**UNITED STATESSECURITIES AND EXCHANGE COMMISSION**

**Washington, D.C. 20549**

** **

**FORM 10-Q**

** **

**x**                              QUARTERLYREPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

** **

**ForQuarterly Period Ended June 30, 2007**

**Or**

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

** **

**Forthe transition periodfrom             to             **

**Commissionfile number 33-90516**
|        |
|--------|
|   |

**NEOPHARM, INC.**

(Exact name of Registrantas 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) (ZipCode)

**(847) 887-0800**

(Registrant’s telephone number, including areacode)

Indicate by checkmark whether the 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   x   No  o

Indicate by check markwhether Registrant is a large accelerated filer, an accelerated filer, or a non-acceleratedfiler. See definition of “accelerated filer and large accelerated filer” inRule 12b-2 of the Exchange Act. (Check one):

Large accelerated filer o    Acceleratedfiler x    Non-accelerated filer o

Indicate by checkmark whether the registrant is a shell company (as defined in Rule 12b-2 of theExchange Act). Yes  o   No  x

As of, July 31,2007 the number of shares outstanding of each of the issuer’s classes of commonstock was as follows:
| **Title of each class**             |   | **Number  of shares outstanding** |
|-------------------------------------|--------|-----------------------------------|
| Common Stock  ($.0002145 par value) |   | 28,092,164                        |

 

 

 

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NEOPHARM, INC.

FORM 10-QINDEX

 
| PART I. FINANCIAL  INFORMATION |
|--------------------------------|
| Item  1.                       | Financial  Statements |
|                           | Condensed Consolidated Balance Sheets as of June 30,  2007 (unaudited) and December 31, 2006 |
|                           | Condensed Consolidated Statements of Operations for  the three and six months ended June 30, 2007 and June 30, 2006 (unaudited) |
|                           | Condensed Consolidated Statements of Cash Flows for  the six months ended June 30, 2007 and June 30, 2006 (unaudited) |
|                           | Notes to Condensed Consolidated 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  1A.                      | Risk Factors |
| Item 2.                        | Unregistered Sales of Equity 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 |
| SIGNATURE PAGE                 |

 

2

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**PART I - FINANCIAL INFORMATION**

**Item 1 - Financial Statements**

**NEOPHARM, INC.**

**Condensed Consolidated Balance Sheets**
| ** **                                                                                                                                | ** ** | **June 30,  2007** | ** ** | **December 31,  2006** | ** ** |
|-------------------------------------------------------------------------------------------------------------------------------------------|------------|-------------------------|------------|-----------------------------|------------|
| ** **                                                                                                                                | ** ** | **(unaudited)**         | ** ** | ** **                  | ** ** |
| **ASSETS**                                                                                                                                | ** ** | ** **              | ** ** | ** **                  | ** ** |
| Current assets:                                                                                                                           |       |                    |       |                        |       |
| Cash and cash  equivalents                                                                                                                |       | $                       | 642,000    |                        | $          | 1,852,000 |   |
| Available for  sale securities                                                                                                            |       | 25,070,000              |       | 36,735,000                  |       |
| Prepaid expenses  and other                                                                                                               |       | 690,000                 |       | 627,000                     |       |
| Total current  assets                                                                                                                     |       | 26,402,000              |       | 39,214,000                  |       |
| Fixed assets,  net                                                                                                                        |       | 813,000                 |       | 1,266,000                   |       |
| Other assets                                                                                                                              |       | 212,000                 |       | 209,000                     |       |
| Total assets                                                                                                                              |       | $                       | 27,427,000 |                        | $          | 40,689,000 |   |
|                                                                                                                                      |       |                    |       |                        |       |
| **LIABILITIES AND STOCKHOLDERS’  EQUITY**                                                                                            |       |                    |       |                        |       |
| Current  liabilities:                                                                                                                     |       |                    |       |                        |       |
| Accounts payable                                                                                                                          |       | $                       | 601,000    |                        | $          | 5,085,000 |   |
| Accrued clinical  trial expenses                                                                                                          |       | 1,870,000               |       | 2,272,000                   |       |
| Accrued  compensation                                                                                                                     |       | 1,062,000               |       | 811,000                     |       |
| Obligations  under capital lease                                                                                                          |       | 31,000                  |       | 30,000                      |       |
| Other accrued  expenses                                                                                                                   |       | 1,771,000               |       | 1,379,000                   |       |
| Total current  liabilities                                                                                                                |       | 5,335,000               |       | 9,577,000                   |       |
|                                                                                                                                      |       |                    |       |                        |       |
| Obligations  under capital lease                                                                                                          |       | 90,000                  |       | 105,000                     |       |
| Deferred revenue                                                                                                                          |       | 2,000,000               |       | 2,000,000                   |       |
| Deferred rent                                                                                                                             |       | 22,000                  |       | 35,000                      |       |
| Derivative  financial instruments                                                                                                         |       | 49,000                  |       | 101,000                     |       |
| Total  liabilities                                                                                                                        |       | 7,496,000               |       | 11,818,000                  |       |
|                                                                                                                                      |       |                    |       |                        |       |
| Stockholders’  equity:                                                                                                               |       |                    |       |                        |       |
| Common stock,  $0.0002145 par value; 50,000,000 shares authorized: 28,092,164 and 28,080,408  shares issued and outstanding, respectively |       | 6,000                   |       | 6,000                       |       |
| Additional  paid-in capital                                                                                                               |       | 290,226,000             |       | 290,098,000                 |       |
| Accumulated  deficit                                                                                                                      |       | (270,301,000            | )          | (261,233,000                | )          |
| Total  stockholders’ equity                                                                                                          |       | 19,931,000              |       | 28,871,000                  |       |
| Total liabilities and  stockholders’ equity                                                                                          |       | $                       | 27,427,000 |                        | $          | 40,689,000 |   |

 

The accompanyingnotes to the condensed consolidated financial statements

are an integral part of these financial statements.

3

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**NEOPHARM, INC.**

**Condensed Consolidated Statements of Operations**

**Three and Six Months Ended June 30, 2007 and June30, 2006**(Unaudited)
| ** **                                                | ** ** | **Three Months Ended** | ** ** | **Six Months Ended** | ** ** |
|-----------------------------------------------------------|------------|----------------------------------|------------|--------------------------------|------------|
| ** **                                                | ** ** | **June 30, 2007**      | ** ** | **June 30, 2006**    | ** ** | **June 30, 2007** | ** ** | **June 30, 2006** | ** ** |
| ** **                                                | ** ** | ** **                       | ** ** | ** **                     | ** ** | ** ** | ** ** | ** ** | ** ** |
| Product revenue                                           |       | $                                | —     |                           | $          | 9,000 |   | $ | — |   | $ | 10,000 |   |
| Total revenue                                             |       | —                           |       | 9,000                          |       | — |   | 10,000 |   |
|                                                      |       |                             |       |                           |       |   |   |   |   |
| Expenses:                                                 |       |                             |       |                           |       |   |   |   |   |
| Research and  development                                 |       | 1,138,000                        |       | 6,037,000                      |       | 4,145,000 |   | 11,881,000 |   |
| Selling,  general, and administrative                     |       | 2,335,000                        |       | 4,497,000                      |       | 5,194,000 |   | 7,542,000 |   |
| Employee  termination costs                               |       | 555,000                          |       | 570,000                        |       | 555,000 |   | 570,000 |   |
| Change in fair  value of derivative financial instruments |       | (55,000                          | )          | (628,000                       | )          | (53,000 | ) | (1,171,000 | ) |
| Total expenses                                            |       | 3,973,000                        |       | 10,476,000                     |       | 9,841,000 |   | 18,822,000 |   |
| Loss from operations                                      |       | (3,973,000                       | )          | (10,467,000                    | )          | (9,841,000 | ) | (18,812,000 | ) |
|                                                      |       |                             |       |                           |       |   |   |   |   |
| Interest income                                           |       | 358,000                          |       | 676,000                        |       | 773,000 |   | 1,342,000 |   |
| Net loss                                                  |       | (3,615,000                       | )          | $                              | (9,791,000 | ) | $ | (9,068,000 | ) | $ | (17,470,000 | ) |
| Net loss per share —                                 |       |                             |       |                           |       |   |   |   |   |
| Basic and  diluted                                        |       | $                                | (0.13      | )                              | $          | (0.35 | ) | $ | (0.32 | ) | $ | (0.63 | ) |
| Weighted average shares  outstanding —               |       |                             |       |                           |       |   |   |   |   |
| Basic and diluted                                         |       | 28,086,748                       |       | 27,798,475                     |       | 28,083,630 |   | 27,559,480 |   |

 

The accompanyingnotes to the condensed consolidated financial statements

are an integral part of these financial statements.

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**NEOPHARM, INC.**

**Condensed Consolidated Statements of Cash Flows**

**Six Months Ended June 30, 2007 and June 30, 2006(**Unaudited)
| ** **                                                                   | ** ** | **Six Months Ended** | ** ** |
|------------------------------------------------------------------------------|------------|--------------------------------|------------|
| ** **                                                                   | ** ** | **June 30, 2007**    | ** ** | **June 30, 2006** | ** ** |
| Cash flows from  operating activities:                                       |       |                           |       |   |   |
| Net loss                                                                     |       | $                              | (9,068,000 | ) | $ | (17,470,000 | ) |
| Adjustments to  reconcile net loss to net cash used in operating activities: |       |                           |       |   |   |
| Depreciation and  amortization                                               |       | 456,000                        |       | 676,000 |   |
| Stock-based  compensation expense                                            |       | 115,000                        |       | 1,036,000 |   |
| Decrease in fair  value of derivative financial instruments                  |       | (53,000                        | )          | (1,171,000 | ) |
| (Gain) loss on  retirement of equipment and furniture                        |       | (1,000                         | )          | 9,000 |   |
| Changes in  assets and liabilities:                                          |       |                           |       |   |   |
| Decrease  (increase) in interest receivable on available for sale securities |       | 14,000                         |       | (15,000 | ) |
| (Increase)  decrease in prepaid expenses and other                           |       | (63,000                        | )          | 316,000 |   |
| (Increase)  decrease in other assets                                         |       | (3,000                         | )          | 2,000 |   |
| Decrease in  accounts payable                                                |       | (4,484,000                     | )          | (319,000 | ) |
| Increase  (decrease) in other current liabilities                            |       | 241,000                        |       | (1,627,000 | ) |
| Increase in  deferred and unearned revenue                                   |       | —                         |       | 1,000 |   |
| (Decrease)  increase in deferred rent                                        |       | (13,000                        | )          | 13,000 |   |
| Net cash and cash  equivalents used in operating activities                  |       | (12,859,000                    | )          | (18,549,000 | ) |
|                                                                         |       |                           |       |   |   |
| Cash flows from  investing activities:                                       |       |                           |       |   |   |
| Proceeds from  sales of available for sale securities                        |       | 11,651,000                     |       | 22,150,000 |   |
| Purchase of  marketable securities                                           |       | —                         |       | (40,800,000 | ) |
| Purchase of  equipment and furniture, net                                    |       | (1,000                         | )          | (120,000 | ) |
| Net cash and cash  equivalents provided by (used in) investing activities    |       | 11,650,000                     |       | (18,770,000 | ) |
|                                                                         |       |                           |       |   |   |
| Cash flows from  financing activities:                                       |       |                           |       |   |   |
| Proceeds from  issuance of common stock                                      |       | —                         |       | 38,731,000 |   |
| Proceeds from  employee stock purchase plan                                  |       | 13,000                         |       | 253,000 |   |
| Repayment of  capital lease obligation                                       |       | (14,000                        | )          | (11,000 | ) |
| Net cash and cash  equivalents (used in) provided by financing activities    |       | (1,000                         | )          | 38,973,000 |   |
|                                                                         |       |                           |       |   |   |
| Net (decrease) increase  in cash and cash equivalents                        |       | (1,210,000                     | )          | 1,654,000 |   |
| Cash and cash  equivalents, beginning of period                              |       | 1,852,000                      |       | 1,486,000 |   |
| Cash and cash equivalents, end of period                                     |       | $                              | 642,000    |   | $ | 3,140,000 |   |

 

*Supplementaldisclosure of non-cash financing activities:*

During the six months ended June30, 2006, the Company entered into a capital lease obligation for officeequipment totaling $161,000.

The accompanyingnotes to the condensed consolidated financial statements

are an integral part of these financial statements.

5

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**NEOPHARM,INC.**

**NOTES TO CONDENSED CONSOLIDATED FINANCIALSTATEMENTS**

**(unaudited)**

**Note 1 Basis of Presentation**

The financialinformation herein is unaudited.  Thebalance sheet as of December 31, 2006 is derived from audited financialstatements.

The accompanyingunaudited condensed consolidated financial statements of NEOPHARM, Inc. andsubsidiary (“we”, “us”, “our”, or the “Company”) have been prepared inaccordance with U.S. generally accepted accounting principles, or U.S. GAAP,for interim financial information and with the instructions to Form 10-Q andRule 10-01 of Regulation S-X. Accordingly, these financial statements do notcontain all of the information and notes required by U.S. GAAP for completefinancial statements.  In the opinion ofmanagement, the accompanying unaudited condensed consolidated interim financialstatements contain all adjustments (consisting of normal recurring adjustments)necessary to a fair presentation.  Theresults of operations for the three and six month periods ended June 30, 2007are not necessarily indicative of our operating results for fiscal 2007 orfuture interim periods.

The unauditedcondensed consolidated financial statements include the accounts of NEOPHARM,Inc. and its wholly owned subsidiary, NEOPHARM EU Limited. NEOPHARM EU Limitedwas created in 2004 to comply with regulatory requirements enacted for clinicaltrials conducted in the European Union. NEOPHARM EU has nominal assets and hasnot conducted any business.  All significantintercompany accounts and transactions are eliminated in consolidation.

While we believethat the disclosures presented herein are adequate to make the information notmisleading, it is suggested that these financial statements be read inconjunction with the financial statements and notes included in the Company’s2006 Annual Report on Form 10-K filed with the United States Securities andExchange Commission, or SEC.

The preparation offinancial statements in conformity with U.S. GAAP requires management to makeestimates and assumptions that affect the reported amounts of assets andliabilities and disclosure of contingent assets and liabilities at the date ofthe consolidated financial statements and the reported amounts of revenue andexpense during the reporting periods. Actual results could differ from those estimates.

Amounts presentedhave been rounded to the nearest thousand.

*RecentAccounting Pronouncements*

We adoptedFinancial Accounting Standards Board (FASB) Interpretation No. 48 (FIN No. 48),*Accounting for Uncertainty**in Income Taxes,*effective January 1, 2007. The new standard defines the threshold forrecognizing the benefits of tax return positions in the financial statements as“more-likely-than-not” to be sustained by the taxing authorities based solelyon the technical merits of the position. If the recognition threshold is met, the tax benefit is measured andrecognized as the largest amount of tax benefit that in our judgment is greaterthan 50% likely to be realized.  Theadoption of FIN No. 48 did not have a material impact on the Company’sconsolidated financial position or results of operations.

In September 2006,the FASB issued SFAS No. 157, *Fair Value Measurement*,or SFAS 157.  SFAS 157 defines fairvalue, establishes a framework for measuring fair value under U.S. GAAP, andexpands disclosures about fair value measurements.  SFAS 157 is effective for financialstatements for fiscal years beginning after November 15, 2007 and interimperiods within those fiscal years.  We donot expect the adoption of SFAS 157 to have a material impact on ourconsolidated financial position or results of operations.

In February 2007,the FASB issued SFAS No. 159, The Fair Value Option for Financial Assets andFinancial Liabilities - Including an amendment of FASB No. 115 (“SFAS No. 159”).  SFAS No. 159 permits companies to choose tomeasure many financial instruments and certain other items at fair value inorder to mitigate volatility in reported earnings caused by measuring relatedassets and liabilities differently without having to apply complex hedgeaccounting provisions.  SFAS No. 159 iseffective for the Company’s fiscal year ending December 31, 2009, with earlyadoption permitted.  We are currentlyassessing the impact, if any, of this statement on our consolidated financialstatements.

6

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**Note 2 Loss Per Share**

The following table sets forth the computation of basic and diluted netloss per share:
| ** **                           | ** ** | **Three Months Ended** | ** ** | **Six Months Ended** | ** ** |
|--------------------------------------|------------|----------------------------------|------------|--------------------------------|------------|
| ** **                           | ** ** | **June 30, 2007**      | ** ** | **June 30, 2006**    | ** ** | **June 30, 2007** | ** ** | **June 30, 2006** | ** ** |
| Numerator:                           |       |                             |       |                           |       |   |   |   |   |
| Net loss                             |       | $                                | (3,615,000 | )                              | $          | (9,791,000 | ) | $ | (9,068,000 | ) | $ | (17,470,000 | ) |
| Denominator:                         |       |                             |       |                           |       |   |   |   |   |
| Weighted average shares outstanding  |       | 28,086,748                       |       | 27,798,475                     |       | 28,083,630 |   | 27,559,480 |   |
|                                 |       |                             |       |                           |       |   |   |   |   |
| Loss per share -  basic and diluted  |       | $                                | (0.13      | )                              | $          | (0.35 | ) | $ | (0.32 | ) | $ | (0.63 | ) |
|                                 |       |                             |       |                           |       |   |   |   |   |
| Potential common  share equivalents: |       |                             |       |                           |       |   |   |   |   |
| Stock options                        |       | 1,669,888                        |       | 3,867,619                      |       | 1,535,634 |   | 3,867,619 |   |

 

As we have incurred netlosses in each of the periods presented, basic and diluted loss per shareamounts are the same, as the effect of common share equivalents isanti-dilutive.

**Note 3 Share-based Compensationand Non-Employee Stock Options**

We currentlysponsor 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 providesfor the issuance of stock options, non-vested stock, restricted stock,performance units or performance share awards to employees, directors andconsultants convertible to up to 1,000,000 shares of our common stock. Duringthe second quarter, the Board of Directors approved a resolution to increasethe total shares available for issuance under the 2006 Plan to 3,400,000shares.  In addition, the Board approvedan increase in the number of shares of Common Stock that may be granted to anyGrantee during any calendar year, or earned by any Grantee under anyperformance based award during any calendar year, from 500,000 to 750,000shares.  Each of these Board resolutionsis subject to approval by the shareholders at the Annual Meeting ofStockholders set for August 16, 2007.

Awards under the2006 Plan generally consist of stock options having an exercise price equal tothe average of the lowest and highest reported sale prices of our common stockon the date of grant; vest ratably over four years; have a 10 year term; andare subject to continuous employment. Restricted stock awards granted to our non-employee directors under the2006 Plan typically vest one year from the date of grant.  As of June 30, 2007, there were 370,752 sharesavailable for issuance under the 2006 Plan.

*2006Employee Stock Purchase Plan*

In June 2006,our shareholders also approved the 2006 Employee Stock Purchase Plan, or thePurchase Plan, under which eligible employees may purchase shares of commonstock quarterly through payroll deductions. An aggregate of 100,000 shares of common stock may be issued under thePurchase Plan.  The price per share underthe Purchase Plan is 85% of the lower of the closing price of the common stockon (i) the first business day of the plan period or (ii) the purchasedate.  The Purchase Plan imposes alimitation upon a participant’s right to acquire common stock if immediatelyafter or prior to purchase, the employee owns 5% or more of the total combinedvoting power or value of our common stock. During the three and six month periods ended June 30, 2007, 5,476 and11,756 shares, respectively were issued under the Purchase plan resulting incompensation expense of $2,000 and $10,000, respectively.  At June 30, 2007, 48,920 shares remainedavailable for issuance.

*The1998 Plan*

Our 1998 EquityIncentive Plan, or the 1998 Plan, provided for the grant of awards, primarilystock options, to employees, directors, and consultants to acquire up to4,600,000 shares of our common stock. Following the June 2006 shareholder approval of the 2006 Plan, nofurther awards have been or will be made under the 1998 Plan.

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*Share-BasedCompensation Summary*

Amounts (credits)recognized in the consolidated statements of operations with respect to ourshare-based compensation plans were as follows:
| ** **                                             | ** ** | **Three Months Ended** | ** ** | **Six Months Ended** | ** ** |
|--------------------------------------------------------|------------|----------------------------------|------------|--------------------------------|------------|
| ** **                                             | ** ** | **June 30, 2007**      | ** ** | **June 30, 2006**    | ** ** | **June 30, 2007** | ** ** | **June 30, 2006** | ** ** |
|                                                   |       |                             |       |                           |       |   |   |   |   |
| Research and  development                              |       | $                                | (57,000    | )                              | $          | 221,000 |   | $ | (41,000 | ) | $ | 387,000 |   |
| Selling, general  and administrative                   |       | 41,000                           |       | 244,000                        |       | 156,000 |   | 649,000 |   |
| Total cost of  share-based payment plans during period |       | $                                | (16,000    | )                              | $          | 465,000 |   | $ | 115,000 |   | $ | 1,036,000 |   |

 

We have nevercapitalized, or recognized an income tax benefit from, share-basedcompensation.  The reductions in expenseduring the second quarter of 2007 are primarily attributed to significantforfeitures as a result of the reduction in force in 2007.

*StockOption Award Summary*

The following is asummary of activity relating to option awards to employees and non-employeedirectors during the six months ended June 30, 2007:    
| ** **                                                        | ** ** | **Number of  Options** | ** ** | **Weighted Average  Exercise Price/  Grant Date Fair  Value** | ** **  | **Weighted  Average  Remaining  Contractual Life  in years** | ** ** | **Aggregate  Instrinsic  Value** | ** **                           |
|-------------------------------------------------------------------|------------|-----------------------------|------------|-----------------------------------------------------------------------------------|-------------|------------------------------------------------------------------------|------------|----------------------------------|--------------------------------------|
| Outstanding at  December 31, 2006                                 |       | 2,531,783                   |       | $                                                                                 | 11.28/$8.29 |                                                                   |       |                             |                                 |   |
| Granted                                                           |       | 300,000                     |       | 1.90/1.39                                                                         |        |                                                                   |       |                             |                                 |
| Exercised                                                         |       | —                      |       | —                                                                            |        |                                                                   |       |                             |                                 |
| Forfeited/expired/cancelled                                       |       | (1,492,020                  | )          | 8.88/6.06                                                                         |        |                                                                   |       |                             |                                 |
| Outstanding at  June 30, 2007                                     |       | 1,339,763                   |       | 11.72/9.02                                                                        |        | 4.38                                                                   |       | $                                | —      |   |
|                                                              |       |                        |       |                                                                              |        |                                                                   |       |                             |                                 |
| Exercisable at  June 30, 2007                                     |       | 915,574                     |       | $                                                                                 | 15.48/12.08 |                                                                   | 1.99       |                             | $                                    | —     |   |
|                                                              |       |                        |       |                                                                              |        |                                                                   |       |                             |                                 |
| Weighted-average  fair value of options granted during the period |       |                        |       | $                                                                                 | 1.39        |                                                                   |       |                             |                                 |   |
|                                                              |       |                        |       |                                                                              |        |                                                                   |       |                             |                                 |
| Nonvested at  December 31, 2006                                   |       | 1,438,733                   |       | $                                                                                 | 8.28/5.51   |                                                                   |       |                             |                                 |   |
| Granted                                                           |       | 300,000                     |       | 1.15/1.39                                                                         |        |                                                                   |       |                             |                                 |
| Vested                                                            |       | (70,558                     | )          | 10.61/7.14                                                                        |        |                                                                   |       |                             |                                 |
| Forfeited                                                         |       | (1,243,986                  | )          | 8.19/5.46                                                                         |        |                                                                   |       |                             |                                 |
| Nonvested at June 30,  2007                                       |       | 424,189                     |       | $                                                                                 | 3.62/2.43   |                                                                   |       |                             |                                 |   |

 

As of June 30,2007 the Company expects to recognize $911,000 of unrecognized share-basedcompensation over a weighted average period of 2.6 years.

*RestrictedStock Awards*

During the second quarter, the Company granted Mr.Laurence P. Birch, President and Chief Executive Officer of the Company,180,665 shares of restricted stock under the Company’s 2006 Plan as called forby the terms of his employment agreement. The fair market value of the award is $246,000 based on a grant price of$1.36 per share and is being amortized over the 4-year vesting period.  Compensation expense of $2,000 has been recognizedfor the quarter ending June 30, 2007.

As of June 30,2007, there were 180,665 non-vested employee shares outstanding and nonon-vested non-employee director shares outstanding.

8

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*Stock Option Valuation Information*

We have estimatedthe fair value of our share-based compensation using the Black-Scholesoption-pricing model. This model requires the use of subjective assumptionsthat have a significant impact on the fair value estimate.  There were no additional shares granted inthe quarter ended June 30, 2007.  Theweighted-average estimated fair value of employee stock options granted duringthe first quarter of 2007 were calculated using the Black-Scholes model and therelated weighted-average assumptions:

|                           | ** ** | **Three months ended** | ** ** |
|---------------------------|------------|----------------------------------|------------|
| ** **                | ** ** | **March 31, 2007**     | ** ** |
| Expected  volatility      |       | 80.96                            | %          |
| Risk-free  interest rate  |       | 4.53                             | %          |
| Expected term  (in years) |       | 6.25                             |       |
| Expected dividend yield   |       | 0.0                              | %          |

 

We have based ourassumptions regarding expected volatility on the historic volatility of ourcommon stock, the risk-free interest rate on the U.S. Treasury yield curve ineffect at the time of grant, and the expected term of options using the “SimplifiedMethod” in accordance with SAB No. 107,*Share-Based Payment*.

*Derivative Financial Instruments*

Prior to 2000, wegranted common stock options to certain non-employee consultants ascompensation related to research and development activities.  As of January 1, 2006, the effectivedate of SFAS123(R), options granted to certain non-employees to purchase234,025 shares of our common stock were vested and outstanding.  Upon adoption of SFAS 123(R), thesenon-employee common stock options were accounted for as derivative instrumentsin accordance with SFAS 133,*Accounting forDerivative Instruments and Hedging Activities,* and recorded as aliability.

InAugust 2006, we entered into a separation agreement with Lawrence A.Kenyon, our former Chief Financial Officer, under which Mr. Kenyon’semployment status changed from employee to consultant reflecting his continued serviceto the Company. Under the agreement*,*at that time 40,300 options were forfeited and 17,025 unvested employee stockoptions were reclassified to non-employee option grants which vested throughMay 31, 2007 and are exercisable until August 29, 2007. We haverecognized the expense for these non-employee grants during 2006.

As of June 30,2007, there were 175,150 non-employee options outstanding and the Companyremeasured and calculated the estimated fair value of the *outstanding* non-employee options to be$49,000.  The Company recorded the changein fair value of $55,000 and $53,000 as a change in fair value of derivativefinancial instruments on the Company’s unaudited condensed consolidatedstatement of operations for the three and six months ended June 30, 2007,respectively.

We use theBlack-Scholes option-pricing model to estimate the fair value of thenon-employee option grants outstanding over the remaining contractual terms ofthe outstanding options, which ranged from 2 months to 30 months at June 30,2007.

**Note 4Cash and Cash Equivalents and Available for Sale Securities**

We consider all highlyliquid investments purchased with an original maturity of three months or lessto be cash equivalents.  Included withcash are cash equivalents of $642,000 and $593,000 as of June 30, 2007 andDecember 31, 2006, respectively. The carrying value of these investmentsapproximates their fair market value due to their short maturity and liquidity.

Available for sale securities consist of auction rate certificates with scheduled maturities greater than90 days at the time of purchase.  We believe the structural features of theauction rate certificates, including an interest rate reset feature whichadjusts the rate typically every 7 to 35 days, provide us with liquiditycharacteristics similar to cash equivalents. As provided by Statement ofFinancial Accounting Standards, or SFAS, No. 115, *Accounting for Certain Investments in Debt and Equity Securities,*wehave 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 resetfeatures of our auction rate certificates, the carrying value of theseavailable for sale securities represents their fair value.

As of June 30, 2007, our investments in auction rate certificates havematurities ranging from 18 to 38 years. Despite the long-term nature of their stated contractual maturities, the Company has demonstrated theability to liquidate these 

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securitiesas needed.  Accordingly, as thesesecurities represent the investment of cash, which is available for operations,they have been classified as a current asset on the accompanying ConsolidatedBalance Sheets.

Included with the carrying value of the available for sale securities****was accrued interest income receivable of $68,000and $85,000 as of June 30, 2007 and December 31, 2006, respectively.

Available for sale securities, stated at cost, which approximates fair market value, are as follows:

|                                     | ** ** | **June 30,  2007** | ** ** | **December 31,  2006** | ** ** |
|-------------------------------------|------------|-------------------------|------------|-----------------------------|------------|
| State government  agencies          |       | $                       | 25,002,000 |                        | $          | 36,650,000 |   |
| Total available for sale securities |       | $                       | 25,002,000 |                        | $          | 36,650,000 |   |

 

**Note 5Fixed Assets**

We record fixedassets at cost and record depreciation using the straight-line method over therelated asset’s estimated useful life. Expenditures that do not extend the life or improve the productivity ofassets are charged to expense when incurred. When fixed assets are disposed of, the related costs and accumulateddepreciation are removed from the accounts and any gain or loss isrecorded.  Depreciation and amortizationexpense for the three and six months ended June 30, 2007 was $223,000 and$456,000, respectively as compared to $342,000 and $676,000, respectively forthe corresponding periods of 2006. During the six months ended June 30, 2006, the Company acquired officeequipment under a five year capital lease for $161,000.

Long-lived assetsare reviewed for impairment when changes in circumstances indicate the carryingamount of an asset may not be recoverable. Recoverability of assets to be heldand used is measured by a comparison of the carrying amount of the assets toestimated undiscounted cash flows expected to be generated by the assets.  If the carrying amount of an asset were toexceed its estimated future cash flows, an impairment charge would berecognized by the amount by which the carrying amount of the asset exceeds thefair value of the asset.

**Note 6Employee Termination and Facility Consolidation Costs**

Following the Company’s announcement on March 29, 2007 that additionalPhase III clinical trials have been recommended for its drug product candidate,Cintredekin Besudotox, the Company initiated an organizational realignment onApril 18, 2007 which reduced the workforce from 36 to 21 employees.   The reorganization included the agreement ofthe Company’s Executive VP-Chief Medical Officer and the ExecutiveVP-Commercial Operations to step down, which occurred on June 18, 2007 and May31, 2007, respectively.   In connectionwith the original terms of employment, the Company is obligated to pay theseExecutives six months continued salary equal to $137,500 and $120,000,respectively, which has been accrued for during the quarter ended June 30,2007.  The Company recorded a totalcharge of $555,000 during the quarter ended June 30, 2007 related to these twoexecutives and severance related costs for 13 employees that were part of theCompany’s reduction in workforce.

During 2006, theCompany’s workforce was reduced from 96 to 53 employees through variousorganizational restructuring initiatives, separation agreements with certainofficers and through attrition. Additionally, in March 2007, the Company terminated the employment ofMr. 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, unless and until he obtained alternativefull-time employment, in which case the monthly payments would terminate.  Payments to Mr. Herrera would also terminatefor breach of restrictive covenants.  Subsequent to his termination, the Company determined that Mr. Herrara’stermination should have been for cause as defined in his employment agreement,with the result that no salary continuance would be due Mr. Herrara.  The Company notified Mr. Herrera of thisaction during the second quarter and requested that he make restitution of thesalary payments previously made. Subsequent to his termination, Mr. Herrera filed suit in May 2007seeking payment of a $212,000 bonus for 2006 and a $25,000 salary increase for2007.  The Company is vigorouslydefending this action.

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A roll-forward of the activity in the accrued liability account for thepersonnel costs associated with the various reduction in workforce initiativesis summarized below:

| Balance at December 31, 2006     |   | $       | 415,000 |   |
|----------------------------------|--------|---------|---------|--------|
| Charge for reduction  in force   |   | 555,000 |    |
| Payments made  during the period |   | 660,000 |    |
| Balance at June 30, 2007         |   | $       | 310,000 |   |

 

The remaining payouts are expected to be completed by the end of 2007.

Also in 2006, in connection with our facility consolidation, we vacated ouroffice space in Lake Forest, Illinois and have included $119,000 and $238,000in other accrued expenses as the remaining estimated lease exposure at June 30,2007 and December 31, 2006, respectively.

**Note7 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 $2,053,000and before expenses of $263,000.

We maintain aStockholder Rights Plan whereby rights to purchase shares of Series AParticipating Preferred Stock become exercisable by our stockholders in theevent a non-excluded party acquires, or attempts to acquire, 15% or more of ouroutstanding commonstock.

**Note 8Income Taxes**

In July 2006, theFinancial Accounting Standards Board (the “FASB”) issued FASB InterpretationNo. 48, “Accounting for Uncertainty in Income Taxes—an interpretation of FASBStatement No. 109,” (“FIN 48”) to clarify the accounting for uncertain taxpositions accounted for in accordance with FASB Statement No. 109, “Accountingfor Income Taxes.” The Company adopted FIN 48 as of January 1, 2007. We had nomaterial unrecognized tax benefits and no adjustments to liabilities oroperations were required.

At June 30, 2007,the Company had net operating loss (“NOL”) carryforwards for tax purposes ofapproximately $250.0 million expiring at various dates through 2027 for which afull valuation allowance has been provided. We do not believe the total amountof unrecognized tax benefits will change significantly within the next twelvemonths. In addition, future changes in the unrecognized tax benefit will haveno impact on the effective tax rate due to the existence of the valuationallowance.

The Company filesU.S. federal and state income tax returns. Principally due to the NOLs, allreturns filed since the Company’s conversion from an S-corporation in 1995remain subject to examination by U.S. and state tax jurisdictions.

**Note 9Contingencies**

NEOPHARM, Inc. and certain of our former officers have been named in aconsolidated amended complaint, which alleges various violations of the federalsecurities laws in connection with our public statements regarding our LEP drugproduct 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 February2003. In November 2004, the plaintiffs filed a motion to amend and a motion forsummary adjudication. The motion to amend seeks to include certain pre-classperiod statements in the complaint.  Themotion for summary adjudication asks the Court to rule that certain statementsmade in an arbitration award regarding the LEP drug product candidate be deemedfacts established in this proceeding.  OnFebruary 23, 2007, the Court entered an order denying both the plaintiffs’motion to amend and the plaintiffs’ motion for summary adjudication.  The Court has set a fact discovery cut-offdate of August 24, 2007.  No trial datehas yet been set.  We intend tovigorously defend each and every claim in the complaint. Management is unableto estimate the potential outcome or range of possibilities, if any.  In addition, we maintain insurance coverageto mitigate the financial impact of any potential loss.

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We entered into variouscontractual arrangements, primarily during the fourth quarter of 2006, undertake or pay agreements, with Diosynth Biotechnology, Inc. (“Diosynth”), to secure access to manufacturing capacity forthe potential manufacture and regulatory advancement of Cintredekin Besudotoxthrough early 2008.  As a result of theFDA’s decision to require additional Phase III clinical testing ofCintredekin Besudotox, the Company advised Diosynth that the timing of further workto support a potential BLA submission must be delayed.  Diosynth has indicated that such a delayconstitutes a default under our contract. In response, the Company invoked the dispute resolution provisions ofthe contract in an attempt to resolve these and other differences between thetwo companies.  A dialogue between thesenior executives of our Company and Diosynth is still ongoing.  In the event these discussions fail toresolve the parties’ differences, the contract calls for mediation and eventuallybinding arbitration.  Under the terms ofthe various contractual arrangements, if the Company can not settle itsoutstanding differences with Diosynth, and Diosynth should refuse to delay therelated disputed manufacturing activity, and such dispute were to culminate inan arbitration judgment against the Company, we may be obligated to pay half ofthe disputed processing costs.  TheCompany estimates exposure to be approximately $2.4 million at June 30, 2007.

We are from time to time subject to claims and litigation arising in theordinary course of business.  We intendto defend vigorously any suchlitigation that may arise under all defenses that would be available tous.  In the opinion of management, theultimate outcome of those proceedings of which management is aware, even ifadverse to us, will not have a material adverse effect on our consolidatedfinancial position or results of operations. While we maintain insurance to cover the use of our drug productcandidates in clinical trials, we do not presently maintain insurance coveringthe potential commercial use of our drug product candidates and there is noassurance that we will be able to obtain or maintain such insurance onacceptable terms.

**Note 10Commitments**

On March 23, 2007, the Company entered into an employment agreement withMr. Laurence P. Birch (the “Agreement”) to serve as its President and ChiefExecutive Officer.  Mr. Birch was electedto the Company’s Board ofDirectors on March 30, 2007.   Underterms 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 performancecriteria to be established by the Board in consultation with Mr. Birch, withthe potential to earn up to 100% of his base salary for over achievement ofperformance criteria.  In the event theCompany terminates Mr. Birch’s employment without cause, after six monthsemployment, he would be entitled to receive a continuation of his then currentbase 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, alump sum payment equal to the prior year’s bonus, if any, plus acceleratedvesting of all options or restricted stock.

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**Item 2 - Management’s Discussionand Analysis of Financial Condition and Results of Operations**

Any statements made by NEOPHARM, Inc. (“we”, “us”, “our”, or the “Company”)in this quarterly report that are forward-looking are made pursuant tothe safe harbor provisions of the Private Securities Litigation Reform Act of1995.  We caution readers that importantfactors may affect our actual results and could cause such results to differmaterially from forward-looking statements made by or on our behalf.  Such factors include, but are not limited to,those risks and uncertainties relating to difficulties or delays indevelopment, testing, manufacturing, regulatory approval, recruitment ofpatients, production and marketing of the Company’s drug candidates, including,but not limited to: our drug product candidate IL13-PE38QQR, or CintredekinBesudotox, and our NeoLipid® product candidates LE-SN38, LEP-ETU,  LE-DT, LE-rafAON, and Cintredekin Besudotox  (IL13-PE38); our ability to make, or thetiming of, a filing of any Biologics License Application, or BLA, for approval of Cintredekin Besudotox withthe United States Food and Drug Administration, or FDA; our ability to conserveour cash resources, to implement reductions in general and administrative expendituresand to obtain additional sources of financing in the future; the performance ofthird-party contractors; uncertainty regarding the outcome of certain pendingclass action litigation;  unexpectedadverse side effects or inadequate therapeutic efficacy of our drug productcandidates, including, but not limited to, Cintredekin Besudotox, that couldslow or prevent our drug product candidates coming to market; the uncertaintyof patent protection for our intellectual property and trade secrets; ourability to raise additional funds at all or on terms acceptable to us; andother factors referenced under Item 1A, “Risk Factors” in Part II of this Quarterly Report on Form10-Q and in our Annual Report on Form 10-K for the calendar year ended December31, 2006 and in our Quarterly Report on Form 10-Q for the quarter ended March31, 2007 (the “Prior 10-Q”).

The followingshould be read in conjunction with our condensed consolidated financialstatements and related notes and with Management’s Discussion and Analysis ofFinancial Condition and Results of Operations and the Risk Factors section included as Item 1A herein and in theCompany’s 2006 Annual Report on Form 10-K and Prior 10-Q.  The results discussed below are notnecessarily indicative of the results to be expected in any futureperiods.  The following discussioncontains forward-looking statements that are subject to risks anduncertainties, which could cause actual results to differ from statements made.

**Overview**

We are a biopharmaceutical company engaged in the research, development,and commercialization of drugs for the treatment of cancer.  Since we began our business in1990, we have devoted our resources primarily to funding research and productdevelopment programs.  We have built ourdrug development program around our two proprietary technology platforms: atumor-targeting toxin platform and NeoLipid® liposomal drug delivery system. Wehave advanced six drug product candidates in various stages of clinicaldevelopment for the treatment of cancer. The following table summarizes keyinformation about our current drug product candidate pipeline:
| Drug product candidate               | ** ** | **Clinical  indication(s)**                                            | ** ** | **2007 Clinical  development status** | ** ** | **Commercialization  rights** |
|--------------------------------------|------------|------------------------------------------------------------------------|------------|---------------------------------------|------------|-------------------------------|
|                                 |       |                                                                   |       |                                  |       |                          |
| Cintredekin Besudotox (IL13-PE38QQR) |       | Glioblastoma multiforme (brain cancer)                                 |       | Completed Phase III (1)               |       | World wide (2)                |
|                                 |       |                                                                   |       |                                  |       |                          |
| LE-SN38*(Liposomal SN-38)*           |       | Colorectal cancer and other solid tumors                               |       | Phase II (3)                          |       | World wide                    |
|                                 |       |                                                                   |       |                                  |       |                          |
| LEP-ETU*(Liposomal Paclitaxel)*      |       | Breast cancer, ovarian cancer and other solid tumors                   |       | Planning possible Phase II            |       | World wide                    |
|                                 |       |                                                                   |       |                                  |       |                          |
| LE-DT*(Liposomal Docetaxel)*         |       | Breast cancer, ovarian cancer, prostate cancer and  other solid tumors |       | Pre-IND                               |       | World wide                    |
|                                 |       |                                                                   |       |                                  |       |                          |
| LE-rafAON                            |       | Pancreatic cancer                                                      |       | Re-activate IND                       |       | United States                 |
|                                 |       |                                                                   |       |                                  |       |                          |
| Cintredekin Besudotox (IL13-PE38)    |       | Pulmonary fibrosis and asthma                                          |       | Pre-IND                               |       | World wide                    |

 

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(1)          Representatives of the FDA’s Office of Oncology indicated during a review of the clinicaldata with the Company on March 28, 2007, that an additional Phase III clinicaltrial for Cintredekin Besudotox in the treatment of GBM would be requiredbefore the FDA could accept the Company’s Biologics License Application(BLA).   The Company continues toevaluate its options regarding Cintredekin Besudotox, which is furtherdiscussed below in the Drug Product Candidate Summary.

(2)          Development and commercialization rights ofIL13-PE38 or Cintredekin Besudotox for Japan have been sublicensed to NipponKayaku Co., Ltd.

(3)          The Company announced onMarch 30, 2007 that the interim analysis of data following the completion oftreatment of the first 21 patients demonstrated disease stabilization,but the study for lLE-SN38 did not achieve the primary tumor responseendpoint.  The Company is reassessingproject next steps including additional data analyses and the possibility ofother studies related to lung and breast cancer.

To date, we havenot received FDA approval for any of our drug product candidates.  We expect to continue to incur losses for theforeseeable future as we continue our research and development activities,which include the sponsorship of human clinical trials for our drug productcandidates.  Until we are able tosuccessfully commercialize one or more of our drug product candidates, weanticipate that we will be required to fund our research and developmentactivities primarily by other means, including, but not limited to, issuingequity or other securities, licensing drug product candidates to third partiesand collaborating with third parties to develop formulations of their compoundsusing our technology.

**Drug ProductCandidate Summary**

*CintredekinBesudotox*

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

We haveexclusively licensed Cintredekin Besudotox from the NIH and the FDA, and havebeen developing this drug product candidate under a Cooperative Research andDevelopment Agreement, or CRADA, with the FDA Center for Biologics Evaluationand Research, or CBER. Cintredekin Besudotox has received orphan drugdesignation in the US and Europe and holds fast track drug development programstatus from the FDA.  In addition,Cintredekin Besudotox has been selected to participate in the FDA’s ContinuousMarketing Application, CMA, Pilot 2 program. We also hold a non-exclusive license to utilize a patented process ownedby the U.S. government relating to convection enhanced delivery, or CED, foruse with drugs, including Cintredekin Besudotox in the treatment of gliomas.

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

Cintredekin Besudotox, on the other hand, is being developed as ahighly specific tumor-targeting agent. Cintredekin Besudotox is a recombinant protein consisting of a singlemolecule composed of two parts: a tumor-targeting molecule and a cytotoxicagent.  The targeting component consistsof interleukin-13(IL-13), an immune regulatory cytokine.  Malignant glioma cells, as compared to normalbrain cells, express IL-13 receptors at a higher density.  The cytotoxic agent is a potent bacteriallyderived toxin called PE38.  CintredekinBesudotox is designed to detect and bind IL-13 receptors on the surface ofmalignant glioma cells and selectively deliver PE38 to destroy tumor cellswhile sparing healthy surrounding cells. Cintredekin Besudotox is administered by a technique known asconvection-enhanced delivery, or CED, in which the drug is delivered throughcatheters inserted in brain tissue surrounding the tumor (peritumoraladministration) or into the tumor (intratumoral administration) followingsurgical resection of the tumor.  CED isdesigned to infuse Cintredekin Besudotox directly to the tumor site andadjacent brain tissue with the goal of killing resident tumor cells andpreventing recurrence of tumor cell growth, and minimize systemic drug exposureand toxicity.

During 2006 and the first quarter of 2007, the Company primarily focused oncompleting its Phase III testing and commercialization strategy for Cintredekin Besudotox, including thepreparation of the corresponding BLA submission to the FDA, and furtheringdevelopment of the NeoLipid® liposomal drug product candidates.  However, upon review of the PRECISE trial resultswith the Company on March 28, 2007, the FDA concluded that an additional PhaseIII trial would be required prior to acceptance of a potential BLA filing bythe Company, which will substantially delay, or even prevent, the potentialcommercialization of the product.

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A second Phase III clinical trial, if pursued, is currentlyestimated to require at least three additional years and approximately$25,000,000 to complete.  As the Companydoes not have sufficient resources to undertake such a project, this would require that substantial additionalfinancing be obtained or made available to the Company from sources outside theCompany in order to independently pursue the completion of the trial.

Nevertheless, anddespite the FDAconclusions, the Company continues to believe that Cintredekin Besudotox has demonstrated sufficient efficacy topotentially attract a third party via a licensing arrangement, joint venture orother means, that may enable the completion of a second Cintredekin Besudotox Phase III trial.  If such an arrangement were to be enteredinto, and there can be no assurance given that such financing or otherarrangement would become available, or, even if available, that it would be onterms acceptable to the Company, it is hoped that data could be generated froma second Phase III trial that could demonstrate statistically superior efficacyand safety of Cintredekin Besudotoxbased on, among other factors, enhanced catheter placement technology notavailable during the PRECISE study, a narrowed focus of testing centers and agenetic study that would help to identify patients that may be more responsiveto treatment.

The Company continues to evaluate its optionsrelated to Cintredekin Besudotox.  There can be no assurance that theCompany will be successful in attracting and then consummating any third partyagreement or other financing that would enable the completion of a second PhaseIII trial, or if a second Phase III trial is completed, that data evidencingstatistical superiority would be generated, or, even if such data were produced,that the FDA might require still more data or that the FDA would accept orapprove a BLA submission by theCompany.

***NeoLipid® Platform***

*LE-SN38*

LE-SN38 is ourNeoLipid**®** liposomal formulation ofSN-38, the active metabolite of Camptosar® (Pfizer Inc.), a chemotherapeuticpro-drug, which is used as a first-line and second-line colorectal cancertreatment. At the present time, without the NeoLipid® system, SN-38 isinsoluble and can only be used to treat cancer by administering the pro-drugCamptosar®.  A pro-drug is a compoundthat is converted into the active drug in the body. However, Camptosar® isconverted into SN-38 inthe liver at different rates by different patients, and this variability inconversion rates can result in suboptimal dosing and adverse side effects, suchas severe diarrhea.  Hence, it isapparent that new modalities of treatment should be developed to circumventthese toxicities.  By employing ourproprietary NeoLipid® technology to deliver SN-38, we hope to deliver theactive drug to the tumor cells without the need for conversion, thereforeminimizing variability and optimizing dose with minimal side effects.

During 2004, wecompleted a Phase I clinical trial for LE-SN38. Results from this Phase I studydemonstrated the safety and tolerabilityof LE-SN38 and established a maximum tolerated dose of 35 mg/m2 (MTD) for all but a small subset of patients who metabolize SN-38slowly.  Pharmacokinetic analysis ofblood samples from patients treated with LE-SN38 showed that blood levels andsystemic drug exposure to SN-38 were comparable to or greater than thatexpected from the marketed Camptosar® dose based on previously publishedstudies.

During the secondquarter of 2006, in conjunction with the Cancer and Leukemia Group B, CALGB, weinitiated enrollment in a Phase II clinical trial with LE-SN38 in metastaticcolorectal cancer patients, and completed enrollment of the 21st patient inDecember, 2006.

On March 30, 2007,the Company announced that the interim analysis of data following the completionof treatment of the first 21 patients demonstrated disease stabilization, but the study did not achievethe primary tumor response endpoint.  TheCompany is continuing to reassess the clinical outcome with respect to patients’demography, prior chemotherapy exposure, advanced stage of the disease, andother related factors. The Company is also assessing the potential  next steps for this project includingadditional data analyses and the possibility of other studies related to lungcancer and breast cancer with LE-SN38.

*LEP-ETU*

LEP-ETU is ourNeoLipid® liposomal formulation of the widely used cancer drug,paclitaxel.  Paclitaxel, also known asTaxol® (Bristol-Myers Squibb Company), has been approved in the US for thetreatment 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 includenausea, vomiting, hairloss and nerve and muscle pain.  Becauseof the chemical characteristics of paclitaxel, it cannot be introduced into thebody unless it is first formulated in a mixture of castor oil (Cremophor®) andethanol, which can lead to significant side effects such as hypersensitivityreactions.  We believe that by using ourproprietary NeoLipid® technology, which eliminates the need for Cremophor andethanol, LEP-ETU may overcome many current limitations of paclitaxel treatmentfor cancer patients and may limit the adverse side effects of currenttreatments.

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During 2004, wecompleted a Phase I clinical trial for LEP-ETU. Results of the study indicated that LEP-ETU appeared to be welltolerated in terms of typical paclitaxel side effects by the majority ofpatients, including those receiving the higher doses of drug, as well as thosewho were not premedicated with antihistamines and steroids. Antitumor activitywas observed, with 16% of patients experiencing partial responses (shrinkage oftumor by 50% or more).  Additionally, 44%of patients evidenced stable disease and were able to complete 4 or more 3-weekcycles of LEP-ETU treatment.  Patientspreviously treated with taxanes were among those who responded to LEP-ETU.

In the nearfuture, the Company plans to initiate a Phase II program of LEP-ETU inrecurrent breast cancer patients and, depending on the outcome of thoseclinical results, we may decide to undertake multicenters and multinationalPhase III trials in this indication after thorough discussions with FDA.

***LE-DT***

***Pre-clinical work has also advanced on our earlier stageliposomal formulation of the anti-cancer agent docetaxel, LE-DT, which is theactive ingredient in Sanofi Aventis’ Taxotere® which is approved for use incertain breast cancer, non-small cell lung cancer, gastric adenocarcinoma andhead and neck cancer indications.  Weanticipate filing an LE-DT Investigational New Drug Application, or IND, withthe U.S. FDA in late 2007.   Thereafter,we intend to start a Phase I trial with LE-DT to define the toxicities,pharmacokinetics and maximum tolerated dose with this new modality oftreatment.***

***LE-rafAON***

***Preclinical work with the new formulation of LE-rafAON isongoing and we expect to submit a revised IND to FDA by the end of 2007. Theantisense oligonucleotide agent c-raf has shown significant down regulation ofthe gene in Preclinical studies. Also, LE-rafAON has exhibited significantradiation sensitization and chemo sensitization with other anticancer agentssuch as Gemcitabine and Paclitaxel in human xenograft models in mice.  We plan to perform the bridging Phase I trialwith this newly formulated LE-rafAON and thereafter start Phase II trials inpancreatic and prostate cancer models where this gene seems to be potentiallyover expressed.***

***IL13-PE38***

     The Company has recently licensed IL13-PE38from NIH, FDA, and University of Michigan as a potential therapeutic agent forthe treatment of pulmonary fibrosis and asthma. The Company’s collaboratorshave completed extensive preclincal studies in animal models for the controland reversal of pulmonary fibrosis with this agent. In asthma, IL13-PE38 hasshown significant activity as well. Other preclincal toxicology studies arealso performed. The Company intends to request a pre-IND meeting with FDA andplan to submit an IND to FDA for Phase I evaluation based on the outcome of thediscussion in near future.

We intend to further develop the NeoLipid® drug product candidates by usingour internal resources and by continuing to collaborate with other companies and leading governmental and educationalinstitutions.

In addition, we intend to explore the use ofour proprietary NeoLipid® liposomal drug delivery technology to createnew products in two ways: life cycle management, therefore extending the patentlife and/or modifying the pharmacokinetic profile of existing cancer drugs, andby utilizing our platform to develop new drugs. We are aware of several widely used cancer drugs that are nearing patentexpiration, as well as other widely used cancer drugs with patents that haveexpired.  When a drug is combined withanother agent or delivery system in a novel way, its patent life may beextended.  Additionally, while manychemotherapeutic drugs have been effective for the treatment of cancer, thesedrugs have been limited in their use because of adverse side effects anddifficulties in administration.  Usingour NeoLipid® drug delivery technology, we believe opportunities exist for usto increase the usefulness of these compounds as improved anti-cancer treatments.  Finally, we believe that our liposomal drugdelivery technology may provide us with a platform for the development of noveltherapeutic agents for cancer drug development.

It is difficult topredict with any certainty the timing of and total estimated costs to completedevelopment of drug product candidates in early stage, or Phase I, clinicaldevelopment, as well as the estimated date such drug product candidates wouldbe available for sale, if approved by the FDA. A number of factors contribute to this uncertainty, 

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including: side effectsencountered in early stage clinical trials, ability to scale up manufacturingfor commercial supply, and the fact that the size and scope of pivotal PhaseIII clinical trials are unknown until sufficient data is available to present aPhase III plan to the FDA for approval.  In addition, our drug product candidates require approval by the FDAafter completing Phase III clinical trials before we can sell the drugs togenerate revenue and, potentially, realize net cash inflows.  Additional clinical trial expenses areexpected to be incurred for Cintredekin Besudotox to meet our ongoing patientand potential manufacturing obligations.

The table belowincludes a summary of identified direct project costs incurred to date for ourclinical research and development projects. Generally, identified project costs include expenses incurredspecifically for clinical trials and pre-clinical studies we conduct, andexclude expenses incurred for salaries paid to our professional staff, ourWaukegan facility and the related depreciation of equipment as well as  general laboratory supplies used in ourresearch, which are included with non-project specific costs.
| ** **                               | ** ** | **Total Direct Costs**                          | ** ** |
|------------------------------------------|------------|-----------------------------------------------------------|------------|
| **Research Project**                | ** ** | **Three months ended  June 30, 2007** | ** ** | **Six months ended  June 30, 2007** | ** ** | **Cummulative costs  through June 30, 2007** | ** ** |
| Cintredekin  Besudotox (IL13-PE38QQR)    |       | $                                                         | 334,000    |   | $ | 1,513,000 |   | $ | 67,773,000 |   |
| LEP-ETU                                  |       | 47,000                                                    |       | 94,000 |   | 7,677,000 |   |
| LE-SN38                                  |       | 16,000                                                    |       | 55,000 |   | 5,282,000 |   |
| LE-DT                                    |       | 134,000                                                   |       | 142,000 |   | 142,000 |   |
| LE-rafAON                                |       | 11,000                                                    |       | 23,000 |   | 23,000 |   |
| Non-project  specific                    |       | 596,000                                                   |       | 2,318,000 |   | N/A |   |
| Total research  and development expenses |       | $                                                         | 1,138,000  |   | $ | 4,145,000 |   | $ | N/A |   |

 

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**Results of Operations — ThreeMonths Ended June 30, 2007 vs. Three Months Ended June 30, 2006.**

There was no product revenue for the three months ended June 30, 2007, ascompared to $9,000 for the three months ended June 30, 2006.  Thesole source of the $9,000 in product revenue in the second quarter 2006 wasfrom sales of NeoPhectin and NeoPhectin-AT.

Research and development expense for the three months ended June 30, 2007 decreased by almost $4.9 millioncompared to the same period in 2006.  The decrease is attributed to a $1.6million reduction in payroll expenses, primarily attributed to the Company’svarious restructuring initiatives implemented during 2006 and 2007 and a $3.1million decrease in project costs.  Thedecrease in project costs is primarily attributed to decreases in the PRECISEtrial and Initial Diagnosis GBM Phase I trial expenditures related to sitescosts, data management and third party contract services.

Selling, general, and administrative expenses decreased approximately $2.2million for the three months ended June 30, 2007 compared to the same period in2006.  The decrease is primarily attributed to a $3.1 million decrease inpersonnel costs primarily related to the Company’s various restructuringinitiatives in 2006 and 2007 offset partially by increased outsourced personnelcosts.

Following the Company’s announcement on March 29, 2007 that additionalPhase III clinical trials have been recommended for its drug productcandidate, Cintredekin Besudotox, the Company initiated an organizationalrealignment on April 18, 2007 which reduced the workforce from 36 to 21employees resulting in a charge to earnings totaling approximately$555,000.  Similarly in April 2006the Company reduced its workforce by a total of 22 employees, primarily in theresearch and development departments, resulting in a charge totaling $570,000.

Thechange in fair value ofderivative financial instruments of $(55,000) during the three month periodended June 30, 2007 was attributed to a decrease in valuation of stock optionsgranted to non-employee consultants prior to 2000 resulting from the Company’sstock value declining $0.55 per share since the beginning of the second quarterto $1.15 per share at June 30, 2007.  Similarly, the Company recorded a credit to earnings of $(0.6) millionin the second quarter of 2006, resulting from a decrease in the Company’s stockprice from $8.36 at March 31, 2006 to $5.33 per share at June 30, 2006.

The Company generatedinterest income on cash and available for sale securities of approximately $0.4million and $0.7 million for the three months ended June 30, 2007 and 2006,respectively.  The decrease in interest income during the period wasprimarily due to a decrease in average short-term investment balances, whichwere used to fund operations.

**Results of Operations — SixMonths Ended June 30, 2007 vs. Six Months Ended June 30, 2006.**

There was no product revenue for the six months ended June 30, 2007, ascompared to $10,000 for the six months ended June 30, 2006.  The solesource of the $10,000 in product revenue in the six month period of 2006 wasfrom sales of NeoPhectin and NeoPhectin-AT.

Research and development expense for the six months ended June 30, 2007 decreased by approximately $7.7million compared to the same period in 2006.  The decrease is attributedto a $3.0 million reduction in payroll expenses, primarily attributed to theCompany’s various restructuring initiatives implemented during 2006 and 2007and a $4.7 million decrease in project costs. The decrease in project costs is primarily attributed to decreases inthe PRECISE trial and Initial Diagnosis GBM Phase I trial expenditures relatedto sites costs, data management and third party contract services.

Selling, general, and administrative expenses decreased approximately $2.3million for the six months ended June 30, 2007 compared to the same period in2006.  The decrease is attributed to a $3.6 million decrease in personnelcosts, also primarily attributed to the Company’s various restructuringinitiatives implemented during 2006 and 2007, partially offset by $0.4 millionin costs associated with the termination of the Company’s former ChiefExecutive Officer in March, 2007 and increased outsourced personnel costs.

Following the Company’s announcement on March 29, 2007 that additionalPhase III clinical trials have been recommended for its drug product candidate,Cintredekin Besudotox, the Company initiated an organizational realignment onApril 18, 2007 which reduced the workforce from 36 to 21 employees resulting ina charge to earnings totaling approximately $555,000.  Similarly in April 2006 the Company reducedits workforce by a total of 22 employees, primarily in the research anddevelopment departments, resulting in a charge totaling $570,000.  Currently, the Company has 19 employees.

     The change in fair value of derivative financial instruments of $(53,000)during the six month period ended June 30, 2007 was attributed to a decrease invaluation of stock options granted to non-employee consultants prior to 2000resulting from the Company’s stock value declining $0.55 per share since thebeginning of the second quarter to $1.15 per share at June 30, 2007 andremaining relatively constant during the first quarter.   Similarly, the Company recorded a credit toearnings of  $(1.2) million in the firstsix month  period of 2006, resulting froma decrease in the Company’s stock price 

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from$10.79 at December 31, 2005 to $5.33 per share at June 30, 2006.

     The Company generated interest income on cash and available for salesecurities of approximately $0.8 million and $1.3 million for the six monthsended June 30, 2007 and 2006, respectively.  The decrease in interestincome during the period was primarily due to a decrease in average short-terminvestment balances, which were used to fund operations.

**Liquidityand Capital Resources**

Net cash used inoperating activities decreased $5.6 million from $18.5 million to $12.9 millionfor the six months ended June 30, 2006 and 2007, respectively.  The decrease in cash used by operations wasprimarily a result of the lower net loss in the first half of 2007, offset bythe significant reduction in accounts payable balances which were paid down inthe first six months of 2007.

InJanuary 2006, the Company completed the sale of 4,025,000 shares of ourcommon stock to the public. Proceeds to the Company were approximately $39.0million net of underwriting fees but before expenses. The proceeds from thissale of stock were invested in available for sale securities and are being usedto fund clinical trials of our drug product candidates; preclinical studies forother potential drug product candidates; and for working capital, capitalexpenditures, and other general corporate purposes.  The Company continues to draw down proceedsfrom 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 commonshares and interest earned on the investment of the stock issuance proceeds.  Asof June 30, 2007, we had $0.6 million in cash and cash equivalents and$25.1 million in available forsale securities, consisting solely of state government auction ratecertificates, which we believe provide us liquidity characteristics verysimilar to cash equivalents.

Our primary use ofcash over the next 12 to 18 months is expected to fund, in addition to generaland administrative expenses,  advancementof our NeoLipid® clinical and pre-clinical research and development efforts andour remaining Cintredekin Besudotox Phase III clinical trial patientobligations.

As a result of theApril 18, 2007 restructuring initiative coupled with other ongoing cost-cuttinginitiatives, the Company expects to reduce selling, general and administrativeexpenditures for 2007 by approximately $6.8 million compared to 2006.  The total cost reductions implemented andplanned, before consideration of project costs and certain legacy costs areexpected to result in annualized cash consumption rate of approximately $5.0million. The Company currently projects it has sufficient funds to continueoperations into 2009 before requiring additional financing.  The date as to which sufficient fundscontinue to be available for operations, without additional financing, may varydepending upon the timing and implementation of various strategies underconsideration by the Company.

We may seek tomeet future funding requirements through public or private offerings ofsecurities or with collaborative or other development or licensing arrangementswith corporate or private venture partners. Additional financing may not beavailable when needed or on terms acceptable to us, if at all.  If adequate financing is not available, wemay be required to further delay, scale back, or eliminate certain of ourresearch and development programs, relinquish rights to certain of ourtechnologies, drugs or products, or license our products or technologies tothird parties that we would otherwise seek to develop ourselves.

We have noexposure to off-balance sheet arrangements, no special purpose entities, oractivities that include non-exchange-traded contracts accounted for at fairvalue.

**Critical Accounting Policies**

In preparing ourfinancial statements in conformity with U.S. generally accepted accountingprinciples, or GAAP, we must make a variety of decisions and estimates thatimpact reported results and related disclosures. Such decisions include theselection of the appropriate accounting principles to be applied, theassumptions on which our accounting estimates are based, and the consistentapplication of those accounting principles. Due to the industry in which weoperate and the nature of our business, the following accounting policies arethose that we believe are most important to the portrayal of our financialcondition and results and that require the most difficult, subjective orcomplex judgments, often as a result of the need to make estimates about theeffect of matters that are inherently uncertain.

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*IncomeTaxes*

Income taxes areaccounted for under SFAS No. 109, “Accounting for Income Taxes”, in whichdeferred tax assets and liabilities are recognized for the future tax consequencesattributable to differences between the financial statement carrying amounts ofexisting assets and liabilities and their respective tax bases and operating loss and tax credit carryforwards.  Deferred tax assets andliabilities are measured using enacted tax rates that are expected to bein effect in the years in which those temporary differences are expected to berecovered or settled.   We recognize, atthe largest amount that is more-likely-than-not to be sustained upon audit bythe relevant taxing authority, the impact of an uncertain income tax positionon its income tax return.  An uncertainincome tax position will not be recognized if management judges that it hasless than a 50% likelihood of being sustained. Interest expense and penalties are recorded as income tax expense.  We providevaluation allowances against deferred tax assets for amounts which are notconsidered “more likely than not” to be realized.

*Contingencies*

To properlyaccount for and provide disclosure of loss contingencies, management must applyjudgment in determining whether a loss contingency is: probable, reasonablypossible, or remote. In instances where management has determined that a losscontingency is probable, it must make use of estimates to determine the amountof probable loss. Management must apply judgment in determining whether or notit can make a reasonable estimate. Management must also apply judgment indetermining whether or not disclosure of loss contingencies that have beenaccrued should be made for the consolidated financial statements not to bemisleading.

*Stock-BasedCompensation*

The Companyaccounts for stock-based compensation in accordance with SFAS No. 123R, *Share-Based Payment*. Under the fair valuerecognition provisions of this statement, we measure stock-based compensationcost at the grant date based upon the fair value of the award and recognize thecost of awards that are expected to ultimately vest as expense over therequisite service period. Management judgment and the use of estimates arerequired in determining the inputs to an option pricing model used to estimatefair value of stock-based awards. Management judgment and the use of estimatesare also required in estimating the number of stock-based awards that willultimately vest. Additionally, management judgment and the use of estimates maybe required in determining the requisite service period over which to recognizethe compensation cost as expense.

**Item 3 — Quantitative andQualitative Disclosures about Market Risk**

As ofJune 30, 2007, we did not own any derivative instruments, but we were exposedto market risks, limited primarily to the impact of changes in U.S. interestrates on our cash and available for sale securities. As of June 30, 2007, weheld total cash and cash equivalents of $0.6 million and available for sale securities inauction rate certificates of $25.1 million. All cash equivalents have a maturity of less than 90 days.  Declines in future interest rates wouldreduce interest income from our investments. Based upon our balance of cash,cash equivalents and available for salesecurities****at June30, 2007, a 1.0% decline in interest rates would decrease our annual interestincome by approximately $0.2 million.

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**Item 4 — Controls and Procedures**

*Evaluationof Disclosure Controls and Procedure*

Our disclosure controlsand procedures are designed to ensure that information required to be disclosedin the reports that we file or submit under the Securities Exchange Act of1934, as amended, is recorded, processed, summarized and reported within thetime periods specified in the Securities and Exchange Commission’s rules andforms, including ensuring that such information is accumulated and communicatedto management as appropriate to allow timely decisions regarding requireddisclosure.  We necessarily applyjudgment in assessing the costs and benefits of such controls and proceduresthat, by their nature, can only provide reasonable assurance regardingmanagement’s control objectives.

Our President and ChiefExecutive Officer/Acting Chief Financial Officer, has carried out anevaluation, with the participation of our management and outside consultants,of the effectiveness of the Company’s disclosure controls and procedures (asdefined in Rule 13a-15(e) of the Securities Exchange Act of 1934), as ofthe end of the period covered by this report, based on the evaluation requiredby paragraph (b) of Rule 13a-15 under the Securities Act of 1934.

Based on the evaluationof internal control over financial reporting, management identified thefollowing material weakness as of March 31, 2007 and determined that it stillexists as of June 30, 2007:

TheCompany has not maintained sufficient staff with appropriate training inUS GAAP and SEC financial rules and regulations.  This deficiency results in the potential ofmaterial misstatements and/or inadequate disclosures in the Company’s financialstatements.

As a result of thismaterial weakness, management concluded that internal controls over financialreporting were not effective as of June 30, based on the criteria identifiedabove.

In light of the materialweakness described above, in preparing our financial statements at and for thesix months ended June 30, 2007, we performed additional procedures in anattempt to ensure that such financial statements were fairly presented in allmaterial respects in accordance with generally accepted accountingprinciples.  Notwithstanding the materialweakness described above, management believes that the condensed consolidatedfinancial statements included in this Form 10-Q fairly present, in allmaterial respects, the Company’s financial condition, results of operations andcash flows for the periods and dates presented.

*Changes in Internal Control Over Financial Reportingand Management’s Remediation Efforts*

Our management hasdiscussed the material weakness described above and other potentialdeficiencies with our Audit Committee.  In an effort to improve our internal controls over financial reporting,we engaged a third party financial advisory firm to assist us in both theproper accounting and disclosures related SFAS 123R *Share-Based Payment*as well as GAAP and SEC reporting matters. We are continuing to evaluate the finance and accounting functions toensure we meet all of our financial reporting obligations.

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**PART II - OTHER INFORMATION**

**Item 1 - Legal Proceedings**

NEOPHARM, Inc. and certain of our former officers have been named in aconsolidated amended complaint, which alleges various violations of the federalsecurities laws in connection with our public statements regarding our LEP drugproduct candidate during the period from October 31, 2001 through April 19,2002.  On November 4, 2002, we moved tohave the complaintdismissed.  Our motion to dismiss wasgranted in part and denied in part in February 2003. In November 2004, theplaintiffs filed a motion to amend and a motion for summary adjudication. Themotion to amend seeks to include certain pre-class period statements in thecomplaint.  The motion for summary adjudicationasks the Court to rule that certain statements made in an arbitration awardregarding the LEP drug product candidate be deemed facts established in thisproceeding.  On February 23, 2007, theCourt entered an order denying both the plaintiffs’ motion to amend and theplaintiffs’ motion for summary adjudication. The Court has set a fact discovery cut-off date of August 24, 2007.  No trial date has yet been set.  We intend to vigorously defend each and everyclaim in the complaint. Management is unable to estimate the potential outcomeor range of possibilities, if any.  Inaddition, we maintain insurance coverage to mitigate the financial impact ofany potential loss.

We entered into variouscontractual arrangements, primarily during the fourth quarter of 2006, undertake or pay agreements, with Diosynth Biotechnology, Inc. (“Diosynth”), to secure access to manufacturing capacity forthe potential manufacture and regulatory advancement of Cintredekin Besudotoxthrough early 2008.  As a result of theFDA’s decision to require additional Phase III clinical testing ofCintredekin Besudotox, the Company advised Diosynth that the timing of furtherwork to support a potential BLA submission must be delayed.  Diosynth has indicated that such a delayconstitutes a default under our contract. In response, the Company invoked the dispute resolution provisions ofthe contract in an attempt to resolve these and other differences between thetwo companies.  A dialogue between thesenior executives of our Company and Diosynth is still ongoing.  In the event these discussions fail toresolve the parties’ differences, the contract calls for mediation andeventually binding arbitration.  Underthe terms of the various contractual arrangements, if the Company can notsettle its outstanding differences with Diosynth, and Diosynth should refuse todelay the related disputed manufacturing activity, and such dispute were toculminate in an arbitration judgment against the Company, we may be obligatedto pay half of the disputed processing costs. The Company estimates exposure to be approximately $2.4 million at June30, 2007.

We are from time to time subject to claims and litigation arising in theordinary course of business.  We intendto defend vigorously any such litigation that may arise under all defenses thatwould be available to us.  In the opinionof management, the ultimate outcome of those proceedings of which management isaware, even if adverse to us, will not have a material adverse effect on ourconsolidated financial position or results of operations.  While we maintain insurance to cover the useof our drug product candidates in clinical trials, we do not presently maintaininsurance covering the potential commercial use of our drug product candidatesand there is no assurance that we will be able to obtain or maintain suchinsurance on acceptable terms.

**Item 1A. -Risk Factors**

Below are the riskfactors that have been revised since the filing of our annual report on March,16, 2007 on Form 10-K for the year ended December 31, 2006 (the “2006Form 10-K”) and our Quarterly Report for the Quarter ended March 31, 2007 (“Prior10-Q”).  We face significant additionalrisks, which are set forth in the Part 1, Item 1A in our 2006 Form 10-K underthe caption “Risk Factors.”  You areurged to read these risk factors in the 2006 Form 10-K and Prior 10-Q, inaddition to the following revised risk factors set forth below.  Each of the risk factors set forth here andin our 2006 Form 10-K and Prior 10-Q could materially adversely affect ourbusiness, operating results and financial condition, as well as the value of aninvestment in our common stock.  Additional risks and uncertainties not presently known to us, or thosewe currently deem immaterial, may also materially harm our business,operating results and financial condition.

**Ourstock price has been and is likely to continue to be volatile, and aninvestment in our common stock could decline in value.  If our stock price declines below $1.00 pershare and remains there, or we fail to otherwise satisfy NASDAQ listingrequirements, our stock could be delisted by NASDAQ.**

The market price of ourcommon stock has been highly volatile and may continue to be so. For example,during 2006, the market price of our common stock fluctuated between $1.66 and$12.67 per share and during 2005 the market price of our common stockfluctuated between $15.47 and $7.16 per share. During the six months ended June 30, 2007 our stock price fluctuatedbetween $1.12 and $2.37 per share.  As ofAugust 2, 2007 our stock closed at $1.04.

In addition, failure tomaintain NASDAQ listing requirements, including but not limited to, a minimumbid price of 

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$1.00 per share for 30 consecutive days, would resultin notification of a possible delisting if the deficiency were not corrected, adelisting of our stock could be expected to have a negative impact on the valueof our shares.

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

·                  thesuccess or failure of our clinical trials or those of our competitors;

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

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

·                  actualor anticipated fluctuations in our financial results;

·                  economicconditions in the US and abroad;

·                  commentsby or changes in Company assessments or financial estimates by securitiesanalysts;

·                  adverseregulatory actions or decisions;

·                  lossesof key management;

·                  changinggovernmental regulations;

·                  ourability to secure adequate third party reimbursement for products developed byus;

·                  developmentsor disputes concerning patents or other proprietary rights;

·                  productor patent litigation; and

·                  public concernas to the safety of products developed by us.

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

These factors andfluctuations, as well as political and market conditions, may materiallyadversely affect the market price of our common stock.

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

Since January 1, 2006, wehave had substantial turnover in our personnel at all levels, but particularlyamong our senior management ranks, with all of the named executive officersserving as of that date having either resigned or been terminated.  With the exception of the position ofPresident and Chief Executive Officer, we have not yet filled several of thesepositions.  At the present time, we arehighly dependent on our President and Chief Executive Officer, Mr. Laurence P.Birch, who is also serving as our Acting Chief Financial Officer.  Additionally, our Chief Medical Officer Dr.Jeffrey W. Sherman left us effective June 18, 2007 and we are postponing asearch for a replacement until our clinical trial activity necessitatesfull-time oversight..  Dr. Aquilur Rahmanhas been retained as an outside consultant and will function as the Company’sChief Scientific Officer and will work with the rest of the team to oversee ourpre-clinical activities.    Mr. TimothyWalbert’s position as Executive VP-Commercial Operations was no longerconsidered vital to current operations of the Company given the delay in thecommercialization of Cintredekin Besudotox and as a result, the position waseliminated as part of the April  2007restructuring initiative.  Mr. Walbertleft us effective May 31, 2007.

Dr. Sherman and Mr.Walbert accepted employment on the basis of written offers which set forth thesalary and benefits to be provided, including, but not limited to, salarycontinuation payments upon termination of employment.  Mr. Birch has a written employment contractwith us, which also provides post termination benefits as described therein. Wedo not have key man insurance on any of our management.  If we were to lose the services ofMr. Birch, or are unable to replace other key members of our seniorexecutive staff, (including our consultant, Dr. Rahman), our productdevelopment and achievement of our strategic objectives could be delayed.  In addition, our success will depend on ourability to attract and retain qualified commercial, scientific, technical, andmanagerial personnel.  Given the largeturnover in our employees, and the recent set backs in our various clinicaltrials, it is expected that recruiting additional personnel and retaining ourexisting personnel will be more difficult, No assurance can be given that we will be able to retain existingpersonnel or attract and retain qualified staff in the future.

**Material weaknesses or deficienciesin our internal control over financial reporting could harm stockholder andbusiness confidence in our financial reporting, our ability to obtainfinancing, and other aspects of our business.**

Ourmanagement evaluated the effectiveness of the design and operation of ourdisclosure controls and procedures as of the three months ended June 30,2007 and concluded that our disclosure controls and procedures were noteffective as of that date, because of the material weakness in our internalcontrol over financial reporting. Specifically, management has concluded that the Company’s accountingstaff did not have sufficient expertise in the area of U.S. GAAP and SEC

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financial rules.  A material weakness is a control deficiency,or combination of control deficiencies that results in more than a remotelikelihood that a material misstatement of the annual or interim financialstatements will not be prevented or detected.  **  **A description of the material weakness related toour inadequate controls over financial reporting is set forth above in Part I,Item 4 “Controls and Procedures”.

Whilewe have adopted, or are in the process of adopting, various remedial measuresthat are designed to improve our internal controls over financial reporting, we cannot assure you,however, that these remedial measures will be effective.

Internal control overfinancial reporting can provide only reasonable and not absolute assurance thatdeficiencies or weaknesses are identified. Additionally, potential controldeficiencies that are not yet identified could emerge and internal controlsthat are currently deemed to be in place and operating effectively are subjectto the risk that those controls may become inadequate because of changes inconditions, or that the degree of compliance with the policies or proceduresmay deteriorate. Identification and corrections of these types of potentialcontrol deficiencies could have a material impact on our business, financialposition, results of operations and disclosures and impact our ability to raisefunds.

Additionally, as ofSeptember 30, 2006, management had concluded that a control deficiency withrespect to the review and verification of the accuracy of the calculationestimating the fair value of non-employee stock options constituted a materialweakness in internal control over financial reporting.

        During2006, management revised its policies and procedures with respect to itscontrols over the review and verification of the accuracy of the calculationestimating the fair value of non-employee stock options to ensure that allreasonable steps will be taken to correct this material weakness.  AtDecember 31, 2006, this deficiency was considered to be remediated as the newinternal controls were operational for a period of time, were tested, andmanagement concluded that the controls are operating effectively at that time.

**Item 2. - Unregistered Sales ofEquity Securities and Use of Proceeds**

None

**Item 3. - Defaults Upon SeniorSecurities**

None

**Item 4. - Submission of Mattersto a Vote of Security Holders**

None

**Item 5. - Other Information**

None

**Item 6.- Exhibits**

31.1        Certificationpursuant to Section 302 of the Sarbanes-Oxley Act of 2002

32.1        Certificationpursuant to section 906 of the Sarbanes-Oxley Act or 2002

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**SIGNATUREPAGE**

**Pursuantto the requirements of the Securities Exchange Act of 1934, the Registrant hasduly caused this report to be signed on its behalf by the undersigned,thereunto duly authorized.**

 
| Dated: August 8, 2007 | /s/ Laurence P. Birch                                                                                                                  |   |
|-----------------------|----------------------------------------------------------------------------------------------------------------------------------------|--------|
|                  | Laurence P. Birch                                                                                                                      |   |
|                  | President and Chief Executive  Officer (Principal Executive Officer) and Acting Chief Financial Officer  (Principal Financial Officer) |

 

 

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