total of these payments for the three year period is $183,000.
  Future
minimum lease payments under noncancelable operating leases as of December 31,
2007 are:
  Year
      ending December 31:2008
                
                
                $
                348,0002009
                
                
                
                320,0002010
                
                
                
                324,0002011
                
                
                
                271,0002012
                
                
                
                279,000Later
      years
                
                
                659,000Total
      minimum lease payments
                
                $
                2,201,000
  72
 
 The Company
has a five year capital lease on five copy machines which expires in January
2011.  Their gross asset value in Fixed Assets-Furniture was $161,000
at the beginning of the lease in February 2006.  Included in the
capitalized amount  is imputed interest of $28,000.  These
copiers were included in the impairment writedown in the third quarter of
2007.  The impairment for these copiers was $64,000 leaving a gross
asset value at December 31, 2007 of $43,000.  Depreciation expense for
the capitalized copiers was $27,000 and $30,000 for the years ended 2007 and
2006, respectively.  Minimum future lease payments under a capital
lease as of December 31, 2007 are as follows:
  For
      the year ending December 31, 2008
                
                $
                38,000For
      the year ending December 31, 2009
                
                
                38,000For
      the year ending December 31, 2010
                
                
                38,000For
      the year ending December 31, 2011
                
                
                3,000Subsequent
      to 2011
                
                
                -Total
      minimum lease payments
                
                
                117,000Less
      amount representing interest
                
                
                (11,000
                )Present
      value of minimum lease payments
                
                $
                106,000
  Termination and
Employment Agreements—On October 28, 2005, NeoPharm entered into an
employment agreement with Guillermo A. Herrera (the “Herrera Agreement”) to
serve as its President and CEO and member of the Board of
Directors.  Under the terms of the Herrera Agreement, Mr. Herrera
received an annual base salary of $425,000 and a grant of shares of the
Company’s common stock, at the time of hire, equal to a total fair market of
$200,000 based upon the closing price as of October 28, 2005.  Mr.
Herrera was also eligible for an annual performance-based bonus payment and
received a monthly car allowance of $1,000.  Additionally, Mr. Herrera
received a common stock option grant of 500,000 options with a grant price equal
to the fair market value on the date of grant.  These options were to
vest in four equal annual installments on the anniversary of the option grant
date.
  In May
2006, Dr. Imran Ahmad resigned as the Company’s Executive Vice President and
Chief Scientific Officer and, in accordance with the terms of his original offer
letter, Dr. Ahmad received a twelve-month salary continuation and a separation
payment of $20,000.  Additionally, in June 2006, we entered into a
separation and consulting agreement with our former Chief Financial Officer, Mr.
Larry Kenyon, which became effective August 31, 2006.  Under this
agreement, Mr. Kenyon received a nine-month salary continuation, reimbursement
of medical and dental coverage and his previously granted options continued to
vest during the consulting period.
  On March
23, 2007, the Company terminated the employment of Mr. Guillermo Herrera, its
President and Chief Executive Officer.  In accordance with his
employment agreement, Mr. Herrera was scheduled to receive a salary
continuation of approximately $35,400 per month for twelve
months.  However, subsequent to his termination, the Company
determined that, based on the terms of the employment agreement, no salary
continuance was due Mr. Herrera and further payments were
stopped.  Refer to Note 13 for further discussion.
  On March
23, 2007, the Company entered into an employment agreement with Mr. Laurence P.
Birch (the “Agreement”) to serve as its President and Chief Executive
Officer.  Mr. Birch was elected to the Company’s Board of Directors on
March 30, 2007.   Under terms of the Agreement, Mr. Birch has
been provided an annual base salary of $275,000 and a target bonus of 50% of his
base salary based on performance criteria to be established by the Board in
consultation with Mr. Birch, with the potential to earn up to 100% of his base
salary for over achievement of performance criteria.  In the event the
Company terminates Mr. Birch’s employment without cause, he would be entitled to
receive a continuation of his then current base salary for a period of twelve
months.    In the event of a termination after a change of
control of the Company, Mr. Birch would receive, in addition to twelve months’
salary continuation, a lump sum payment equal to the prior year’s bonus, if any,
plus accelerated vesting of all options or restricted stock.
  On May 10,
2007, Mr. Timothy Walbert, Executive Vice President-Commercial Operations, and
the Company  entered into a Separation Agreement and Mutual Release
providing for Mr. Walbert’s termination to take effect May 31, 2007. Pursuant to
the terms of the Agreement, NeoPharm paid Mr. Walbert salary continuance for six
months during the period June 1, 2007 through November 30, 2007, at the rate of
$20,000 per month, and reimbursement for COBRA coverage for the period June 1,
2007 through July 31, 2007.
  On May 24,
2007, Dr. Jeffrey W. Sherman, Executive Vice President-Chief Medical Officer,
and the Company entered into a Separation Agreement and Mutual Release providing
for Dr. Sherman’s termination to take effect June 18, 2007.  Pursuant to
the terms of the Agreement, NeoPharm paid Dr. Sherman salary continuance for six
months during the period June 18, 2007 through December 18, 2007, at the rate of
$22,917 per month, and reimbursement for unused vacation time and for COBRA
coverage for the period June 18, 2007 through August 18,
2007.
  73
  Defined
Contribution Retirement Plan (401(k) Plan)—We sponsor a
401(k) Plan covering all full-time employees. Participants may contribute
up to legal limitations.  The 401(k) Plan provides for us to make
qualified non-elective contributions on behalf of all eligible
participants.  Employees are eligible to receive the non-elective
contribution if they were eligible to participate in the 401(k) plan at any time
during the year.  The contribution is 3% of an employee’s eligible
compensation. Our qualified non-elective  contributions were $99,000,
$252,000 and $288,000 for the years ended December 31, 2007, 2006 and 2005,
respectively.
  13.
              CONTINGENCIES
  In
December 2006, we suffered a significant setback with the results of our Phase
III clinical trial of Cintredekin Besudotox, the PRECISE
trial.  Patients in the PRECISE trial received treatment either with
Cintredekin Besudotox or with Gliadel® Wafers, a product currently approved to
treat this disease. The primary endpoint of the study was to determine if there
was a statistically significant overall patient survival difference between
patients treated with Cintredekin Besudotox and patients treated with Gliadel®
Wafers. The Phase III PRECISE trial did not meet the primary endpoint at 215
deaths.  After the announcement of the PRECISE trial results, the
Company met with its Scientific Advisory Board to identify potential regulatory
paths forward, meaning a rationale for FDA approval, based on the totality of
the clinical data gathered to date.  In a meeting with the Company on
March 28, 2007 to review the PRECISE trial results, the FDA concluded that an
additional Phase III trial would be required prior to acceptance of a potential
BLA filing by the Company.
  In
December 2006, we were advised by the staff of the U.S. Securities and Exchange
Commission, the SEC, that the SEC’s investigation of the Company, which the
Company believe concerned the Company’s disclosures regarding the development of
its LEP and LED drug product candidates, had been terminated and no enforcement
action had been recommended.  The decision by the SEC to terminate its
investigation is not a finding or judgment regarding the matters
investigated.
  NeoPharm,
Inc. and certain of our former officers have been named in a consolidated
amended complaint, which alleges various violations of the federal securities
laws in connection with our public statements regarding our LEP drug product
candidate during the period from October 31, 2001 through April 19,
2002.  On November 4, 2002, we moved to have the complaint
dismissed. Our motion to dismiss was granted in part and denied in part in
February 2003.  In November 2004, the plaintiffs filed a
motion to amend and a motion for summary adjudication. The motion to amend seeks
to include certain pre-class period statements in the complaint. The motion for
summary adjudication asks the Court to rule that certain statements made in an
arbitration award regarding the LEP drug product candidate be deemed facts
established in this proceeding. On February 23, 2007, the Court entered an order
denying both the plaintiffs’ motion to amend and the plaintiffs’ motion for
summary adjudication.  Fact and expert discovery is closed and the
dispositive motion filing deadline was March 21, 2008.  No trial date
has yet been set.  We intend to vigorously defend each and every claim
in the complaint.  Management is unable to estimate the potential
outcome or range of possibilities, if any.  In addition, we maintain
insurance coverage to mitigate the financial impact of any potential
loss.
  The
employment of Mr. Guillermo Herrera, the former CEO of the Company, was
terminated effective March 23, 2007.  Since that date, he has
retained counsel and on May 7, 2007, Mr. Herrera’s attorney filed a suit
entitled Guillermo Herrera vs.
NeoPharm, Inc., Case No. 2007 L 004711 in the Circuit Court of Cook
County, Illinois, seeking payment of $212,500 for his 2006 bonus and $25,000 for
a salary increase for 2007.  Subsequent to this filing, the Company
determined that under the terms of his employment agreement the Company should
not be responsible for the payment of severance and terminated further
payments.  Mr. Herrera filed an Amended Complaint on February 21, 2008
alleging breach of his employment agreement with the Company, defamation, and
tortiously presenting plaintiff in a false light.  Mr. Herrera
seeks an additional $363,612 representing the remaining severance payments, plus
attorneys’ fees and costs.  Mr. Herrera also seeks unspecified
compensatory and punitive damages.  The Company is vigorously
defending this matter. We are unable at this time to make any prediction as to
the outcome of this litigation.
  We entered
into various contractual arrangements, primarily during the fourth quarter of
2006, under take or pay agreements, with Diosynth Biotechnology, Inc.
(“Diosynth”), to secure access to manufacturing capacity for the potential
manufacture and regulatory advancement of Cintredekin Besudotox through early
2008.  As a result of the FDA’s decision to require additional Phase
III clinical testing of Cintredekin Besudotox, the Company advised Diosynth that
the timing of further work to support a potential BLA submission must be
delayed.  Diosynth has indicated that such a delay constitutes a
default under our contract.  In response, the Company invoked the
dispute resolution provisions of the contract in an attempt to resolve these and
other differences between the two companies.  A dialogue between the
senior executives of our Company and Diosynth was initiated, but no resolution
has been forthcoming.  In the event these discussions fail to resolve
the parties’ differences, the contract provides for mediation and eventually
binding arbitration.  Under the terms of the various contractual
arrangements, if the Company can not settle its outstanding differences with
Diosynth, and Diosynth should refuse to delay the related disputed manufacturing
activity, and such dispute were to culminate in an arbitration judgment against
the Company, we may be obligated to pay half of the disputed processing
costs.  The Company estimates the potential exposure to be
approximately $2.1 million at December 31, 2007.
  74
  We are
from time to time subject to claims and litigation arising in the ordinary
course of business. We intend to defend vigorously any such litigation that may
arise under all defenses that would be available to us. In the opinion of
management, the ultimate outcome of those proceedings of which management is
aware, even if adverse to us, will not have a material adverse effect on our
consolidated financial position or results of operations.  While we
maintain insurance to cover the use of our drug product candidates in clinical
trials, we do not presently maintain insurance covering the potential commercial
use of our drug product candidates and there is no assurance that we will be
able to obtain or maintain such insurance on acceptable terms.
  14.
              SUBSEQUENT
      EVENTS
  Subsequent
to December 31, 2007, all of the auction rate certificates held by the Company
in February 2008 have experienced failed auctions.  An auction failure
is not a default.  An auction failure means that the parties wishing
to sell securities could not because the number of sellers was greater than the
number of buyers of the reset dates.  Because the investments
typically have provisions such that the interest rates reset at higher
percentages upon failure in the auction market, the issuers have a strong
incentive to restructure and repurchase the underlying
bonds.  However, this process could take time and as a result, the
Company’s ability to liquidate these investment and fully recover the carrying
value of the investment in the near term may be limited or not
exist.  If the issuers are unable to successfully close future
auctions and their current AAA credit rating deteriorates, the Company may in
the future be required to record an impairment charge on these
investments.  Should the Company need to sell these securities in
order to meet cash needs in markets other than a successful auction, the Company
could be required to accept less than the face value and therefore, recognize a
loss.
  75
  15.
              QUARTERLY
      FINANCIAL DATA (unaudited)
  The
following table summarizes the quarterly financial data for the years ended
December 31, 2007 and 2006.
  NeoPharm,
      IncCondensed
      Consolidated Statements of Operations(Unaudited)2007First
                
                
                Second
                
                
                Third
                
                
                FourthRevenue
                
                $
                -
                
                
                $
                -
                
                
                $
                -
                
                
                $
                -Research
      and development expenses
                
                
                3,007,000
                
                
                
                1,500,000
                
                
                
                1,668,000
                
                
                
                195,000Selling,
      general, and administrative expenses
                
                
                2,862,000
                
                
                
                1,973,000
                
                
                
                1,265,000
                
                
                
                1,263,000Cost
      reduction initiative costs
                
                
                -
                
                
                
                555,000
                
                
                
                296,000
                
                
                
                243,000Other
      Income
                
                
                -
                
                
                
                -
                
                
                
                2,000,000
                
                
                
                -Net
      loss
                
                $
                (5,453,000
                )
                
                $
                (3,615,000
                )
                
                $
                (881,000
                )
                
                $
                (1,052,000
                )Net
      loss per basic and diluted share
                
                $
                (0.19
                )
                
                $
                (0.13
                )
                
                $
                (0.03
                )
                
                $
                (0.04
                )2006First
                
                
                Second
                
                
                Third
                
                
                FourthRevenue
                
                $
                2,000
                
                
                $
                8,000
                
                
                $
                1,000
                
                
                $
                -Research
      and development expenses
                
                
                5,844,000
                
                
                
                6,037,000
                
                
                
                4,319,000
                
                
                
                4,999,000Selling,
      general, and administrative expenses
                
                
                3,046,000
                
                
                
                4,496,000
                
                
                
                3,266,000
                
                
                
                3,328,000Reorganization
      costs
                
                
                -
                
                
                
                570,000
                
                
                
                1,156,000
                
                
                
                235,000Net
      loss
                
                $
                (7,679,000
                )
                
                $
                (9,791,000
                )
                
                $
                (8,004,000
                )
                
                $
                (7,734,000
                )Net
      loss per basic and diluted share
                
                $
                (0.28
                )
                
                $
                (0.35
                )
                
                $
                (0.29
                )
                
                $
                (0.28
                )
  76