**UNITED STATESSECURITIES AND EXCHANGE COMMISSION**

**Washington, D.C. 20549**

 

**FORM 10-Q**

 

 
| **ý**                                                                                                                                                                                         | **QUARTERLY REPORT UNDER SECTION 13  OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934**            |
|----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|--------------------------------------------------------------------------------------------------------|
| ** **                                                                                                                                                                                         | ** **                                                                                             |
| **For  Quarterly Period Ended March 31, 2004**                                                                                                                                                |
|                                                                                                                                                                                               |                                                                                                   |
| **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 ofRegistrant as specified in its charter)

 
| **Delaware**                                                    | ** ** | **51-0327886**                          |
|-----------------------------------------------------------------|------------|-----------------------------------------|
| (State or other jurisdiction of  incorporation or organization) |       | (I.R.S. Employer Identification Number) |
|                                                            |       |                                    |
| **150  Field Drive  Suite 195  Lake Forest, Illinois 60045**    |
| (Address of principal executive offices)  (Zip Code)            |
|                                                            |       |                                    |
| **(847)  295-8678**                                             |
| (Registrant’s telephone number, including  area code)      |

 

Indicate by check mark whetherthe registrant (1) has filed all reports required to be filed bySection 13 or 15(d) of the Securities Exchange Act of 1934 during thepreceding 12 months (or for such shorter period that the registrant wasrequired to file such reports), and (2) has been subject to such filingrequirements for the past 90 days.  Yes  ý   No  o

 

Indicate by check mark whetherthe registrant is an accelerated filer (as defined in Rule 12b-2 of the ExchangeAct).  Yes   ý  No  o

 

As of April 30, 2004 thenumber of shares outstanding of each of the issuer’s classes of common stockwas as follows:

 
| **Title of each class**            | ** ** | **Number of shares outstanding** |
|------------------------------------|------------|----------------------------------|
| Common Stock ($.0002145 par value) |       | 23,218,579                       |

 

 

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NEOPHARM,INC.

 

FORM10-QINDEX

 
| PART I. FINANCIAL  INFORMATION |
|--------------------------------|
|                           | Item 1. | Financial Statements |
|                           |   | Balance Sheets as of March 31, 2004  (Unaudited) and December 31, 2003 |
|                           |   | Statements of Operations for  the three months ended March 31, 2004 and 2003 (Unaudited) |
|                           |   | Statements of Cash Flows for the  three months ended March 31, 2004 and 2003 (Unaudited) |
|                           |   | Notes to Financial  Statements (Unaudited) |
|                           | Item  2. | Management’s  Discussion and Analysis of Financial Condition and Results of Operations |
|                           | Item  3. | Quantitative  and Qualitative Disclosures About Market Risk |
|                           | Item 4 | Controls and Procedures |
| PART II. OTHER INFORMATION     |
|                           | Item  1. | Legal  Proceedings |
|                           | Item 2. | Changes in Securities  and Use of Proceeds |
|                           | Item 3. | Defaults Upon Senior Securities |
|                           | Item 4. | Submission of Matters to a Vote of  Security-Holders |
|                           | Item  5. | Other  Information |
|                           | Item 6. | Exhibits and Reports on Form 8-K |
| SIGNATURE PAGE                 |

 

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**PART I - FINANCIAL INFORMATION**

 

**Item 1- Financial Statements**

 

**NEOPHARM, INC.Balance Sheets**

 
| ** **                                                                                                                                | ** ** | **March 31, 2004** | ** **  | **December 31, 2003** | ** ** |
|-------------------------------------------------------------------------------------------------------------------------------------------|------------|-------------------------|-------------|----------------------------|------------|
| ** **                                                                                                                                | ** ** | **(Unaudited)**         | ** **  | ** **                 | ** ** |
| **ASSETS**                                                                                                                                |       |                    |        |                       |       |
| Current assets:                                                                                                                           |       |                    |        |                       |       |
| Cash and cash equivalents                                                                                                                 |       | $                       | 101,725,081 |                       | $          | 36,958,941 |   |
| Investments in marketable  securities                                                                                                     |       | 911,189                 |        | 4,166,351                  |       |
| Trade accounts receivable                                                                                                                 |       | 8,000                   |        | —                     |       |
| Inventories                                                                                                                               |       | 3,864                   |        | —                     |       |
| Prepaid expenses                                                                                                                          |       | 515,218                 |        | 909,833                    |       |
| Other receivables                                                                                                                         |       | 304,990                 |        | 284,750                    |       |
| Total  current assets                                                                                                                     |       | 103,468,342             |        | 43,219,875                 |       |
| Fixed assets, net of  accumulated depreciation                                                                                            |       | 3,570,236               |        | 3,760,705                  |       |
| Total assets                                                                                                                              |       | $                       | 107,038,578 |                       | $          | 46,080,580 |   |
|                                                                                                                                      |       |                    |        |                       |       |
| **LIABILITIES AND  STOCKHOLDERS’ EQUITY**                                                                                            |       |                    |        |                       |       |
| Current liabilities:                                                                                                                      |       |                    |        |                       |       |
| Accounts payable                                                                                                                          |       | $                       | 554,372     |                       | $          | 499,682 |   |
| Accrued clinical trial expense                                                                                                            |       | 4,016,011               |        | 1,658,293                  |       |
| Accrued legal expenses                                                                                                                    |       | 576,045                 |        | 1,076,228                  |       |
| Accrued compensation                                                                                                                      |       | 1,143,860               |        | 2,144,163                  |       |
| Other accrued expenses                                                                                                                    |       | 915,468                 |        | 684,859                    |       |
| Unearned revenue                                                                                                                          |       | 5,800                   |        | —                     |       |
| Total current liabilities                                                                                                                 |       | 7,211,556               |        | 6,063,225                  |       |
|                                                                                                                                      |       |                    |        |                       |       |
| Stockholders’ equity:                                                                                                                |       |                    |        |                       |       |
| Preferred stock, $0.01 par  value; 15,000,000 shares authorized: 0 shares issued and outstanding                                          |       | —                  |        | —                     |       |
| Common stock, $0.0002145 par  value; 50,000,000 shares authorized: 23,214,986 and 18,862,906 shares issued  and outstanding, respectively |       | 4,981                   |        | 4,046                      |       |
| Additional paid-in capital                                                                                                                |       | 245,760,550             |        | 171,704,628                |       |
| Accumulated deficit                                                                                                                       |       | (145,938,509            | )           | (131,691,319               | )          |
| Total stockholders’ equity                                                                                                           |       | 99,827,022              |        | 40,017,355                 |       |
| Total liabilities and  stockholders’ equity                                                                                          |       | $                       | 107,038,578 |                       | $          | 46,080,580 |   |

 

Theaccompanying notes are an integral part of these financial statements.

 

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**NEOPHARM, INC.**

 

**Statements of Operation****sThree Months Ended March 31, 2004 and 2003**(Unaudited)

 

| ** **                                  | ** ** | **Three Months Ended**  | ** **  |
|---------------------------------------------|------------|-------------------------|-------------|
| ** **                                  | ** ** | **March 31, 2004** | ** **  | **March 31, 2003** | ** ** |
| Revenues                                    |       | $                       | 12,200      |   | $ | — |   |
| Cost of revenues                            |       | 244                     |        | — |   |
| Gross margin                                |       | 11,956                  |        | — |   |
|                                        |       |                    |        |   |   |
| Expenses:                                   |       |                    |        |   |   |
| Research and development                    |       | 11,249,227              |        | 7,108,556 |   |
| Selling, general and  administrative        |       | 3,200,069               |        | 4,404,384 |   |
| Related party expenses                      |       | 35,364                  |        | 39,192 |   |
| Total expenses                              |       | 14,484,660              |        | 11,552,132 |   |
| Loss from operations                        |       | (14,472,704             | )           | (11,552,132 | ) |
|                                        |       |                    |        |   |   |
| Interest income                             |       | 225,514                 |        | 284,892 |   |
| Net loss                                    |       | $                       | (14,247,190 | ) | $ | (11,267,240 | ) |
| Net loss per share —                   |       |                    |        |   |   |
| Basic and diluted                           |       | $                       | (0.65       | ) | $ | (0.60 | ) |
| Weighted average shares  outstanding — |       |                    |        |   |   |
| Basic and diluted                           |       | 21,911,987              |        | 18,809,625 |   |

 

Theaccompanying notes are an integral part of these financial statements.

 

4

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**NEOPHARM, INC.**

 

**Statements of Cash****FlowsThree Months Ended March 31, 2004 and 2003**(Unaudited)
| ** **                                                                   | ** ** | **Three Months Ended**  | ** **  |
|------------------------------------------------------------------------------|------------|-------------------------|-------------|
| ** **                                                                   | ** ** | **March 31, 2004** | ** **  | **March 31, 2003** | ** ** |
| Cash flows from operating  activities:                                       |       |                    |        |   |   |
| Net loss                                                                     |       | $                       | (14,247,190 | ) | $ | (11,267,240 | ) |
| Adjustments to reconcile net  loss to net cash used in operating activities: |       |                    |        |   |   |
| Depreciation and amortization                                                |       | 329,671                 |        | 250,124 |   |
| Stock-based compensation  expense                                            |       | 147,814                 |        | 34,000 |   |
| Changes in assets and  liabilities:                                          |       |                    |        |   |   |
| (Increase)/decrease in current  assets                                       |       | 362,511                 |        | (87,347 | ) |
| Increase in current liabilities                                              |       | 1,148,331               |        | 819,389 |   |
| Net cash and cash equivalents  used in operating activities                  |       | (12,258,863             | )           | (10,251,074 | ) |
|                                                                         |       |                    |        |   |   |
| Cash flows from investing  activities:                                       |       |                    |        |   |   |
| Proceeds from maturities of  marketable securities                           |       | 892,749                 |        | 2,008,485 |   |
| Proceeds from sales of  marketable securities                                |       | 2,362,413               |        | — |   |
| Purchase of marketable  securities                                           |       | —                  |        | (378,263 | ) |
| Purchase of equipment and  furniture                                         |       | (139,202                | )           | (255,146 | ) |
| Net cash and cash equivalents  provided by investing activities              |       | 3,115,960               |        | 1,375,076 |   |
|                                                                         |       |                    |        |   |   |
| Cash flows from financing  activities:                                       |       |                    |        |   |   |
| Net proceeds from issuance of  common stock                                  |       | 73,909,043              |        | — |   |
| Net cash and cash equivalents  provided by financing activities              |       | 73,909,043              |        | — |   |
|                                                                         |       |                    |        |   |   |
| Net increase/(decrease) in cash  and cash equivalents                        |       | 64,766,140              |        | (8,875,998 | ) |
| Cash and cash equivalents,  beginning of period                              |       | 36,958,941              |        | 87,591,975 |   |
| Cash and cash equivalents, end  of period                                    |       | $                       | 101,725,081 |   | $ | 78,715,977 |   |
|                                                                         |       |                    |        |   |   |
| Supplemental disclosure of cash  paid for:                                   |       |                    |        |   |   |
| Interest                                                                     |       | $                       | —      |   | $ | — |   |
| Income taxes                                                                 |       | $                       | —      |   | $ | — |   |

 

Theaccompanying notes are an integral part of these financial statements.

 

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**NEOPHARM, INC.**

 

**NOTES TO FINANCIAL STATEME****NTS**

 

**Note 1 Basis of Presentation**

 

The financial information hereinis unaudited. The balance sheet as of December 31, 2003 is derived fromaudited financial statements.

 

The accompanying unauditedfinancial statements of NeoPharm, Inc. (the “Company”) have been prepared inaccordance with generally accepted accountingprinciples for interim financial information and with the instructions to Form10-Q and Rule 10-01 of Regulation S-X. Accordingly, they do not contain all ofthe information and footnotes required by accounting principles generallyaccepted in the United States of America for complete financial statements. Inthe opinion of the Company, the accompanying unaudited interim financialstatements contain all adjustments (consisting of normal recurring adjustments)necessary to present fairly the Company’s financial position as ofMarch 31, 2004, and the results of its operations and its cash flows forthe three months ended March 31, 2004 and 2003.

 

While the Company believes thatthe disclosures presented are adequate to make the information not misleading,it is suggested that these financial statements be read in conjunction with thefinancial statements and notes included in the Company’s 2003 Annual Report onForm 10-K filed with the Securities and Exchange Commission.

 

**Note 2 Investments**

 

The Company considers all highly liquid investments purchased with anoriginal maturity of three months or less to be cash equivalents. The carryingvalue of these investments approximates the fair market value due to theirshort maturity and liquidity. Investments in marketable securities includeliquid investments purchased with an original maturity of between three monthsand one year. As provided by SFAS No. 115, *Accounting for Certain Investments in Debt and Equity Securities,*theCompany has elected to treat all of its investments in marketable securities as“available-for-sale”, which requires these investments to be recorded at fairmarket value. Unrealized gains and losses, net of related tax effect, onavailable-for-sale securities deemed to be temporary are excluded from earningsand are reported as a separate component of other comprehensive income untilrealized. Realized gains and losses from the sale of available-for-salesecurities are determined on a specific identification basis. A decline inmarket value of available-for-sale securities that is deemed to be other thantemporary, results in the reduction of the carrying amount to fair value. Theimpairment is charged to earnings and a new cost basis for the security isestablished. At March 31, 2004, the Company’s investments in marketablesecurities consisted primarily of commercial paper, which are recorded at costplus accrued interest as this approximated the fair market value of thesecurities held. Dividend and interest income are recognized when earned.Realized gain on investments sold during the three months ended March 31,2004 was $172.  No investments were soldduring the three month period ended March 31, 2003.

 

As of March 31, 2004, all of the Company’s investments inmarketable securities had maturities of less than eight months.  Due to the short-term maturity and liquidityof these investments, the differences between carrying value and fair marketvalue were nominal.  The Company has notexperienced any declines in fair market value of its investments that wereother than temporary.

 

**Note 3 Inventory**

 

Inventory is comprised solely of finished goods associatedwith NeoPhectin and is stated at the lower of cost or market, as determined bythe first in, first out method (FIFO). Inventory cost consists of direct material and direct labor costs.  As products are currently produced in theCompany’s research and development facilities, the Company has not allocatedany overhead costs as a product cost. Application of overhead as a product cost is not material as of March31, 2004.  Inventory at March 31, 2004and December 31, 2003 consisted of the following:

 
| ** **                   | ** ** | **March 31, 2004** | ** ** | **December 31, 2003** | ** ** |
|------------------------------|------------|--------------------|------------|-----------------------|------------|
|                         |       |               |       |                  |       |
| Finished  goods on hand      |       | $                  | 3,589      |                  | $          | — |   |
| Inventory  subject to return |       | 275                |       | —                |       |
|                         |       |               |       |                  |       |
|                         |       | $                  | 3,864      |                  | $          | — |   |

 

Inventory subject to return represents NeoPhectinproducts shipped to a wholesale customer that have not been recognized asrevenue (see note 5).

 

**Note4  Fixed Assets**

 

Fixedassets are recorded at cost and are depreciated using the straight line methodover their estimated useful lives. During 2003, the Company revised itsestimate of the useful life of computer equipment from five years to threeyears. Maintenance and repairs that do not extend the life of assets arecharged to expense when incurred.

 

Long-livedassets are reviewed for impairment whenever events or changes in circumstancesindicate the carrying amount of an asset may not be recoverable. Recoverabilityof assets to be held and used is measured by a comparison of the carryingamount of an asset to estimated undiscounted cash flows expected to begenerated by the asset. If the carrying amount of an asset exceeds itsestimated future cash flows, an impairment charge is recognized by the amountby which the carrying amount of the asset exceeds the fair value of the asset.

 

**Note5 Revenue Recognition**

 

The Company commenced sales of products in the first quarterof 2004.  All revenue represents sales ofNeoPhectinTM and NoePhectin-ATTM (together “NeoPhectin”) transfection reagentproducts sold to Avanti Polar Lipids, Inc. (Avanti), through a non-exclusivedistribution agreement, or end-user customers.

 

Revenue is recognized when persuasive evidence of anarrangement with the customer at a fixed or determinable price exists, productsare shipped, title and risk of loss passes to thecustomer, and collectibility is reasonably assured.

 

Shipments of product to Avanti are subject to unconditionalrights of return for a period of 180 days from the date of shipment.  Given the limited sales history of NeoPhectinTM,the Company is currently unable to reasonably estimate the level of returns atthe time of product shipment. Accordingly, revenue is currently being recognized when the right ofreturn has expired, which occurs upon the earlier of shipment of product by thedistributor to an end-user or 180 days.

 

6

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**Note 6 Stock-based Compensation**

 

The Company applies theintrinsic-value-based method of accounting prescribed by Accounting PrinciplesBoard (APB) Opinion No. 25, *Accountingfor Stock Issued to Employees*, and related interpretations, to account forits fixed-plan stock options.  Under thismethod, compensation expense is recorded only if the current market price ofthe underlying stock exceeded the exercise price.   Statement of Financial Accounting Standards(SFAS) No. 123, *Accounting forStock-Based Compensation*, established accounting and disclosurerequirements using a fair-value-based method of accounting for stock-basedemployee compensation plans.  As allowedby SFAS No. 123, the Company has elected to continue to apply theintrinsic-value-based method of accounting described above, and has adoptedonly the disclosure requirements of SFAS No. 123.

 

The Company accounts for optiongrants under the plan by applying the provisions of APB Opinion No. 25, underwhich no compensation cost has been recognized for the stock option awards toemployees, since the exercise price of the options granted is equal to marketvalue on the date of grant.  Thefollowing table illustrates the effect on net loss if the fair-value-basedmethod had been applied in each period.

 

| ** **                                                                                                      | ** ** | **For the three months ended:** | ** **  |
|-----------------------------------------------------------------------------------------------------------------|------------|---------------------------------|-------------|
| ** **                                                                                                      | ** ** | **March 31, 2004**         | ** **  | **March 31, 2003** | ** ** |
|                                                                                                            |       |                            |        |   |   |
| Net loss, as reported                                                                                           |       | $                               | (14,247,190 | ) | $ | (11,267,240 | ) |
| Add stock-based employee compensation expense included in reported net  loss(1)                                 |       | 147,814                         |        | — |   |
| Deduct total stock-based employee compensation expense determined under  fair-value-based method for all awards |       | (1,942,255                      | )           | (1,905,787 | ) |
| Pro forma net loss                                                                                              |       | $                               | (16,041,631 | ) | $ | (13,173,027 | ) |
|                                                                                                            |       |                            |        |   |   |
| Basic and diluted loss per share of common stock                                                                |       |                            |        |   |   |
| As reported                                                                                                     |       | $                               | (0.65       | ) | $ | (0.60 | ) |
| Pro forma                                                                                                       |       | $                               | (0.73       | ) | $ | (0.70 | ) |

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(1)           Value of restricted stock granted to independentdirectors.

 

**Note 7  LossPer Share**

 

The following table sets forththe computation of the basic and diluted net loss per share:

 

| ** **                          | ** ** | **For the three months ended:** | ** **  |
|-------------------------------------|------------|---------------------------------|-------------|
| ** **                          | ** ** | **March 31, 2004**         | ** **  | **March 31, 2003** | ** ** |
| Numerator:                          |       |                            |        |   |   |
| Net loss                            |       | $                               | (14,247,190 | ) | $ | (11,267,240 | ) |
|                                |       |                            |        |   |   |
| Denominator:                        |       |                            |        |   |   |
| Weighted average shares outstanding |       | 21,911,987                      |        | 18,809,625 |   |
|                                |       |                            |        |   |   |
| Loss per share - basic and diluted  |       | $                               | (0.65       | ) | $ | (0.60 | ) |
|                                |       |                            |        |   |   |
| Potential common share equivalents: |       |                            |        |   |   |
| Stock options                       |       | 3,433,091                       |        | 3,312,517 |   |

 

As the Company has incurred a netloss for all periods presented, basic and diluted per share amounts areequivalent as the effect of all potential common share equivalents isanti-dilutive.

 

**Note 8 Transactions with Related Parties**

 

The following table providesfurther detail of the related party expenses reflected in the statements ofoperations.

 

| ** **                   | ** ** | ** **       | ** ** | **For the three months ended:** | ** ** |
|------------------------------|------------|------------------|------------|---------------------------------|------------|
| **Related Party**            | ** ** | **Expense Type** | ** ** | **March 31, 2004**         | ** ** | **March 31, 2003** | ** ** |
| Akorn, Inc.                  |       | Consulting       |       | $                               | 3,750      |   | $ | 7,669 |   |
| E.J. Financial Enterprises   |       | Consulting       |       | 31,250                          |       | 31,250 |   |
| E.J. Financial Enterprises   |       | Direct Expenses  |       | 364                             |       | 273 |   |
| Total related party expenses |       |             |       | $                               | 35,364     |   | $ | 39,192 |   |

 

In December 2001, NeoPharm entered into a transaction wherebyNeoPharm loaned to Akorn, Inc., a Louisiana corporation, $3,250,000 toassist Akorn in the completion of its lyophilized products manufacturingfacility in Decatur, Illinois. Dr. John N. Kapoor, NeoPharm’sChairman of the Board of Directors, is the Chairman of the Akorn Board ofDirectors and holds a substantial stock position in both companies. In connectionwith the loan transaction, NeoPharm entered into the following agreements:Promissory Note, dated December 20, 2001, in the original principal amountof $3,250,000 by Akorn to NeoPharm; Processing Agreement, datedDecember 20, 2001, by and between Akorn and NeoPharm; Subordination andIntercreditor Agreement, dated December 20, 2001, by and between John N.Kapoor, as Trustee under The John N. Kapoor Trust, dated September 20,1989 and NeoPharm; and a Subordination, Standby and Intercreditor Agreement,dated December 20, 2001, by and among Akorn, Akorn (NewJersey), Inc., The Northern Trust Company and NeoPharm. The PromissoryNote issued by Akorn was due in December 2006, and accrued interest at arate equal to that received on the Company’s investments in marketablesecurities, which is lower than the interest rate paid by Akorn on its otheroutstanding debt. The Processing Agreement grants NeoPharm access to at least15% of the annual lyophilization manufacturing capacity at Akorn at most favoredcustomer pricing, upon completion of the facility. The Processing Agreementalso provided that Akorn was to begin providing lyophilization services on orbefore June 30, 2003. At the time these transactions were entered into,Akorn represented that the manufacturing facility would be operational in 2003,approximately the time when NeoPharm anticipated it would need to manufactureits lyophilized drug product candidates for Phase II/III clinical trials. In2001, NeoPharm recorded the Promissory Note net of a valuation allowance of$1,266,619 reflecting the difference between the actual loan amount and thepresent value of the loan using an estimated market interest rate of 10%. As ofDecember 31, 2002, the Company determined the Promissory Note was impairedand recorded a charge to fully reserve for the Promissory Note and relatedaccrued interest. On August 18, 2003, NeoPharm presented Akorn with aformal “Notice of Default” on the Promissory Note. Because the carrying valueof the Promissory Note was zero, there was no financial statement impact as aresult of any event of default under, or non-payment of, the Promissory Note.In September 2003, Akorn advised NeoPharm that it wished to refinance itssenior debt with a new senior lender, which lender would require NeoPharm tosubordinate its debt. In order to preserve the possibility of collectingAkorn’s debt to NeoPharm and in consideration of a higher rate of interest(which would now equal that to be charged by the new senior lender, which isthe prime rate plus 175 basis points) and the possibility of acceleratedmandatory repayments once Akorn’s senior debt was repaid in full, NeoPharmagreed to waive Akorn’s default, to allow Akorn until October 2004 toprovide the required manufacturing rights and to subordinate Akorn’sindebtedness to NeoPharm to Akorn’s indebtedness to its new senior lender.Akorn’s refinancing was completed on October 7, 2003.

 

**Note 9 Contingencies**

 

On April 19, 2002, the Company filed a Demand for Arbitration withthe American Arbitration Association in accordance with the terms of itslicense agreement dated February 19, 1999 (the “License Agreement”) withPharmacia Corporation, Pharmacia and Upjohn, Inc. and Pharmacia and UpjohnCompany (collectively, “Pharmacia”), for the purpose of resolving a disputewith Pharmacia concerning delays in the development programs for LEP (LiposomeEncapsulated Paclitaxel) and LED (Liposome Encapsulated Doxorubicin) which werebeing conducted by Pharmacia. The Company contended that Pharmacia failed inits duty under the License Agreement to use reasonable efforts to develop LEPand LED and that such failure constituted a breach of the License Agreement.The 

 

7

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Company further contended that Pharmacia breached its duty to consultwith NeoPharm on the progress of the drug development program and therebyimpaired NeoPharm’s ability to monitor the development of these compounds. TheCompany sought all damages to which it was entitled, including but not limitedto, loss of co-promotion and royalty revenues that would have been received ifLEP and LED had not been delayed, and milestone payments that would have beenreceived if the programs had been properly conducted by Pharmacia. OnMay 16, 2002, Pharmacia responded by denying the Company’s allegations,asserting various counterclaims and seeking restitution of monies paid,reimbursement of out-of-pocket expenses and substantial punitive damages.  See Note 11 - Subsequent Event.

 

The Company was also named in several putative class action lawsuits(the “Class Action Suits”) each of which alleges various violations of thefederal securities laws in connection with the Company’s public statementsduring the period from September 25, 2000 through April 19, 2002 asthey relate to the Company’s LEP drug product candidate. The original lawsuitsalso named as individual defendants John N. Kapoor, Chairman of the Company,and James M. Hussey, the Company’s President and CEO, and Dr. AquilurRahman, a former director and executive officer of the Company. The first ofthese Class Action Suits was filed on April 26, 2002 and all of the ClassAction Suits have been filed in the United States District Court for theNorthern District of Illinois, Eastern Division. On September 16, 2002, aconsolidated amended complaint was filed against NeoPharm in this matter. Theamended complaint shortened the class period to October 31, 2001 throughApril 19, 2002, removed Dr. Rahman as a defendant, and added Dr. ImranAhmad, the Company’s current Chief Scientific Officer and Senior Vice Presidentof Research and Development, as a defendant. The Company intends to vigorouslydefend each and every claim in the class action suits and, on November 4,2002, moved to have the complaint dismissed. The Company’s motion to dismisswas granted in part and denied in part in February 2003. Dr. Kapoorwas dismissed from the lawsuit at that time. No trial date has been set.Management is unable to estimate a range of possible loss, if any. In addition,the Company maintains insurance coverage to mitigate the financial impact ofany potential loss.

 

On March 26, 2004, the Companyreceived a letter from the Securities and Exchange Commission (SEC) statingthat the SEC is conducting a formal investigation of the Company.  The SEC stated in its letter that it has madeno determination of any violation of law by the Company or any individual atthis time.  Previously, this matter hadbeen the subject of an informal SEC inquiry. The Company continues to fully cooperate with the SEC and intends tocontinue to do so in order to bring the inquiry to a conclusion as promptly aspossible.  The Company believes theinvestigation is an outgrowth of the Company’s recently concluded arbitrationwith Pharmacia (now Pfizer) regarding the development of its LEP and LED drugproduct candidates and the class action lawsuits which have been filed againstthe Company relating to its public statements regarding the development ofLEP.  The Company cannot predict withcertainty the direction the investigation will take or its ultimate outcome.

 

The pharmaceutical industry has traditionally experienced difficulty inmaintaining product liability insurance coverage at desired levels. To date, nosignificant product liability suit has ever been filed against the Company.However, if a suit was filed and a judgment entered against the Company, itcould have a material adverse effect upon the Company’s operations andfinancial condition. While the Company maintains insurance to cover the use ofits drug product candidates in clinical trials, the Company does not maintaininsurance covering the sale of its drug product candidates nor is there anyassurance that it will be able to obtain or maintain such insurance onacceptable terms or with adequate coverage against potential liabilities.

 

8

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**Note 10 Stockholders' Equity**

 

On January 27, 2004, the Companyreceived proceeds of $73,980,938 (net of the underwriting discounts andcommissions, but before expenses) by issuing 4,312,500 shares of common stockin a public offering.

** **

**Note 11 Subsequent Event**

 

On April 30, 2004, the Companywas advised that its claims against Pharmacia and Upjohn Company (now Pfizer) and Pfizer’s claims against the Company,which arose from a dispute surrounding a license agreement between the parties,had been denied by arbitrators of the American Arbitration Association. TheCompany intends to work with Pfizer to resolve remaining issues as to theownership of LEP-ETU, LEP and LED, and has commenced discussions with Pfizerregarding the return of development rights for these drug product candidates.No prediction can be made as to the successful outcome of these discussions.See Note 9 - Contingencies.

 

**Item 2****- Management’s Discussion andAnalysis of Financial Condition and Results of Operations**

 

The following should be read in conjunction with the financialstatements and related footnotes and Management’s Discussion and Analysis ofFinancial Condition and Results of Operations and the Risk Factors sectionincluded in the Company’s Annual Report on Form 10-K.  The results discussed below are notnecessarily indicative of the results to be expected in any future periods.  The following discussion contains forward-lookingstatements that are subject to risks and uncertainties which could cause actualresults to differ from statements made. See “Forward LookingStatements” below.

 

**Overview**

 

We are a biopharmaceutical company engaged inthe research, development and commercialization of drugs for the treatment ofvarious cancers. Our corporate strategy is to become a leader in the research,development and commercialization of new and innovative anti-cancer treatments.We currently operate at two locations, and had 120 full time employees as ofMarch 31, 2004.  Our corporateheadquarters and clinical development team are located in Lake Forest,Illinois, and our research and development facility is in Waukegan, Illinois.

 

Since we began doing business inJune 1990, we have devoted our resources primarily to funding research andproduct development programs. To date, we have not received FDA approval of anyof our drug product candidates.  Weexpect to continue to incur losses for the foreseeable future as we continueour research and development activities, which include the sponsorship of humanclinical trials for our drug product candidates.  Until we are able to consistently generaterevenue through the sale of drug or non-drug products, we anticipate that wewill be required to fund the development of our pre-clinical compounds and drugproduct candidates primarily by selling stock in the Company.

 

In the first quarter ended March 31,2004, management’s efforts were devoted to securing additional financialresources for the continued development of our drug product candidates,initiating the Phase III PRECISE clinical trial for our lead drug productcandidate, IL13-PE38QQR, advancing our lead NeoLipid drug product candidates(LE-SN38 and LEP-ETU) through Phase I clinical development toward possibleinitiation of Phase II in 2004, and launching the sales program for our newcationic cardiolipin based transfection reagents, NeoPhectin and NeoPhectin-AT.

 

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In January 2004, we successfullycompleted the sale of 4,312,500 shares of common stock to the public through ashelf registration, resulting in net proceeds to the Company of approximately$73.5 million net of all underwriting fees and expenses. As we only used aportion of the proceeds available to us from our shelf registration filed inDecember 2003, a maximum amount of approximately $90 million remainsavailable to us through December 2005 in the event that we need to raiseadditional funds to support our programs, assuming that market conditions arefavorable.

 

The PRECISE trial, our Phase III clinicaltrial for IL13-PE38QQR for the treatment of glioblastoma multiforme (GBM),began in March 2004 with the enrollment of our first patient. Our currentplans anticipate the completion of enrollment for PRECISE in 2005 and thesubmission of a BLA with the FDA in 2006 seeking marketing approval of thedrug. However, there can be no assurance the trial will meet its endpoint orthat the FDA will approve the BLA. Assuming that we received authorization tobegin selling IL13-PE38QQR, we anticipate the first sales of the product in2007.

 

During the first quarter of 2004, wecontinued to advance our Phase I NeoLipid drug product candidates towards PhaseII/III clinical trials. The drug product candidates currently in Phase Iclinical development include: LE-SN38 (liposomal SN38)for the treatment of colorectal and other cancers; LEP-ETU, our new NeoLipidTMformulation of liposomal paclitaxel; and, LErafAON (liposomal craf antisenseoligonucleotide) for the treatment of radiation and/or chemotherapy resistanttumors. We currently anticipate that both LE-SN38 and LEP-ETU will enter PhaseII clinical trials by the end of 2004.  In addition, in February 2004, we decided to stop development ofLEM (liposomal mitoxantrone) due to our conclusion that the market potentialfor the product was limited.

 

It is difficult to predict with any certaintythe timing, estimated costs to complete development, and anticipated completiondates of drug product candidates in Phase I clinical development. A number offactors contribute to this uncertainty, including: side effects encountered inearly stage clinical trials, ability to scale up manufacturing for commercialsupply, and the size and scope of pivotal Phase III clinical trials are unknownuntil sufficient data is available to present a Phase III plan to the FDA forapproval. In addition, our drug product candidates are required to be approvedby the FDA after completing Phase III clinical trials before we can sell thedrugs to generate revenue and, potentially, realize net cash inflows. Becauseour lead drug product candidate, IL13-PE38QQR, has recently entered a Phase IIIclinical trial, we are able to make some estimates regarding the completion of thePhase III PRECISE study. Our current estimates anticipate further expenses ofapproximately $31 million to complete the Phase III clinical trial forIL13-PE38QQR. Additional Phase I and Phase II expenses will also be incurredfor IL13-PE38QQR as we are conducting other trials to investigate the potentialto use IL13-PE38QQR in other forms of glioblastoma multiforme in addition torecurrent glioblastoma multiforme.

 

The table below includes a summary ofidentified project costs incurred to date for our major research anddevelopment projects. Generally, identified project costs include expensesincurred specifically for clinical trials and pre-clinical studies we conduct,and exclude expenses incurred for salaries paid to our professional staff,overhead expenses for our Lake Forest and Waukegan facilities and generallaboratory supplies used in our research, which are identified as non-projectspecific.

 

| **Research  Project**                    | ** ** | **Costs Incurred in  Current Quarter** | ** ** | **Total Costs  Incurred Since  Beginning of Project** | ** ** |
|------------------------------------------|------------|----------------------------------------|------------|-------------------------------------------------------|------------|
| IL13-PE38                                |       | $                                      | 4,978,658  |                                                  | $          | 24,036,944 |   |
| LE-SN38                                  |       | 461,461                                |       | 3,062,868                                             |       |
| LEP-ETU                                  |       | 626,323                                |       | 1,564,680                                             |       |
| LErafAON                                 |       | 277,847                                |       | 6,513,923                                             |       |
| Non-project specific                     |       | 4,904,938                              |       | N/A                                                   |       |
| Total research and development  expenses |       | 11,249,227                             |       | N/A                                                   |       |
|                                          |            |                                        |            |                                                       |            |  |  |

 

We successfully launched our novel cationiccardiolipin based transfection reagents with sales of both NeoPhectin andNeoPhectin-AT during the first quarter. NeoPhectin is our *in vitro*transfection reagent, and NeoPhectin-AT is our *in vivo* transfection reagent for use in animals. Our currentlaboratory facilities provide us with the ability to produce commercialquantities of the material without reducing the level of our research anddevelopment activities.  Accordingly, wedo not expect to incur significant incremental costs to produce NeoPhectinTMgene transfection kits.

 

A decision was rendered in the Pharmaciaarbitration case on April 30, 2004 (see Part II Item 1. Legal Proceedings). During the first quarter of 2004, weincurred approximately $1 million in arbitration related expenses,including legal expenses. This brings the total expenses incurred for thearbitration through March 31, 2004 to approximately $14.4 million. Atthis time, we do not expect to incur any material additional arbitrationrelated expenses in 2004.

 

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**Results of Operations – ThreeMonths Ended March 31, 2004 vs. Three Months Ended March 31, 2003.**

 

The Company recorded revenue of $12,200 forthe three months ended March 31, 2004. The sole source of revenue was from sales of NeoPhectin andNeoPhectin-AT.  No revenue was recordedfor the three months ended March 31, 2003.

 

Research and development expense for thethree months ended March 31, 2004 increased by approximately $4.1 millionas compared to the same period in 2003. The increase in research anddevelopment expenses was primarily related to approximately $4.2 million inexpenses incurred for the Phase III PRECISE trial initiated in March 2004.

 

Selling, general and administrative expensesdecreased by approximately $1.2 million for the three months endedMarch 31, 2004 versus the three months ended March 31, 2003 due to areduction of approximately $1.9 million in arbitration related expenses duringthe first quarter of 2004.  The reductionin arbitration related expenses was offset by increases in other selling,general and administrative expenses of approximately $700 thousand, primarilydue to increased payroll related expenses of approximately $250 thousandassociated with increases in staffing, increased directors' fees ofapproximately $150 thousand, increased insurance expense of approximately $150thousand resulting from increases in premiums combined with increased limitsfor our property and casualty coverage, and increased legal expenses ofapproximately $100 thousand related to general corporate issues such ascompliance with new laws and regulations.

 

The Company generated interest income on cashand investments of approximately $226 thousand and $285 thousand for the threemonths ended March 31, 2004 and March 31, 2003, respectively.  The reduction in interest income in 2004 wasa direct result of a decrease in interest rates earned on investments.

 

As a result of the above items, net loss andbasic and diluted loss per share for the three month periods endedMarch 31, 2004 and March 31, 2003 were approximately $14.2 millionand $11.3 million, respectively, and $0.65 and $0.60, respectively.

 

**Liquidity and Capital Resources**

 

As of March 31, 2004, we hadapproximately $102.6 million in cash, cash equivalents, and investments inmarketable securities, and no debt. All excess cash is currently invested inmarketable securities with less than twelve months to maturity. InJanuary 2004, we received approximately $73.5 million, after underwritingfees and expenses, through the sale of common stock via a shelf registration.We currently believe that our cash on hand at March 31, 2004, should beadequate to fund our operations into at least the third quarter of 2005.Assuming that no other sources of positive cash flow are secured, we will mostlikely need to attempt to raise funds later this year or early in 2005. Onepotential source of funds would be selling more stock as part of the currentlyeffective shelf registration, of which, a maximum of up to approximately$90 million remains available.

 

We no longer expect to incur materialexpenses related to our arbitration case. As a result, the primary use of fundsover the next 12 - 24 months will be to fund our clinical andpre-clinical research and development efforts. The most significant expenseswill be incurred in relation to the PRECISE Phase III clinical trial for ourbrain tumor drug product candidate, IL13-PE38QQR. At the present time, weexpect to spend approximately $31 million over the next 21 months tocomplete the PRECISE trial. Additional significant expenses are also expectedto be incurred as we continue to move our Phase I drug product candidatestowards, and potentially into, Phase II clinical trials.

 

The launch of our NeoPhectin transfectionreagent products could potentially generate material revenue, and cash flow,later in 2004 or 2005 to support our research and development efforts andreduce the rate at which we are using our currently available cash resources.We do not currently expect to incur material incremental expenses associatedwith producing, selling, or marketing NeoPhectin.

 

We may seek to satisfy our future fundingrequirements through public or private offerings of securities, withcollaborative or other arrangements with corporate partners or from othersources including, but not limited to, sales of NeoPhectinTM. Additionalfinancing may not be available when needed or on terms acceptable to us. Ifadequate financing is not available, we may be required to delay, scale back oreliminate certain of our research and development programs, relinquish rightsto certain of our technologies, cancer drugs or products, or license thirdparties to commercialize products or technologies that we would otherwise seekto develop ourselves.

 

NeoPharm has no debt, no capital leases, noexposure to off-balance sheet arrangements, no special purpose entities, noractivities that include non-exchange-traded contracts accounted for at fairvalue. The following table summarizes our estimated contractual obligations asof March 31, 2004:

 

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| ** **                                              | ** ** | **Payments Due by Period** | ** ** |
|---------------------------------------------------------|------------|----------------------------|------------|
| **Contractual  Obligations**                            | ** ** | **Total**                  | ** ** | **Less than  1 year ** | ** ** | **1-3 years ** | ** ** | **3-5 years ** | ** ** | **More than  5 years ** | ** ** |
| Operating lease                                         |       | $                          | 1,599,535  |   | $ | 579,313 |   | $ | 741,371 |   | $ | 278,852 |   | $ | 0 |   |
| License agreements—milestone  based payments(1)(2) |       | 2,085,000                  |       | 130,000 |   | 195,000 |   | 410,000 |   | 1,350,000 |   |
| Total                                                   |       | $                          | 3,684,535  |   | $ | 709,313 |   | $ | 936,371 |   | $ | 688,852 |   | $ | 1,350,000 |   |

 

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

 

(2)                                Milestone based payment obligations are contingent upon successfullyreaching objectively determinable stages in the development of drug product candidates.The Company has estimated the period the payment may be due, if at all, basedupon its expectations of the timeline for continued successful development ofthe drug product candidates.

 

**Critical Accounting Policies**

 

In preparing the Company’s financialstatements in conformity with accounting principles generally accepted in theUnited States of America, management must make a variety of decisions whichimpact the reported amounts and related disclosures. Such decisions include theselection of the appropriate accounting principles to be applied, theassumptions on which to base accounting estimates, and the consistentapplication of those accounting principles. Due to the type of industry inwhich the Company operates and the nature of its business, the followingaccounting policies are those that management believes are most important tothe portrayal of the Company’s financial condition and results and that requiremanagement’s most difficult, subjective or complex judgments, often as a resultof the need to make estimates about the effect of matters that are inherentlyuncertain.

 

*Investments in Marketable Securities*

 

As provided by SFAS No. 115, *Accountingfor Certain Investments in Debt and Equity Securities*, the Company haselected to treat all of its investments in marketable securities as“available-for-sale”, which requires these investments to be recorded at fairmarket value. Unrealized gains and losses, net of related tax effect, onavailable-for-sale securities are excluded from earnings and are reported as aseparate component of other comprehensive income until realized. Realized gainsand losses from the sale of available-for-sale securities are determined on aspecific identification basis. A decline in market value of available-for-salesecurities that is deemed to be other than temporary, results in the reductionof the carrying amount to fair value. The impairment is charged to earnings anda new cost basis for the security is established. Significant judgment isrequired to determine instances in which an other than temporary decline in thefair value of marketable securities has occurred. Management considersavailable positive and negative information in making this judgment, including:the nature of the investments; the causes of impairments; the number ofinvestment positions that are in an unrealized-loss position; and the severityand duration of the impairment.

 

*Income Taxes*

 

In assessing the realizability of deferredtax assets, management considers whether it is more likely than not that someportion or all of the deferred tax assets will not be realized. The ultimaterealization of deferred tax assets is dependent upon the generation of futuretaxable 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 thisassessment. Significant judgments are required to estimate the generation offuture taxable income and the timing of the reversal of deferred taxliabilities.

 

*Revenue Recognition*

 

The Company provides for general rights ofreturn of products sold to its distributor. Appropriately determining revenue recognition when the general right ofreturn exists requires the use of judgment in estimating the level ofreturns.  In certain circumstances,management may not be able to develop a reasonable estimate of the level ofreturns.  Making such a determinationalso requires the use of significant judgment. Management has determined that given the limited sales history ofNeoPhectin, the Company is currently unable to develop a reasonable estimate ofthe level of returns.  Accordingly, theCompany is currently recognizing revenue for products shipped to its distributorupon the expiration of the right of return which occurs upon the earlier ofshipment of product by the distributor to an end-user or 180 days.

 

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*Stock-Based Compensation*

 

The Company applies the intrinsic-value-basedmethod of accounting prescribed by Accounting Principles Board (APB) OpinionNo. 25, *Accounting for Stock Issued to Employees*, and relatedinterpretations including FASB Interpretation No. 44, *Accounting forCertain Transactions Involving Stock Compensation, an Interpretation of APBOpinion No. 25*, issued in March 2000, to account for itsfixed-plan stock options. Under this method, compensation cost is recorded onthe date of grant only if the current market price of the underlying stockexceeded the exercise price. SFAS No. 123, *Accounting for Stock-BasedCompensation*, established accounting and disclosure requirements using afair-value-based method of accounting for stock-based employee compensationplans. As allowed by SFAS No. 123, the Company has elected to continue toapply the intrinsic-value-based method of accounting described above, and hasadopted only the disclosure requirements of SFAS No. 123. Significantjudgments are required in determining an appropriate method for determining thefair value of stock-based compensation. The Company has elected to utilize theBlack-Scholes option-pricing model to make the fair value determination. Inputsinto the option-pricing model are subject to estimation that may affect thedetermination of fair value.

 

**Forward Looking Statements**

 

Any statements madeby NeoPharm, Inc. (“we”, “us”, “our”, or the “Company”) in this quarterlyreport that are forward looking are made pursuant to the safe harbor provisionsof the Private Securities Litigation Reform Act of 1995.  The Company cautions readers that importantfactors may affect the Company’s actual results and could cause such results todiffer materially from forward-looking statements made by or on behalf of theCompany.  Such factors include, but arenot limited to, those risks and uncertainties relating to difficulties ordelays in development, testing, regulatory approval, production and marketingof the Company’s drug candidates, including, but not limited to IL13-PE38QQR,including the PRECISE trial, the marketing of non-drug products such asNeoPhectinTM and NeoPhectin-ATTM, uncertainty regarding the outcome of classaction litigation against the Company, resolution of the ongoing SECinvestigation, resolution of ownership issues for LEP, LED and LEP-ETU withPfizer, unexpected adverse side effects or inadequate therapeutic efficacy ofthe Company’s drug candidates that could slow or prevent products coming tomarket, the uncertainty of patent protection for the Company’s intellectual propertyor trade secrets, and other factors referenced under “Risk Factors” in theCompany’s Annual Report on Form 10-K for the fiscal year endedDecember 31, 2003.

 

**Item 3****– Quantitative and QualitativeDisclosures about Market Risk**

 

As of March 31, 2004, we did not own anyderivative instruments, but we were exposed to market risks, primarily changesin U.S. interest rates. As of March 31, 2004, we held total cash, cashequivalents, and investments of $102,636,270. Maturities of investments rangefrom cash equivalents (maturity less than 90 days) to approximately8 months. Declines in interest rates over time will reduce our interestincome from our investments. Based upon our balance of cash, cash equivalents,and marketable securities as of March 31, 2004, a decrease in interestrates of 1.0% would cause a corresponding decrease in our annual interestincome of approximately $1 million.

 

**Item4****–Controls and Procedures**

 

As of March 31, 2004, we carried out an evaluation, under thesupervision and with the participation of our management, including our ChiefExecutive Officer and Chief Financial Officer, of the effectiveness of thedesign and operation of our disclosure controls and procedures. Based on thatevaluation, our management, including the Chief Executive Officer and ChiefFinancial Officer, concluded that our disclosure controls and procedures areoperating effectively as designed.

 

We are committed to a continuing process of identifying, evaluating andimplementing improvements to the effectiveness of our disclosure and internalcontrols and procedures. Our management, including our Chief Executive Officerand Chief Financial Officer, does not expect that our controls and procedureswill prevent all errors. A control system, no matter how well conceived andoperated, can provide only reasonable, not absolute, assurance that theobjectives of the control system are met. Because of the inherent limitationsin all control systems, no evaluation of controls can provide absoluteassurance that all control issues within the Company have been detected. Theseinherent limitations include the realities that judgments in decision-makingcan be faulty, and that breakdowns can occur because of a simple error ormistake. Additionally, controls can be circumvented by the individual acts ofsome persons, by collusion of two or more people, or by management override ofthe control. The design of any system of controls is also based in part uponcertain assumptions about the likelihood of future events, and there can be noassurance that any design will 

 

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succeedin achieving its stated goals under all potential future conditions. Over time,controls may become inadequate because of changes in conditions, or the degreeof compliance with the policies or procedures may deteriorate. Because of theinherent limitations in any control system, misstatements due to error orviolations of law may occur and not be detected.

 

There have been no significant changes in our internal controls overfinancial reporting that occurred during the period covered by this report thathave materially affected, or are reasonably likely to affect, our internalcontrol over financial reporting.

 

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**PART II - OTHER INFORMATION**

 

Item 1.                                                           Legal Proceedings

 

On April 19, 2002, the Company filed aDemand for Arbitration with the American Arbitration Association in accordancewith the terms of its license agreement dated February 19, 1999 (the“License Agreement”) with Pharmacia Corporation, Pharmacia andUpjohn, Inc. and Pharmacia and Upjohn Company (collectively, “Pharmacia”),for the purpose of resolving a dispute with Pharmacia concerning delays in thedevelopment programs for LEP (Liposome Encapsulated Paclitaxel) and LED(Liposome Encapsulated Doxorubicin) which were being conducted by Pharmacia.The Company contended that Pharmacia failed in its duty under the LicenseAgreement to use reasonable efforts to develop LEP and LED and that such failureconstituted a breach of the License Agreement. The Company further contendedthat Pharmacia breached its duty to consult with NeoPharm on the progress ofthe drug development program and thereby impaired NeoPharm’s ability to monitorthe development of these compounds. The Company sought all damages to which itis entitled, including but are not limited to, loss ofco-promotion and royalty revenues that would have been received if LEP and LEDhad not been delayed, and milestone payments that would have been received ifthe programs had been properly conducted by Pharmacia. On May 16, 2002,Pharmacia responded by denying the Company’s allegations, asserting variouscounterclaims and seeking restitution of monies paid, reimbursement ofout-of-pocket expenses and substantial punitive damages. On April 30, 2004, theCompany was advised that its claims against Pharmacia, and Pharmacia’s claimsagainst the Company, had been denied by the Arbitral Panel.  The Company intends to work with Pharmacia(now Pfizer) to resolve remaining issues as to the ownership of LEP-ETU, LEPand LED and has commenced discussions with Pfizer regarding the return ofdevelopment rights for these drug product candidates. No prediction can be madeas to the successful outcome of these discussions.

 

The Company was also named in severalputative class action lawsuits (the “Class Action Suits”) each of which allegesvarious violations of the federal securities laws in connection with theCompany’s public statements during the period from September 25, 2000through April 19, 2002 as they relate to the Company’s LEP drug productcandidate. The original lawsuits also named as individual defendants John N.Kapoor, Chairman of the Company, and James M. Hussey, the Company’s President andCEO, and Dr. Aquilur Rahman, a former director and executive officer ofthe Company. The first of these Class Action Suits was filed on April 26,2002 and all of the Class Action Suits have been filed in the United StatesDistrict Court for the Northern District of Illinois, Eastern Division. OnSeptember 16, 2002, a consolidated amended complaint was filed againstNeoPharm in this matter. The amended complaint shortened the class period toOctober 31, 2001 through April 19, 2002, removed Dr. Rahman as adefendant, and added Dr. Imran Ahmad, the Company’s current ChiefScientific Officer and Senior Vice President of Research and Development, as adefendant. The Company intends to vigorously defend each and every claim in theclass action suits and, on November 4, 2002, moved to have the complaintdismissed. The Company’s motion to dismiss was granted in part and denied inpart in February 2003. Dr. Kapoor was dismissed from the lawsuit atthat time. No trial date has been set. Management is unable to estimate a rangeof possible loss, if any.

 

On March 26,2004, the Company received a letter from the Securities and Exchange Commission(SEC) stating that the SEC is conducting a formal investigation of theCompany.  The SEC stated in its letterthat it has made no determination of any violation of law by the Company or anyindividual at this time.  Previously,this matter had been the subject of an informal SEC inquiry.  The Company continues to fully cooperate withthe SEC and intends to continue to do so in order to bring the inquiry to aconclusion as promptly as possible.  TheCompany believes the investigation is an outgrowth of the Company’s recentlyconcluded arbitration with Pharmacia (now Pfizer) regarding the development ofits LEP and LED drug product candidates and the class action lawsuits whichhave been filed against the Company relating to its public statements regardingthe development of LEP.  The Companycannot predict with certainty the direction the investigation will take or itsultimate outcome.

 

Item 2.                                                           Changes in Securities and Use of Proceeds

None

 

Item 3.                                                           DefaultsUpon Senior Securities

None

 

Item 4.                                                           Submissionof Matters to a Vote ofSecurity-Holders

None

 

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Item 5.                                                           Other Information

None

 

Item 6.                                                             Exhibits and Reports on Form 8-K

 

(a)        Exhibits

 
| Exhibit 3.2  |   | NeoPharm, Inc. Bylaws, as  amended                                   |
|--------------|--------|----------------------------------------------------------------------|
|         |   |                                                                 |
| Exhibit 31.1 |   | Certification of the Chief Executive Officer                         |
|         |   |                                                                 |
| Exhibit 31.2 |   | Certification of the Chief Financial Officer                         |
|         |   |                                                                 |
| Exhibit 32.1 |   | Certification pursuant to section 906 of the Sarbanes-Oxley Act |
|         |   |                                                                 |
| Exhibit 32.2 |   | Certification pursuant to section 906 of the Sarbanes-Oxley Act |

 

(b)         Reports on Form 8-K

 

On January 8, 2004, the Companyfurnished a report on Form 8-K incorporating a press release announcing theCompany’s plans to publicly offer 3,500,000 shares of its common stock inan offering made from a shelf registration statement that was declaredeffective by the Securities and Exchange Commission on December 17, 2003.

 

On January 22, 2004, the Company filed areport on Form 8-K to disclose it had entered into an underwriting agreementwith UBS Secruities, LLC, Robert W. Baird & Co Incorporated, First AlbanyCapital Inc., and JMP Securities LLC (collectively, the “Underwriters”), withrespect to the issue and sale by the Company, and the purchase by theUnderwriters, of 3,750,000 shares of the Company’s common stock, $0.0002145 parvalue per share, plus up to an additional 562,500 shares subject to theUnderwriter’s over-allotment option (the “Shares”).  The offering of theshares was made by means of a prospectus supplement dated January 22,2004, and a base prospectus dated December 17, 2003, filed with theSecurities and Exchange Commission.  On January 22, 2004 the Companyissued a press release relating to the pricing of the offering of the shares.

 

On January 27, 2004, the Company filed areport on Form 8-K announcing the completion of the sale of 4,312,500 shares of commonstock at a public offering price of $18.25 per share, including the exercise ofthe underwriters’ option to purchase 562,500 shares to coverover-allotments.  All of the shares were offered by the Company.  Thenet proceeds from the offering to the Company, after underwriting discounts andcommissions and estimated expenses, were approximately $73.5 million.  OnJanuary 27, 2004, the Company issued a press release relating to thecompletion of the sale of its securities.

 

On March 19,2004, the Company furnished a report on Form8-K incorporating a press release reporting the Company’s financial results forthe fourth quarter ended December 31, 2003.

 

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**SIGNATUREPAGE**

 

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

 
|               | NEOPHARM, INC. |
|--------------------|----------------|
| Date: May 10, 2004 | By:            | /s/  Lawrence A. Kenyon |
|               |           | Lawrence A. Kenyon, |
|               |           | *Chief Financial Officer  (Principal Accounting Officer and  Principal Financial Officer)* |

 

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