**UNITEDSTATESSECURITIES AND EXCHANGE COMMISSION**

**Washington, D.C. 20549**

 

**FORM 10-Q**

 
| **ý**                                                                                                                                                                                        | **QUARTERLY REPORT UNDER  SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934**         |
|---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|-----------------------------------------------------------------------------------------------------|
| ** **                                                                                                                                                                                        | ** **                                                                                          |
| **For Quarterly Period Ended June 30, 2005**                                                                                                                                                      |
|                                                                                                                                                                                              |                                                                                                |
| **Or**                                                                                                                                                                                            |
|                                                                                                                                                                                              |                                                                                                |
| **o**                                                                                                                                                                                             | **TRANSITION REPORT PURSUANT TO  SECTION 13 OR 15 (d) OF THE SECURITIES EXCHANGE ACT OF 1934** |
| ** **                                                                                                                                                                                        | ** **                                                                                          |
| **For the transition period  from             to             ** |
| ** **                                                                                                                                                                                        | ** **                                                                                          |
| **Commission file number 33-90516**                                                                                                                                                               |

 

 

**NEOPHARM,INC.**

(Exact name of Registrant as specified in itscharter)

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

 

**150 Field DriveSuite 195Lake Forest, Illinois 60045**

(Address of principal executive offices) (Zip Code)

 

**(847) 295-8678**

(Registrant’s telephone number, including area code)

 

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

 

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

 

As of July 31, 2005 the number of shares outstanding of each of theissuer’s classes of common stock was as follows:

 
| **Title of each class**            | ** ** | **Number of shares outstanding** |
|------------------------------------|------------|----------------------------------|
| Common Stock ($.0002145 par value) |       | 23,596,623                       |

 

 

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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, 2005  (unaudited) and December 31, 2004 |   |
|                          |     | Condensed Consolidated Statements of Operations for the three and six  months ended June 30, 2005 and 2004 (unaudited) |   |
|                          |     | Condensed Consolidated Statements of Cash Flows for the six months  ended June 30, 2005 and 2004 (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 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, 2005** | ** ** | **December 31, 2004** | ** ** |
|-----------------------------------------------------------------------------------------------------------------------------|------------|-------------------|------------|-----------------------|------------|
| ** **                                                                                                                  | ** ** | **(unaudited)**   | ** ** | ** **            | ** ** |
| **ASSETS**                                                                                                                  |       |              |       |                  |       |
| Current assets:                                                                                                             |       |              |       |                  |       |
| Cash and cash equivalents                                                                                                   |       | $                 | 48,304,819 |                  | $          | 63,106,655 |   |
| Trade accounts receivable                                                                                                   |       | 357,573           |       | 10,888                |       |
| Inventories                                                                                                                 |       | 4,771             |       | 5,736                 |       |
| Prepaid expenses                                                                                                            |       | 574,959           |       | 1,108,282             |       |
| Other receivables                                                                                                           |       | 283,157           |       | 308,087               |       |
| Total current assets                                                                                                        |       | 49,525,279        |       | 64,539,648            |       |
| Fixed assets, net of accumulated depreciation                                                                               |       | 2,279,345         |       | 2,894,723             |       |
| Total assets                                                                                                                |       | $                 | 51,804,624 |                  | $          | 67,434,371 |   |
|                                                                                                                        |       |              |       |                  |       |
| **LIABILITIES AND STOCKHOLDERS’ EQUITY**                                                                               |       |              |       |                  |       |
| Current liabilities:                                                                                                        |       |              |       |                  |       |
| Accounts payable                                                                                                            |       | $                 | 288,911    |                  | $          | 398,505 |   |
| Accrued clinical trial expense                                                                                              |       | 5,724,914         |       | 4,634,618             |       |
| Accrued compensation                                                                                                        |       | 1,655,953         |       | 3,227,230             |       |
| Other accrued expenses                                                                                                      |       | 1,097,088         |       | 940,343               |       |
| Deferred and unearned revenue                                                                                               |       | —            |       | 3,400                 |       |
| Total current liabilities                                                                                                   |       | 8,766,866         |       | 9,204,096             |       |
|                                                                                                                        |       |              |       |                  |       |
| Deferred revenue                                                                                                            |       | 2,000,000         |       | —                |       |
|                                                                                                                        |       |              |       |                  |       |
| Stockholders’ equity:                                                                                                  |       |              |       |                  |       |
| Preferred stock, $0.01 par value;  15,000,000 shares authorized: none issued and outstanding                                |       | —            |       | —                |       |
| Common stock, $0.0002145 par value;  50,000,000 shares authorized: 23,596,623 and 23,372,755 shares issued and  outstanding |       | 5,063             |       | 5,013                 |       |
| Additional paid-in capital                                                                                                  |       | 248,854,297       |       | 247,525,290           |       |
| Accumulated deficit                                                                                                         |       | (207,821,602      | )          | (189,300,028          | )          |
| Total stockholders’ equity                                                                                             |       | 41,037,758        |       | 58,230,275            |       |
| Total liabilities and stockholders’ equity                                                                             |       | $                 | 51,804,624 |                  | $          | 67,434,371 |   |

 

The accompanying notes to condensed consolidatedfinancial statements are an integral part of these financial statements.

 

3

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**NEOPHARM, INC.**

 

**Condensed Consolidated Statements ofOperationsThree and Six Months Ended June 30, 2005 and 2004**(Unaudited)

 
| ** **                                             | ** ** | **Three months ended** | ** ** | **Six months ended** | ** ** |
|--------------------------------------------------------|------------|------------------------|------------|----------------------|------------|
| ** **                                             | ** ** | **June 30,**           | ** ** | **June 30,**         | ** ** |
| ** **                                             | ** ** | **2005**               | ** ** | **2004**             | ** ** | **2005** | ** ** | **2004** | ** ** |
| Collaboration revenue                                  |       | $                      | 435,000    |                 | $          | — |   | $ | 500,000 |   | $ | — |   |
| Product revenue                                        |       | 19,600                 |       | 19,080               |       | 25,900 |   | 31,280 |   |
| Total revenue                                          |       | 454,600                |       | 19,080               |       | 525,900 |   | 31,280 |   |
|                                                   |       |                   |       |                 |       |   |   |   |   |
| Expenses:                                              |       |                   |       |                 |       |   |   |   |   |
| Cost of product revenue                                |       | 1,060                  |       | 298                  |       | 1,350 |   | 542 |   |
| Research and development                               |       | 7,960,917              |       | 12,008,378           |       | 16,034,678 |   | 23,257,605 |   |
| Selling, general and administrative                    |       | 3,051,288              |       | 2,984,560            |       | 6,284,597 |   | 6,184,629 |   |
| Recovery of note receivable                            |       | (2,500,000             | )          | —               |       | (2,500,000 | ) | — |   |
| Related party expenses                                 |       | —                 |       | 34,006               |       | — |   | 69,370 |   |
| Total expenses                                         |       | 8,513,265              |       | 15,027,242           |       | 19,820,625 |   | 29,512,146 |   |
|                                                   |       |                   |       |                 |       |   |   |   |   |
| Loss from operations                                   |       | (8,058,665             | )          | (15,008,162          | )          | (19,294,725 | ) | (29,480,866 | ) |
|                                                   |       |                   |       |                 |       |   |   |   |   |
| Interest income                                        |       | 401,364                |       | 248,683              |       | 773,151 |   | 474,197 |   |
|                                                   |       |                   |       |                 |       |   |   |   |   |
| Net loss                                               |       | $                      | (7,657,301 | )                    | $          | (14,759,479 | ) | $ | (18,521,574 | ) | $ | (29,006,669 | ) |
|                                                   |       |                   |       |                 |       |   |   |   |   |
| Basic and diluted net loss per share                   |       | $                      | (0.32      | )                    | $          | (0.63 | ) | $ | (0.79 | ) | $ | (1.28 | ) |
|                                                   |       |                   |       |                 |       |   |   |   |   |
| Basic and diluted weighted average shares  outstanding |       | 23,561,539             |       | 23,244,608           |       | 23,515,755 |   | 22,578,297 |   |

 

The accompanying notes to condensed consolidatedfinancial statements are an integral part of these financial statements.

 

4

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**NEOPHARM, INC.**

 

**Condensed Consolidated Statements of CashFlowsSix Months Ended June 30, 2005 and 2004**(Unaudited)

 
| ** **                                                                                        | ** ** | **Six months ended** | ** **  |
|---------------------------------------------------------------------------------------------------|------------|----------------------|-------------|
| ** **                                                                                        | ** ** | **June 30,**         | ** **  |
| ** **                                                                                        | ** ** | **2005**             | ** **  | **2004** | ** ** |
| Cash flows from operating activities:                                                             |       |                 |        |   |   |
| Net loss                                                                                          |       | $                    | (18,521,574 | ) | $ | (29,006,669 | ) |
| Adjustments to reconcile net loss to net  cash and cash equivalents used in operating activities: |       |                 |        |   |   |
| Depreciation and amortization                                                                     |       | 680,095              |        | 678,898 |   |
| Stock-based compensation expense                                                                  |       | 361,779              |        | 257,154 |   |
| Loss on retirement of equipment and  furniture                                                    |       | 4,963                |        | — |   |
| Changes in assets and liabilities:                                                                |       |                 |        |   |   |
| Decrease in current assets                                                                        |       | 212,533              |        | 429,436 |   |
| Increase/(decrease) in current liabilities                                                        |       | (248,877             | )           | 1,296,048 |   |
| Increase in deferred revenue                                                                      |       | 2,000,000            |        | — |   |
| Net cash and cash equivalents used in  operating activities                                       |       | (15,511,081          | )           | (26,345,133 | ) |
|                                                                                              |       |                 |        |   |   |
| Cash flows from investing activities:                                                             |       |                 |        |   |   |
| Proceeds from maturities of marketable  securities                                                |       | —               |        | 1,046,168 |   |
| Proceeds from sales of marketable  securities                                                     |       | —               |        | 3,120,183 |   |
| Purchase of equipment and furniture                                                               |       | (69,680              | )           | (382,315 | ) |
| Net cash and cash equivalents (used in)  provided by investing activities                         |       | (69,680              | )           | 3,784,036 |   |
|                                                                                              |       |                 |        |   |   |
| Cash flows from financing activities:                                                             |       |                 |        |   |   |
| Proceeds from issuance of common stock                                                            |       | —               |        | 73,472,948 |   |
| Proceeds from exercise of stock options                                                           |       | 778,925              |        | 683,185 |   |
| Net cash and cash equivalents provided by  financing activities                                   |       | 778,925              |        | 74,156,133 |   |
|                                                                                              |       |                 |        |   |   |
| Net (decrease)/increase in cash and cash  equivalents                                             |       | (14,801,836          | )           | 51,595,036 |   |
| Cash and cash equivalents, beginning of  period                                                   |       | 63,106,655           |        | 36,958,941 |   |
| Cash and cash equivalents, end of period                                                          |       | $                    | 48,304,819  |   | $ | 88,553,977 |   |
|                                                                                              |       |                 |        |   |   |
| Supplemental schedule of non-cash financing  activities                                           |       |                 |        |   |   |
| Issuance of common stock in satisfaction of  a liability                                          |       | $                    | 188,353     |   | $ | — |   |
|                                                                                              |       |                 |        |   |   |
| Supplemental disclosure of cash paid for:                                                         |       |                 |        |   |   |
| Interest                                                                                          |       | $                    | —      |   | $ | — |   |
| Income taxes                                                                                      |       | $                    | —      |   | $ | — |   |

 

The accompanying notes to condensed consolidatedfinancial 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 financial information herein isunaudited. The balance sheet as of December 31, 2004 is derived fromaudited financial statements.

 

The accompanying unaudited condensed financialstatements of NeoPharm, Inc. and subsidiary (the “Company”) have been preparedin accordance with U.S. generally accepted accounting principles (“GAAP”) forinterim financial information and with the instructions to Form 10-Q and Rule10-01 of Regulation S-X. Accordingly, they do not contain all of theinformation and notes required by U.S. GAAP for complete financial statements.In the opinion of the Company, the accompanying unaudited, condensed, consolidatedinterim financial statements contain all adjustments (consisting of normalrecurring adjustments) necessary to present fairly the Company’s financialposition as of June 30, 2005, and the results of its operations for the threeand six months ended June 30, 2005 and 2004 and its cash flows for the sixmonths ended June 30, 2005 and 2004.  Theresults of operations for the three and six months ended June 30, 2005 are notnecessarily indicative of operating results for fiscal 2005 or future interimperiods.

 

The unaudited, condensed, consolidatedfinancial statements include the accounts of NeoPharm, Inc. and its wholly ownedsubsidiary, NeoPharm EU Limited. NeoPharm EU Limited was created in 2004 tocomply with regulatory requirements enacted for clinical trials conducted inthe European Union. This subsidiary has nominal assets and had not conductedany business. All significant intercompany accounts and transactions areeliminated in consolidation.

 

While the Company believes that thedisclosures presented are adequate to make the information not misleading, itis suggested that these financial statements be read in conjunction with thefinancial statements and notes included in the Company’s 2004 Annual Report onForm 10-K and Amendment No. 1 filed on Form 10-K/A with the Securities andExchange Commission (“SEC”).

 

The preparation of financial statements inconformity with U.S. GAAP requires management to make estimates and assumptionsthat affect the reported amounts of assets and liabilities and disclosure ofcontingent assets and liabilities at the date of the consolidated financialstatements and the reported amounts of revenue and expense during the reportingperiod.  Actual results could differ fromthose estimates.

 

Certain prior year amounts have beenreclassified to conform to current year presentation.

 

In December 2004, the Financial AccountingStandards Board (“FASB”) issued Statement of Financial Accounting Standards (“SFAS”)No. 123R, *Share-Based Payment*, a revision of SFASNo. 123, which requires the use of the fair value method of accounting forstock-based employee compensation effective for all awards granted, modified,repurchased or cancelled.  This standardis now effective for the first annual reporting period beginning after June 15,2005.  The standard provides for aprospective application of its provisions. Under this method, the Company will begin recognizing compensation costfor equity based compensation for all new or modified grants after the date ofadoption.  In addition, the Company willrecognize the unvested portion of the grant date fair value of awards issuedprior to adoption based on the fair values previously calculated under thedisclosure provisions of SFAS No. 123. The Company is currently evaluating the impact that the adoption of SFASNo. 123R will have on its financial position, results of operations and cashflows.

 

In May 2005, the FASB issued SFASNo. 154, *Accounting Changes and Error Corrections*,a replacement of Accounting Principles Board (“APB”) Opinion No. 20, *Accounting Changes* and FASB Statement No. 3, *Reporting Accounting Changes in Interim Financial Statements*.  SFAS No. 154 applies to allvoluntary changes in accounting principle. It also applies to changes required by an accounting pronouncement inthe unusual instance that the pronouncement does not include specifictransition provisions. SFAS No. 154 requires the retrospectiveapplication to prior periods’ financial statements of the direct effect of avoluntary change in accounting principle unless it is impracticable to do so.  Unless early adoption is elected,SFAS No. 154 is effective for fiscal years beginning afterDecember 15, 2005. Early adoption is permitted for fiscal years beginningafter June 1, 2005. SFAS No. 154 does not change the transitionprovisions of any existing accounting pronouncements, including those that arein a transition phase as of the effective date of this statement. The Companywill assess the impact of a retrospective application of a change in accountingprinciple in accordance with SFAS No. 154, if the need for such a changearises. 

 

**Note 2  Stock-based Compensation**

** **

The Company applies the intrinsic-valuemethod of accounting prescribed by APB Opinion No. 25, *Accountingfor Stock Issued to Employees*, and related interpretations, toaccount for its fixed-plan stock options. Under this method, compensation expense is measured on the date of grantif the current market price of the underlying stock exceeded the exercise priceor when the number of shares and exercise price are known if both are notdeterminable at the date of grant. Compensation expense for fixed stock optionsis recognized ratably over the vesting period. SFAS No. 123, *Accounting for Stock-BasedCompensation*, established accounting and disclosure requirementsusing a fair-value method of accounting for stock-based employee compensationplans.  As allowed by SFAS 

 

6

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No. 123, the Company has elected to continueto apply the intrinsic-value-based method of accounting described above, andhas adopted only the disclosure requirements of SFAS No. 123.

 

The following table illustrates the effect onnet loss if the fair-value method had been applied in each period:

 
| ** **                                                                                                      | ** ** | **Three months ended** | ** ** | **Six months ended** | ** ** |
|-----------------------------------------------------------------------------------------------------------------|------------|------------------------|------------|----------------------|------------|
| ** **                                                                                                      | ** ** | **June 30,**           | ** ** | **June 30,**         | ** ** |
| ** **                                                                                                      | ** ** | **2005**               | ** ** | **2004**             | ** ** | **2005** | ** ** | **2004** | ** ** |
| Net loss, as reported                                                                                           |       | $                      | (7,657,301 | )                    | $          | (14,759,479 | ) | $ | (18,521,574 | ) | $ | (29,006,669 | ) |
| Add stock-based employee compensation  expense included in reported net loss (1)                                |       | 24,519                 |       | 52,069               |       | 152,425 |   | 199,883 |   |
| Deduct total stock-based employee  compensation expense determined under fair-value-based method for all awards |       | (221,644               | )          | (2,098,145           | )          | (397,500 | ) | (4,040,400 | ) |
| Pro forma net loss                                                                                              |       | $                      | (7,854,426 | )                    | $          | (16,805,555 | ) | $ | (18,766,649 | ) | $ | (32,847,186 | ) |
|                                                                                                            |       |                   |       |                 |       |   |   |   |   |
| Basic and diluted loss per share of common  stock                                                               |       |                   |       |                 |       |   |   |   |   |
| As reported                                                                                                     |       | $                      | (0.32      | )                    | $          | (0.63 | ) | $ | (0.79 | ) | $ | (1.28 | ) |
| Pro forma                                                                                                       |       | $                      | (0.33      | )                    | $          | (0.72 | ) | $ | (0.80 | ) | $ | (1.45 | ) |

 

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(1)           Value of restricted stock granted to non-employeedirectors and compensation expense relating to options granted to an executiveat 85% of fair value.

 

**Note 3  Cash Equivalentsand Investments**

 

The Company considers all highly liquidinvestments purchased with an original maturity of three months or less to becash equivalents. Included with cash are cash equivalents of $47,670,996 and $62,919,437as of June 30, 2005 and December 31 2004, respectively. The carrying value ofthese investments approximates their fair market value due to their shortmaturity and liquidity.

 

**Note 4Inventory**

 

Inventory is comprised solely of finishedgoods associated with NeoPhectin and is stated at the lower of cost or market,as determined by the first in, first out method (“FIFO”).  Inventory cost consists of direct materialand direct labor costs.  Since productsare currently produced in the Company’s research and development facilities,the Company has not allocated any overhead costs as a product cost.  Application of overhead as a product cost isnot material. 

 

Inventory at June 30, 2005 and December 31,2004 consisted of the following:

 
| ** **                  | ** ** | **June 30, 2005** | ** ** | **December 31, 2004** | ** ** |
|-----------------------------|------------|-------------------|------------|-----------------------|------------|
|                        |       |              |       |                  |       |
| Finished goods on hand      |       | $                 | 4,771      |                  | $          | 5,413 |   |
| Inventory subject to return |       | —            |       | 323                   |       |
|                        |       |              |       |                  |       |
|                        |       | $                 | 4,771      |                  | $          | 5,736 |   |

 

Inventory subject to returnrepresents NeoPhectin products shipped to wholesale customers that have notbeen recognized as revenue.

 

**Note 5  Fixed Assets**

 

Fixed assets are recorded at cost and aredepreciated using the straight line method over their estimated useful lives.Maintenance and repairs that do not extend the life of assets are charged toexpense when incurred. When properties are disposed of, the related costs andaccumulated depreciation are removed from the accounts and any gain or loss isreported in the period the transaction takes place. Total depreciation andamortization expense for the three months ended June 30, 2005 and 2004, was $342,267and $349,227, respectively.  Totaldepreciation and amortization expense for the six months ended June 30, 2005and 2004 was $680,095 and $678,898, respectively.

 

Long-lived assets are reviewed for impairmentwhenever events or changes in circumstances indicate the carrying amount of anasset may not be recoverable. Recoverability of assets to be held and used ismeasured by a comparison of the carrying amount of an asset to estimatedundiscounted cash flows expected to be generated by the asset. If the carryingamount of an asset exceeds its estimated future cash flows, an impairmentcharge is recognized by the amount by which the carrying amount of the assetexceeds the fair value 

 

7

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of the asset.

 

**Note 6 Stockholders’ Equity**

 

TheCompany maintains a Stockholder Rights Plan whereby rights to purchase sharesof Series A Participating Preferred Stock becomeexercisable by the Company’s stockholders after any non-excluded partyacquires, or announces an intention to acquire, 15% or more of the Company’soutstanding common stock.

 

OnJanuary 27, 2004, the Company received proceeds of $73,980,938 (net ofunderwriting discounts and commissions of $4,722,188, but before expenses of$507,990) by issuing 4,312,500 shares of common stock in a public offering.

 

**Note 7Revenue Recognition**

 

The Company recognizes revenue whenpersuasive evidence of an arrangement exists, delivery has occurred or serviceshave been rendered, the price is fixed or determinable, and collectibility isreasonably assured.

 

For product sales not subject tounconditional rights of return, the Company recognizes revenue upon shipment astitle and risk of loss has passed to the customer. For product sales subject tounconditional rights of return, the Company recognizes revenue upon shipmentwhen it can reasonably estimate the level of returns at the time of shipment.Given the limited sales history of its products, the Company is currentlyunable to reasonably estimate the level of returns at the time of shipment.Accordingly, revenue related to shipments to distributors that have beengranted an unconditional right of return is currently being recognized when theright of return has expired, which occurs upon the earlier of shipment of theproduct by the distributor to an end user or expiration of the right of return,which is 60-180 days depending upon the distributor. The Company warrants itsproducts in a manner consistent with industry standards and has not incurredany warranty costs related to the sale of NeoPhectin.

 

The Company enters into collaboration andtechnology licensing arrangements, which contain multiple deliverables. Underthe provisions of Emerging Issues Task Force (“EITF”) Issue No. 00-21, *Accounting for Revenue Arrangements with Multiple Deliverables*,the Company evaluates whether these deliverables constitute separate units ofaccounting to which total arrangement consideration is allocated. A deliverablequalifies as a separate unit of accounting when the item delivered to thecustomer has standalone value, there is objective and reliable evidence of fairvalue of items that have not been delivered to the customer, and, if there is ageneral right of return for the items delivered to the customer, delivery orperformance of the undelivered items is considered probable and substantiallyin the control of the Company. Arrangement consideration is allocated to unitsof accounting on a relative fair basis or the residual method if the Company isunable to determine the fair value of all deliverables in the arrangement.Consideration allocated to a unit of accounting is limited to the amount thatis not contingent upon future performance by the Company. Upon determination ofseparate units of accounting and allocated consideration, the general criteriafor revenue recognition are applied to each unit of accounting. In instanceswhere an arrangement provides for up-front non-refundable payments that are nototherwise allocated to a unit of accounting, the Company recognizes thesepayments ratably over the term of the contract or expected period ofperformance, whichever is longer.

 

TheCompany has entered into collaboration and license agreements with thirdparties.  Under the terms of one of itscollaboration agreements, the agreement provides for an upfront nonrefundablepayment to the Company of $150,000 as well as an additional $350,000 upondelivery of a customized formulation of NeoPhectin to the customer.  The Company delivered the customizedformulation in June 2005, and the Company has recognized the full contractamount as revenue.  The Company has alsoentered into an agreement with Nippon Kayaku Co., Ltd. (“Nippon”) in which thedevelopment and commercialization rights in Japan for cintredekin besudotoxwere licensed.  The Company received a $2million upfront nonrefundable fee in January 2005 and is entitled to receivefuture additional fees, milestone payments and royalties.  Nippon is responsible for all developmentcosts in Japan.  The Company has agreedto provide or arrange for contract manufacture of a commercial supply ofcintredekin besudotox upon receipt of marketing approval by Nippon.  The upfront nonrefundable fee received by theCompany will be recognized ratably as revenue once the general criteria forrevenue recognition have been met for the unit of accounting to which the feehas been allocated.  

 

**Note 8 Loss Per Share**

 

The following table sets forth thecomputation of basic and diluted net loss per share:

 

8

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| ** **                          | ** ** | **Three months ended** | ** ** | **Six months ended** | ** ** |
|-------------------------------------|------------|------------------------|------------|----------------------|------------|
| ** **                          | ** ** | **June 30,**           | ** ** | **June 30,**         | ** ** |
| ** **                          | ** ** | **2005**               | ** ** | **2004**             | ** ** | **2005** | ** ** | **2004** | ** ** |
| Numerator:                          |       |                   |       |                 |       |   |   |   |   |
| Net loss                            |       | $                      | (7,657,301 | )                    | $          | (14,759,479 | ) | $ | (18,521,574 | ) | $ | (29,006,669 | ) |
|                                |       |                   |       |                 |       |   |   |   |   |
| Denominator:                        |       |                   |       |                 |       |   |   |   |   |
| Weighted average shares outstanding |       | 23,561,539             |       | 23,244,608           |       | 23,515,755 |   | 22,578,297 |   |
|                                |       |                   |       |                 |       |   |   |   |   |
| Basic and dliuted loss per share    |       | $                      | (0.32      | )                    | $          | (0.63 | ) | $ | (0.79 | ) | $ | (1.28 | ) |
|                                |       |                   |       |                 |       |   |   |   |   |
| Potential common share equivalents: |       |                   |       |                 |       |   |   |   |   |
| Stock options                       |       | 3,388,057              |       | 3,621,647            |       | 3,492,453 |   | 3,529,263 |   |

 

As the Company has incurred a net loss forall periods presented, basic and diluted per share amounts are the same, sincethe effect of all potential common share equivalents is anti-dilutive.

 

**Note 9  Transactions with Related Parties**

 

The following table provides furtherinformation about related party expenses reflected in the condensed consolidatedstatements of operations.

 
| ** **                 | ** ** | ** **       | ** ** | **Three months ended** | ** ** | **Six months ended** | ** ** |
|----------------------------|------------|------------------|------------|------------------------|------------|----------------------|------------|
| ** **                 | ** ** | ** **       | ** ** | **June 30,**           | ** ** | **June 30,**         | ** ** |
| **Related  Party**         | ** ** | **Expense Type** | ** ** | **2005**               | ** ** | **2004**             | ** ** | **2005** | ** ** | **2004** | ** ** |
| Akorn, Inc.                |       | Consulting       |       | $                      | —     |                 | $          | 2,500 |   | $ | — |   | $ | 6,250 |   |
| E.J. Financial Enterprises |       | Consulting       |       | —                 |       | 31,250               |       | — |   | 62,500 |   |
| E.J. Financial Enterprises |       | Direct  expenses |       | —                 |       | 256                  |       | — |   | 620 |   |
|                       |       |             |       | $                      | —     |                 | $          | 34,006 |   | $ | — |   | $ | 69,370 |   |

 

Prior to June 30, 2004, the Company receivedmanagement consulting services from EJ Financial Enterprises, Inc. (“EJFinancial”), a healthcare consulting and investment firm in which John N.Kapoor, Ph.D., (“Dr. Kapoor”) a member of the Company’s Board of Directors andthe Company’s former Chairman of the Board of Directors, and a significantstockholder of the Company, is the sole stockholder. The consulting agreementwith EJ Financial expired on June 30, 2004 and was not renewed.

 

The Company had entered into a consulting agreementwith an individual who is also an employee of Akorn, Inc. (“Akorn”).  Dr. Kapoor is also the Chairman of theAkorn Board of Directors, and a substantial stockholder in both Companies. Theconsulting agreement was terminated in 2004.

 

In December 2001, NeoPharm entered intoa transaction whereby NeoPharm loaned to Akorn, a Louisiana corporation,$3,250,000 to assist Akorn in the completion of its lyophilized productsmanufacturing facility in Decatur, Illinois. In connection with the loantransaction, NeoPharm entered into the following agreements: Promissory Note,dated December 20, 2001, in the original principal amount of $3,250,000 byAkorn to NeoPharm; Processing Agreement, dated December 20, 2001, by andbetween Akorn and NeoPharm; Subordination and Intercreditor Agreement, datedDecember 20, 2001, by and between John N. Kapoor, as Trustee under TheJohn N. Kapoor Trust, dated September 20, 1989 and NeoPharm; and aSubordination, Standby and Intercreditor Agreement, dated December 20,2001, by and among Akorn, Akorn (New Jersey), Inc., The Northern TrustCompany and NeoPharm. The Promissory Note issued by Akorn was due inDecember 2006, and accrued interest at a rate equal to that received onthe Company’s investments in marketable securities, which is lower than theinterest rate paid by Akorn on its other outstanding debt. The ProcessingAgreement granted NeoPharm access to at least 15% of the annual lyophilizationmanufacturing capacity at Akorn at most favored customer pricing, uponcompletion of the facility. The Processing Agreement also provided that Akornwas to begin providing lyophilization services on or before June 30, 2003.At the time these transactions were entered into, Akorn represented that themanufacturing facility would be operational in 2003, approximately the timewhen NeoPharm originally anticipated it would need to manufacture itslyophilized drug product candidates for Phase II/III clinical trials. In 2001,NeoPharm recorded the Promissory Note net of a valuation allowance of$1,266,619 reflecting the difference between the actual loan amount and thepresent value of the loan using an estimated market interest rate of 10%. As ofDecember 31, 2002, the Company determined the Promissory Note was impairedand recorded a charge to fully reserve for the Promissory Note and relatedaccrued interest. On August 18, 2003, NeoPharm 

 

9

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presented Akorn with a formal “Notice of Default” onthe Promissory Note. Because the carrying value of the Promissory Note waszero, there was no financial statement impact as a result of any event ofdefault under, or non-payment of, the Promissory Note. In September 2003,Akorn advised NeoPharm that it wished to refinance its senior debt with a newsenior lender, which lender would require NeoPharm to subordinate its debt. Inorder to preserve the possibility of collecting Akorn’s debt to NeoPharm,NeoPharm and Akorn entered into an Amended and Restated Promissory Note inconsideration of a higher rate of interest (which would equal that to becharged by the new senior lender, which was the prime rate plus 175 basispoints) and the possibility of accelerated mandatory repayments once Akorn’s seniordebt was repaid in full. NeoPharm also agreed to waive Akorn’s default, toallow Akorn until October 2004 to provide the required manufacturingrights and to subordinate Akorn’s indebtedness to NeoPharm to Akorn’sindebtedness to its new senior lender. Akorn’s refinancing was completed onOctober 7, 2003. On October 6, 2004, NeoPharm presented Akorn, with aformal “Notice of Default” on the Amended and Restated Promissory Noteresulting from Akorn’s failure to meet its obligations under the ProcessingAgreement. Because the carrying value of the Promissory Note was zero, therewas no financial impact as a result of any event of default under, ornon-payment of, the Promissory Note.  OnMay 16, 2005, the Company and Akorn entered into a Note Repayment Agreement (“RepaymentAgreement”) whereby the Company agreed to accept $2,500,000 as payment in fullfor all outstanding principal and interest due and owing under the PromissoryNote, which has been paid.  In addition,the parties mutually agreed to terminate the Processing Agreement.  As a result of the Repayment Agreement, theCompany recorded a $2,500,000 benefit which was recorded as “Recovery of NoteReceivable” on the Company’s unaudited Condensed Consolidated Statements ofOperations for the three and six months ended June 30, 2005.  

 

**Note 10Employee Termination Benefits**

 

In an effort to decrease expenses, theCompany reduced its workforce by a total of 30 employees (approximately 23%) inNovember 2004, consisting of 26 employees from its research anddevelopment groups and 4 employees from the administrative group. Terminatedemployees were eligible to receive salary continuation throughDecember 31, 2004, severance, 2004 earned bonus,Company paid insurance benefits and outplacement services. All $1,149,277 ofemployee termination costs were expensed in 2004 and no additional amounts wereexpensed in 2005.  The $760,759 accruedas of December 31, 2004 was paid during the first quarter of 2005. 

 

**Note 11 Commitments**

 

On April 25, 2005, the Company andMr. Ronald G. Eidell, a director of the Company, finalized an employmentagreement (“Employment Agreement”) under which Mr. Eidell is employed, onan interim basis, as the Company’s President and Chief Executive Officer (“CEO”). Mr. Eidell had been serving as President and CEO since March 8, 2005under a principal terms employment agreement (PTA) executed between the Companyand Mr. Eidell on March 10, 2005, which has now been superceded bythe terms of the Employment Agreement.  Underthe Employment Agreement, Mr. Eidell will receive a base salary of$260,000.  Under the PTA, Mr. Eidell had agreed to a base salary of$325,000, subject, however, to the Company entering into a separate agreementwith Tatum CFO Partners LLP (“Tatum”), of which Mr. Eidell continues to bea partner, providing for up to 20% of Mr. Eidell’s base salary and bonus,if any, to be remitted to Tatum.  Under the terms of an agreement enteredinto with Tatum, an annualized amount of $65,000, prorated for the period ofMr. Eidell’s employment by the Company, is to be paid to Tatum.  Theamount of the Tatum payment has been deducted from the PTA base salary figureof $325,000, resulting in the new base salary of $260,000 for Mr. Eidell underthe Employment Agreement.  Additionally, Mr. Eidell is entitled to anannual performance-based milestone bonus payment, of which 20% would be payableto Tatum, as per the Tatum agreement, and a monthly transportation allowance of$1,500.  On March 10, 2005, Mr. Eidellreceived a stock option grant of 80,000 shares at an exercise price equal tothe closing price of the Company’s stock on that date.  The stock options shall vest at the earlierof the termination of the Employment Agreement as a result of Mr. Eidell’sresignation to allow a new permanent CEO to take office or one year from the dateof grant. 

 

On June 17, 2004, NeoPharm entered intoan Employment Agreement with Gregory P. Young to serve as the Company’sPresident, Chief Executive Officer and a director. Mr. Young resigned asthe Company’s President and CEO, and as a director, on March 8, 2005, andthe Company entered into a Separation Agreement and Full Release of All Claims(the “Separation Agreement”) with Mr. Young. Under the terms of theSeparation Agreement, Mr. Young is eligible to receive a salarycontinuance for 12 months based upon his annual base salary at the time of hisresignation ($325,000) and Company paid insurance premiums under the Company’smedical insurance plan. The salary continuance and medical insurance premiumpayments will cease at such time as Mr. Young accepts full-time employmentor the first date that Mr. Young provides consulting or other services to certainother competing pharmaceutical or biotechnology organizations, other than acharitable entity. Additionally, Mr. Young agreed to serve as a consultantto the Company for a period of up to 12 months or upon the termination of theSeparation Agreement, whichever is earlier, during which time all optionspreviously granted to Mr. Young continue to vest and remain exercisableuntil 90 days after termination of his consulting duties, resulting in the expectedvesting of 62,500 options. All other options granted to Mr. Young areexpected to be forfeited.  For the threeand six months ended June 30, 2005, the Company recorded compensation expenseof $184,539 and $209,353, respectively, relating to the options granted to Mr.Young that continue to vest during the term of the consulting agreement.

 

On June 17, 2004, James M. Husseyresigned as the Company’s President, Chief Executive Officer and a member ofthe Board of Directors. In accepting Mr. Hussey’s resignation, the Boardof Directors authorized the Company to enter into a Separation Agreement andFull Release of all Claims (the “Hussey Agreement”) with Mr. Hussey. Underthe terms of the Hussey Agreement, 

 

10

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Mr. Hussey was scheduled to receive asalary continuance for 12 months based upon his annual base salary at the timeof his resignation ($339,768), Company paid insurancepremiums under the Company’s medical insurance plan, plus a payment of 50% ofMr. Hussey’s target milestone bonus when 2004 bonuses are paid to theCompany’s employees. The salary continuance and medical insurance premiumpayments will cease at such time as Mr. Hussey accepts full-timeemployment or the first date that Mr. Hussey provides consulting or otherservices to competing pharmaceutical or biotechnology organization.Additionally, Mr. Hussey agreed to serve as a consultant to the Companyfor a period of up to 24 months or upon the termination of the HusseyAgreement, whichever is earlier, during which time all options previouslygranted to Mr. Hussey continue to vest and remain exercisable until 90days after termination as a consultant. All compensation expense associatedwith these options was recorded in 2004 due to the acceleration of vesting thatoccurred upon the execution of the Hussey Agreement. On March 11, 2005, theCompany entered into an amendment to the Hussey Agreement in which Mr. Husseyagreed to accept the Company’s common stock as consideration in lieu of allremaining cash payments due to him under the Hussey Agreement. As of March 10,2005, the effective date of the amendment, Mr. Hussey was owed $188,353, which represented,at the closing price of the Company’s common stock on March 10, 2005, 23,692shares of the Company’s common stock, which shares were issued to Mr. Hussey.Mr. Hussey will continue to provide consulting services to the Company untilJune 17, 2006.

 

**Note 12  Contingencies**

 

TheCompany has been named in several putative class action lawsuits (the “ClassAction Suits”) each of which alleges various violations of the federalsecurities laws in connection with the Company’s public statements during theperiod from September 25, 2000 through April 19, 2002 as they relate tothe Company’s LEP drug product candidate. The original lawsuits also named asindividual defendants John N. Kapoor, former Chairman of the Company, and JamesM. Hussey, the Company’s former President and CEO, and Dr. Aquilur Rahman,a former director and executive officer of the Company. The first of theseClass Action Suits was filed on April 26, 2002 and all of the Class ActionSuits have been filed in the United States District Court for the NorthernDistrict of Illinois, Eastern District. On September 16, 2002, aconsolidated amended complaint was filed against NeoPharm in this matter. Theamended complaint shortened the class period to October 31, 2001 throughApril 19, 2002, removed Dr. Rahman as a defendant, and added Dr. ImranAhmad, the Company’s current Chief Scientific Officer and Executive VicePresident of Research and Development, as a defendant. The Company intends tovigorously defend each and every claim in the Class Action Suits and, onNovember 4, 2002, moved to have the complaint dismissed. The Company’smotion to dismiss was granted in part and denied in part in February 2003.Dr. Kapoor was dismissed from the lawsuit at that time. In November 2004,the plaintiffs filed a motion to amend and a motion for summary adjudication.The motion to amend seeks to again make Dr. Kapoor a defendant, and reallegesthat certain pre-class period statements are actionable. The Company opposedboth motions.  No trial date has been setand discovery is ongoing. Management is unable to estimate the potentialoutcome or a range of possible losses, if any. In addition, the Company maintains insurance coverage to mitigate thefinancial impact of any potential loss.

 

On March 26, 2004, the Company received a letter from the Securitiesand Exchange Commission (“SEC”) stating that the SEC is conducting a formalinvestigation of the Company.  The SECstated in its letter that it has made no determination of any violation of lawby the Company or any individual at this time. Previously, this matter had been the subject of an informal SECinquiry.  The Company continues to fullycooperate with the SEC and intends to continue to do so in order to bring theinquiry to a conclusion as promptly as possible.  The Company believes the investigation is anoutgrowth of the arbitration claim filed by the Company against Pharmacia (nowPfizer) regarding the development of its LEP and LED drug product candidatesand the Class Action Suits which have been filed against the Company relatingto its public statements regarding the development of LEP.  The Company cannot predict with certainty thedirection the investigation will take or its ultimate outcome, and therefore isunable to determine whether the results of the investigation will have amaterial adverse impact on the Company’s results of operations or financialposition.

 

Thepharmaceutical industry has traditionally experienced difficulty in maintainingproduct liability insurance coverage at desired levels. To date, no significantproduct liability suit has ever been filed against the Company. However, if a suit were filed and a judgment entered against theCompany, it could have a material adverse effect upon the Company’s operationsand financial position. While the Company maintains insurance to cover the useof its drug product candidates in clinical trials, the Company does notmaintain insurance covering the sale of its drug product candidates nor isthere any assurance that it will be able to obtain or maintain such insuranceon acceptable terms or with adequate coverage against potential liabilities.

 

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**Item 2****- Management’s Discussion andAnalysis 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 madepursuant to the safe harbor provisions of the Private Securities LitigationReform Act of 1995.  The Company cautionsreaders that important factors may affect the Company’s actual results andcould cause such results to differ materially from forward-looking statementsmade by or on behalf of the Company. Such factors include, but are not limited to, those risks anduncertainties relating to difficulties or delays in development, testing, regulatoryapproval, recruitment of patients, production and marketing of the Company’sdrug candidates, including, but not limited to cintredekin besudotox(IL13-PE38QQR), including the PRECISE trial, the marketing of non-drug productssuch as NeoPhectinTM and NeoPhectin-ATTM, uncertainty regarding the outcome ofclass action litigation against the Company, resolution of the ongoing SECinvestigation, unexpected adverse side effects or inadequate therapeuticefficacy of the Company’s drug candidates that could slow or prevent productscoming to market, the uncertainty of patent protection for the Company’sintellectual property or trade secrets, the ability of the Company to procureadditional future sources of financing, and other factors referenced under “RiskFactors” in the Company’s Annual Report on Form 10-K and Amendment No. 1 filed on Form 10-K/A for the fiscal year ended December 31,2004.

 

Thefollowing should be read in conjunction with the financial statements andrelated notes and Management’s Discussion and Analysis of Financial Conditionand Results of Operations and the Risk Factors section included in the Company’s2004 Annual Report on Form 10-K and Amendment No. 1 filed on Form 10-K/A.  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 and uncertainties,which could cause actual results to differ from statements made. 

 

**Overview**

 

Weare a biopharmaceutical company engaged in the research, development, andcommercialization of drugs for the treatment of various cancers. Our corporatestrategy is to become a leader in the research, development, andcommercialization of new and innovative anti-cancer treatments. We currentlyoperate at two locations, and had 91 full time employees as of June 30,2005.  Our corporate headquarters andclinical development team are located in Lake Forest, Illinois, and ourresearch and development facility is in Waukegan, Illinois.

 

Sincewe began doing business in June 1990, we have devoted our resourcesprimarily to funding research and product development programs. To date, wehave not received Food and Drug Administration (“FDA”) approval of any of ourdrug product candidates.  We expect tocontinue to incur losses for the foreseeable future as we continue our researchand development activities, which include the sponsorship of human clinicaltrials for our drug product candidates. Until we are able to consistently generate revenue through the sale ofdrug or non-drug products, we anticipate that we will be required to fund thedevelopment of our pre-clinical compounds and drug product candidates primarilyby other means, including, but not limited to, licensing the development rightsto some of our drug product candidates to third parties, collaborating withthird parties to develop formulations of their compounds using our technology,or selling Company issued securities.

 

Inthe second quarter ended June 30, 2005, management’s efforts were primarily devotedto overseeing the Phase III PRECISE clinical trial for our lead drug productcandidate, cintredekin besudotox (IL13-PE38QQR), advancing our NeoLipid drugproduct candidates (LEP-ETU, LE-SN38, and LErafAON) through the clinicaldevelopment process, engaging potential partners in discussions pertaining topotential licensing of our drug product candidates, and exploring potentialopportunities to reduce expenses in an effort to reduce the amount of cash usedin operations.

 

ThePRECISE trial, our Phase III clinical trial of cintredekin besudotox for thetreatment of glioblastoma multiforme, began in March 2004 with theenrollment of our first patient. As of July 31, 2005, 225 patients have beenenrolled in the PRECISE trial. In June 2005, the independent Data MonitoringCommittee responsible for overseeing our PRECISE trial met, analyzed, andreviewed the data for the trial’s first futility analysis and recommended thatthe PRECISE trial continue as planned.  Ifcurrent enrollment rates continue, we anticipate the completion of enrollment(approximately 300 patients total) for PRECISE in 2005 and the submission of aBiologics License Application (“BLA”) with the FDA in 2006 seeking marketingapproval of the drug. However, there can be no assurance the trial will meetits endpoint in the time anticipated, that the FDA will approve the BLA or thatthe FDA will not require additional data or testing. Assuming that we receiveauthorization to begin selling cintredekin besudotox, we currently anticipatethe first sales of the product in 2007.  Enrollmentalso continues in our Phase I clinical trial of cintredekin besudotox formalignant glioma patients at initial diagnosis.

 

Duringthe first half of 2005, we continued the enrollment of patients in a clinicaltrial to assess whether LEP-ETU can be considered bioequivalent to paclitaxel,the active component of LEP-ETU. If pharmacokinetic bioequivalency isdemonstrated, we could be allowed to take advantage of a more expeditious pathto submit an application to the FDA for approval of LEP-ETU. Additionally, wecontinued our efforts to begin a Phase II clinical trial for LE-SN38 forpatients suffering from colorectal cancer, which is expected to begin later in2005. We also continued enrollment in our Phase I clinical trial of ourLErafAON drug product 

 

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candidate, with completion of enrollment dependent onthe number of dose levels studied. 

 

Itis difficult to predict with any certainty the timing of and total estimatedcosts to complete development of drug product candidates in early stage, orPhase I/II, clinical development, as well as the estimated date such drugproduct candidates would be available for sale, if approved by the FDA. Anumber of factors contribute to this uncertainty, including, but not limited to:side effects encountered in early stage clinical trials, ability to scale upmanufacturing for commercial supply, and the fact that the size and scope ofpivotal Phase III clinical trials are unknown until sufficient data isavailable to present a Phase III plan to the FDA for approval. In addition, ourdrug product candidates are required to be approved by the FDA after completingPhase III clinical trials before we can sell the drugs to generate revenue and,potentially, realize net cash inflows. Because our lead drug product candidate,cintredekin besudotox, has entered a Phase III clinical trial, we are able toestimate that we will incur further direct expenses of approximately $11 millionto complete the Phase III PRECISE study. Additional Phase I and Phase IIexpenses will also be incurred for cintredekin besudotox as we are conductingother clinical trials to investigate the potential of cintredekin besudotox inother stages of glioblastoma multiforme, such as initial diagnosis, in additionto recurrent glioblastoma multiforme.  Furthermore,additional expense will need to be incurred to file a BLA to complete ourefforts to commercialize cintredekin besudotox. 

 

Thetable below includes a summary of identified direct project costs incurred todate for our major research and development projects. Generally, identifiedproject costs include expenses incurred specifically for clinical trials andpre-clinical studies we conduct, and exclude expenses incurred for salariespaid to our professional staff, overhead expenses for our Lake Forest andWaukegan facilities and general laboratory supplies used in our research, whichare included as non-project specific.

 
| ** **                              | ** ** | ** **            | ** ** | ** **         | ** ** | **Total Costs**          | ** ** |
|-----------------------------------------|------------|-----------------------|------------|--------------------|------------|--------------------------|------------|
| ** **                              | ** ** | **Costs Incurred in** | ** ** | **Costs Incurred** | ** ** | **Incurred Since**       | ** ** |
| **Research  Project**                   | ** ** | **Current Quarter**   | ** ** | **Year to Date**   | ** ** | **Beginning of Project** | ** ** |
| Cintredekin besudotox                   |       | $                     | 3,988,881  |               | $          | 7,623,968                |       | $ | 46,594,575 |   |
| LEP-ETU                                 |       | 693,315               |       | 1,484,963          |       | 5,508,338                |       |
| LE-SN38                                 |       | 180,681               |       | 329,843            |       | 4,797,433                |       |
| LErafAON                                |       | 129,217               |       | 224,843            |       | 7,657,448                |       |
| Non-project specific                    |       | 2,968,823             |       | 6,371,061          |       | N/A                      |       |
| Total research and development expenses |       | $                     | 7,960,917  |               | $          | 16,034,678               |       | N/A |   |
|                                         |            |                       |            |                    |            |                          |            |  |  |  |  |

 

In order to decreaseexpenses, we reduced our workforce by a total of 30 employees (approximately23%) in November 2004, consisting of 26 employees from our research anddevelopment groups and 4 employees from our selling, general, and administrativegroup. Terminated employees were eligible to receive continued salary andinsurance benefits through December 31, 2004 (the termination date), 2004earned bonus payable in February 2005 (contingent on Board of Directors’approval of the 2004 bonus pool, which was subsequently given), two monthsseverance pay in 2005, two months of Company paid medical insurance premiumspaid in 2005, and outplacement services. 

 

We successfully completednegotiations on two collaborations in December 2004. The first collaborationresulted in 2005 revenue of $500,000 as we provided a customized NeoPhectinformulation to our customer, a privately held biotechnology company, of theirproprietary compound. The collaboration allows us to negotiate a licenseagreement for any customized formulation using our NeoPhectin technology thatmay be developed commercially. Additionally, we entered into an exclusivelicense agreement with Nippon Kayaku Co., Ltd. (“Nippon”) for the Japanesedevelopment rights for cintredekin besudotox. In addition to the $2 millionup-front licensing fee we received in January 2005, we have alsocontracted to receive future additional license fees, milestone payments androyalties. Nippon is responsible for all development costs in Japan.

 

Inaddition to our ongoing efforts to enter into additional collaborations, wecontinue to monitor and analyze our expenses in an effort to further reduce ournet loss. We currently estimate that the fiscal year 2005 net loss will bebetween $37 and $39 million, or $1.57 to $1.66 per share, and we now expectthat cash used in operations will be less than $35 million for 2005. Thiscompares to our fiscal year 2004 net loss of approximately $57.6 million, or$2.51 per share, and cash used in operations of approximately $52.2 million.

** **

**Results of Operations – ThreeMonths Ended June 30, 2005 vs. Three Months Ended June 30, 2004.**

 

The Company recorded productrevenue of $19,600 for the three months ended June 30, 2005 as compared to $19,080for the three months ended June 30, 2004. The sole source of product revenue in both periods was from sales ofNeoPhectin and NeoPhectin-AT.  During thethree months ended June 30, 2005, we also recognized a total of $435,000 ofrevenue related to collaboration fees earned in 2005 for a customizedNeoPhectin formulation.  No collaborationrevenue was recognized in 2004.

 

Research and developmentexpense for the three months ended June 30, 2005 decreased by approximately $4.0million as compared to the same period in 2004. The decrease in research anddevelopment expenses was primarily related to a significant 

 

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reduction in the number of clinical trialsbeing conducted by the Company in 2005, resulting in a reduction in expenses ofapproximately $1.7 million, reduced research and development payroll relatedexpenses of approximately $1.2 million primarily resulting from the 2004workforce reduction, and a reduction of approximately $1.1 million in expenses relatedto non-project specific research.

 

Selling,general, and administrative expenses were approximately $3.1 million for thethree months ended June 30, 2005 and $3.0 million for the three months endedJune 30, 2004.  For the three monthsended June 30, 2005, the Company incurred approximately $0.1 million less ofselling, general, and administrative expenses, which was offset by a non-cashcharge of $0.2 million related to the modification of the option terms asoutlined in the separation agreement entered into between us and Gregory Young,former President and CEO.

 

OnMay 16, 2005, we accepted $2.5 million as payment in full for all outstandingprincipal and interest due and owing on a promissory note that we hadpreviously determined to be impaired.  Asa result of the payment, we recorded a $2.5 million benefit as Recovery of NoteReceivable.    

 

TheCompany generated interest income on cash and investments of approximately $0.4million and $0.2 million for the three months ended June 30, 2005 and 2004,respectively.  The increase in interestincome in 2005 was primarily due to increases in short-term interest ratesoffset by the decline in average cash and cash equivalents.

 

**Results of Operations – SixMonths Ended June 30, 2005 vs. Six Months Ended June 30, 2004.**

** **

The Company recorded productrevenue of $25,900 for the six months ended June 30, 2005 as compared to $31,280for the six months ended June 30, 2004. The sole source of product revenue in both periods was from sales ofNeoPhectin and NeoPhectin-AT.  During thesix months ended June 30, 2005, we also recognized a total of $500,000 ofrevenue related to collaboration fees earned in 2005 for a customizedNeoPhectin formulation.  No collaborationrevenue was recognized in 2004.

 

Research and developmentexpense for the six months ended June 30, 2005 decreased by approximately $7.2million as compared to the same period in 2004. The decrease in research anddevelopment expenses was primarily related to a significant reduction in thenumber of clinical trials being conducted by the Company in 2005, resulting ina reduction in expenses of approximately $3.4 million, reduced research anddevelopment payroll related expenses of approximately $1.7 million primarilyresulting from the 2004 workforce reduction, and a reduction of approximately $2.1million in expenses related to non-project specific research.

 

Selling,general, and administrative expenses were approximately $6.3 million for thesix months ended June 30, 2005 and $6.2 million for the six months ended June30, 2004.  For the six months ended June30, 2005, the Company incurred approximately $0.5 million less of selling,general, and administrative expenses, which was offset by an accrual for compensationcosts of $0.4 million and a non-cash charge of $0.2 million related to theseparation agreement entered into between us and Gregory Young, formerPresident and CEO.

 

OnMay 16, 2005, we accepted $2.5 million as payment in full for all outstandingprincipal and interest due and owing on a promissory note that we hadpreviously determined to be impaired.  Asa result of the payment, we recorded a $2.5 million benefit as Recovery of NoteReceivable.    

 

TheCompany generated interest income on cash and investments of approximately $0.8million and $0.5 million for the six months ended June 30, 2005 and 2004,respectively.  The increase in interestincome in 2005 was primarily due to increases in short-term interest ratesoffset by the decline in average cash and cash equivalents.

 

**Liquidityand Capital Resources**

 

Asof June 30, 2005, we had approximately $48.3 million in cash and cashequivalents and no debt. All excess cash is currently invested in marketablesecurities with less than three months to maturity. We currently believe thatour cash on hand at June 30, 2005 should be adequate to fund ouroperations through the fourth quarter of 2006 at current and projected levelsof development and general corporate activity. In May 2005, we received $2.5million as payment in full of all outstanding principal and interest due andowed under a Promissory Note, that we had previously determinedto be impaired.  Additionally during2005, we received approximately $2.0 million for one time, nonrefundablelicensing fees. These fees have been recorded as “Deferred Revenue” on theCompany’s unaudited Condensed Consolidated Balance Sheet at June 30, 2005 and willbe recognized ratably as revenue once the general criteria for revenuerecognition are met.  

 

The primary use of cash overthe next 12-24 months will be to fund our clinical and pre-clinical researchand development efforts and commercialization of cintredekin besudotox. Themost significant expenses will be incurred in relation to the PRECISE 

 

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trial for our brain tumor drug product candidate,cintredekin besudotox. At the present time, we expect to spend approximately $11million over the next 18 months to complete the PRECISE trial. Additionalexpenses are also expected to be incurred as we continue to move our Phase Iand Phase II drug product candidates towards, and potentially into, Phase IIand Phase III clinical trials.

 

Wemay seek to satisfy our future funding requirements through public or privateofferings of securities, with collaborative or other arrangements with corporatepartners or from other sources. In January 2004, we received approximately$73.5 million, after underwriting fees and expenses, through the sale ofcommon stock via a shelf registration.  Currently,the Company has the ability to issue approximately $46 million, plus permittedincreases, but this shelf registration will expire on December 17, 2005,and is conditioned on the Company’s timely filing of all required documentswith the SEC. Further, additional financing may not be available when needed oron terms acceptable to us. If adequate financing is not available, we may berequired to delay, scale back or eliminate certain of our research anddevelopment programs, relinquish rights to certain of our technologies, drugsor products, or license third parties to commercialize products or technologiesthat we would otherwise seek to develop ourselves.

 

NeoPharmhas no debt, no capital leases, no exposure to off-balance sheet arrangements,no special purpose entities, nor activities that include non-exchange-tradedcontracts accounted for at fair value.

 

Thefollowing table summarizes our estimated contractual obligations as of June 30,2005:

 
| ** **                                       | ** ** | **Payments Due by Period** | ** ** |
|--------------------------------------------------|------------|----------------------------|------------|
| ** **                                       | ** ** | ** **                 | ** ** | **Less than** | ** ** | ** ** | ** ** | ** ** | ** ** | **More than** | ** ** |
| **Contractual  Obligations**                     | ** ** | **Total**                  | ** ** | **1 year** | ** ** | **1-3 years** | ** ** | **3-5 years** | ** ** | **5 years** | ** ** |
|                                             |       |                       |       |   |   |   |   |   |   |   |   |
| Operating lease                                  |       | $                          | 871,132    |   | $ | 388,635 |   | $ | 481,537 |   | $ | 960 |   | $ | — |   |
| Clinical trial monitoring (CRO) agreements  (1)  |       | 2,308,023                  |       | 1,853,130 |   | 454,893 |   | — |   | — |   |
| License agreements - milestone based payments(2) |       | 2,350,000                  |       | 50,000 |   | 1,200,000 |   | — |   | 1,100,000 |   |
|                                             |       | $                          | 5,529,155  |   | $ | 2,291,765 |   | $ | 2,136,430 |   | $ | 960 |   | $ | 1,100,000 |   |

 

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(1)           These amounts include only contractualobligations for direct expenses for the PRECISE trial, exclusive of clinicaltrial site costs for treating patients.

 

(2)           These amounts do not include potentialsales-based royalty payments that may be required under the various licenseagreements.  Milestone based payment obligations arecontingent upon successfully reaching objectively determinable stages in thedevelopment of drug product candidates. The Company has estimated the periodthe payment may be due, if at all, based upon its expectations of the timelinefor continued successful development of the drug product candidates.

 

**Critical Accounting Policies**

 

Inpreparing the Company’s financial statements in conformity with U.S. generallyaccepted accounting principles (“GAAP”), management must make a variety ofdecisions which impact the reported amounts and related disclosures. Suchdecisions include the selection of the appropriate accounting principles to beapplied, the assumptions on which to base accounting estimates, and theconsistent application of those accounting principles. Due to the type ofindustry in which the Company operates and the nature of its business, thefollowing accounting policies are those that management believes are mostimportant to the portrayal of the Company’s financial condition and results andthat require management’s most difficult, subjective or complex judgments,often as a result of the need to make estimates about the effect of mattersthat are inherently uncertain.

 

*Income Taxes*

 

Inassessing the realizability of deferred tax assets, management considerswhether it is more likely than not that some portion or all of the deferred taxassets will not be realized. The ultimate realization of deferred tax assets isdependent upon the generation of future taxable income during the periods inwhich those temporary differences become deductible. Management considers thescheduled reversal of deferred tax liabilities, projected future taxableincome, and tax planning strategies in making this assessment. Significantjudgments are required to estimate the generation of future taxable income andthe timing of the reversal of deferred tax liabilities.

 

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*Contingencies*

* *

To properly account for andprovide disclosure of loss contingencies, management must apply judgment indetermining whether a loss contingency is: probable, reasonably possible, orremote. In instances where management has determined that a loss contingency isprobable, it must make use of estimates to determine the amount of probableloss. Management must apply judgment in determining whether or not it can makea reasonable estimate. Management must also apply judgment in determiningwhether or not disclosure of loss contingencies that have been accrued shouldbe made for the consolidated financial statements not to be misleading.

 

*Stock-Based Compensation*

 

The Company applies theintrinsic-value-based method of accounting prescribed by Accounting PrinciplesBoard (“APB”) Opinion No. 25, *Accountingfor Stock Issued to Employees*, and related interpretations includingFASB Interpretation No. 44, *Accountingfor Certain Transactions Involving Stock Compensation, an Interpretation of APBOpinion No. 25*, issued in March 2000, to account for itsfixed-plan stock options. Under this method, compensation expense is measuredon the date of grant only if the current market price of the underlying stockexceeded the exercise price or when the number of shares and exercise price areknown if both are not determinable at the date of grant. Compensation expensefor fixed stock options is recognized ratably over the vesting period.  Statement of Financial Accounting Standards (“SFAS”)  No. 123,*Accounting for Stock-Based Compensation*,established accounting and disclosure requirements using a fair value method ofaccounting for stock-based employee compensation plans. As allowed by SFAS No. 123,the Company has elected to continue to apply the intrinsic value method ofaccounting described above, and has adopted only the disclosure requirements ofSFAS No. 123. Significant judgments are required in determining anappropriate method for determining the fair value of stock-based compensation.The Company has elected to utilize the Black-Scholes option-pricing model tomake the fair value determination. Inputs into the option-pricing model aresubject to estimation that may affect the determination of fair value.

 

*Revenue Recognition*

* *

TheCompany follows the provisions as set forth by current accounting rules, whichprimarily include Staff Accounting Bulletin (“SAB”) 104, *Revenue Recognition,*and Emerging IssuesTask Force (“EITF”) Issue No. 00-21, *Accountingfor Revenue Arrangements with Multiple Deliverables.*Generally,revenue is recognized when evidence of an arrangement exists, delivery hasoccurred or services have been rendered, the price is fixed and determinable,and collectibility is reasonably assured.

 

TheCompany provides for general rights of return of products sold to itsdistributors.  Appropriately determiningrevenue recognition when the general right of return exists requires the use ofjudgment in estimating the level of returns. In certain circumstances, management may not be able to develop areasonable estimate of the level of returns. Making such a determination also requires the use of significantjudgment.  Management has determined thatgiven the limited sales history of NeoPhectin, the Company is currently unableto develop a reasonable estimate of the level of returns.  Accordingly, the Company is currentlyrecognizing revenue for products shipped to its distributor upon the expirationof the right of return which occurs upon the earlier of shipment of product bythe distributor to an end-user or, depending on the distributor, 60 to 180days. 

 

The Company has recentlyentered in collaboration and license agreements with third parties that containmultiple deliverables. Under the provisions of EITF Issue No. 00-21, adetermination must be made on each contract as to whether a deliverableconstitutes a separate unit of accounting. The amount of revenue to berecognized is based on the fair value for each unit of accounting within thearrangement. Management’s judgment is required to determine, based upon thefacts and circumstances of each arrangement, whether or not each deliverablehas standalone value and whether or not there exists a sufficient level ofobjective and reliable evidence of fair value of the undelivered items.  Additionally, units of accounting may bedelivered over an indeterminate period of time. Management judgment is requiredto estimate the period over which recognition of allocated revenue occurs.

 

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

 

Asof June 30, 2005, we did not own any derivative instruments, but we wereexposed to market risks, primarily changes in U.S. interest rates. As of June 30,2005, we held total cash and cash equivalents of $48,304,819. All cashequivalents have a maturity less than 90 days. Declines in interest ratesover time will reduce our interest income from our investments. Based upon ourbalance of cash and cash equivalents as of June 30, 2005, a decrease ininterest rates of 1.0% would cause a corresponding decrease in our annual interestincome of approximately $483,048.

 

**Item 4****– Controls and Procedures**

 

Asof June 30, 2005, we carried out an evaluation, under the supervision andwith the participation of our management, including our Chief Executive Officerand Chief Financial Officer, of the effectiveness of the design and operationof our disclosure controls and procedures. Based on that evaluation, ourmanagement, including the Chief Executive Officer and Chief Financial 

 

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Officer, concluded that our disclosure controls andprocedures are operating effectively as designed.

 

Therehave been no significant changes in our internal control over financialreporting that occurred during the period covered by this report that havematerially affected, or are reasonably likely to affect, our internal controlover financial reporting.

 

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**PART II - OTHER INFORMATION**

 

**Item 1 - Legal Proceedings**

** **

TheCompany has been named in several putative class action lawsuits (the “ClassAction Suits”) each of which alleges various violations of the federalsecurities laws in connection with the Company’s public statements during theperiod from September 25, 2000 through April 19, 2002 as they relateto the Company’s LEP drug product candidate. The original lawsuits also namedas individual defendants John N. Kapoor, Chairman of the Company, and James M.Hussey, the Company’s former President and CEO, and Dr. Aquilur Rahman, aformer director and executive officer of the Company. The first of these ClassAction Suits was filed on April 26, 2002 and all of the Class Action Suitshave been filed in the United States District Court for the Northern Districtof Illinois, Eastern District. On September 16, 2002, a consolidatedamended complaint was filed against NeoPharm in this matter. The amendedcomplaint shortened the class period to October 31, 2001 throughApril 19, 2002, removed Dr. Rahman as a defendant, and addedDr. Imran Ahmad, the Company’s current Chief Scientific Officer andExecutive Vice President of Research and Development, as a defendant. TheCompany intends to vigorously defend each and every claim in the class actionsuits and, on November 4, 2002, moved to have the complaint dismissed. TheCompany’s motion to dismiss was granted in part and denied in part inFebruary 2003. Dr. Kapoor was dismissed from the lawsuit at thattime. In November 2004, the plaintiffs filed a motion to amend and a motion forsummary adjudication. The motion to amend seeks to again make Dr. Kapoor a defendant,and realleges that certain pre-class period statements are actionable. TheCompany opposed both motions.  No trialdate has been set and discovery is ongoing. Management is unable to estimatethe potential outcome or a range of possible losses, if any.  In addition, the Company maintains insurancecoverage to mitigate the financial impact of any potential loss.

 

On March 26, 2004, the Company received a letter from the Securitiesand Exchange Commission (“SEC”) stating that the SEC is conducting a formalinvestigation of the Company.  The SECstated in its letter that it has made no determination of any violation of lawby the Company or any individual at this time. Previously, this matter had been the subject of an informal SECinquiry.  The Company continues to fullycooperate with the SEC and intends to continue to do so in order to bring theinquiry to a conclusion as promptly as possible.  The Company believes the investigation is anoutgrowth of the Company’s recently concluded arbitration with Pharmacia (nowPfizer) regarding the development of its LEP and LED drug product candidatesand the class action lawsuits which have been filed against the Companyrelating to its public statements regarding the development of LEP.  The Company cannot predict with certainty thedirection the investigation will take or its ultimate outcome, and therefore isunable to determine whether the results of the investigation will have amaterial adverse impact on the Company’s results of operations and financialposition.

 

**Item 2.****                   ****Unregistered Sales of EquitySecurities and Use of Proceeds**

** **

None

 

**Item 3.****                   ****Defaults UponSenior Securities**

** **

None

 

**Item 4.****                   ****Submission of Matters to a Voteof Security Holders**

** **

OnJune 16, 2005, the Company held its Annual Meeting of Stockholders to vote onthe matters listed below.  All of thematters voted on at the Annual Meeting were approved the Company’s stockholdersat the Annual Meeting.

 

1.     To elect seven directors to serve until the2006 Annual Meeting of Stockholders

Withrespect to the election for directors, the notes were as follows:

 
| ** **       | ** ** | **Votes For** | ** ** | **Votes Against** | ** ** | **Votes Withheld** | ** ** |
|------------------|------------|---------------|------------|-------------------|------------|--------------------|------------|
| Frank C. Becker  |       | 22,154,898    |       | —            |       | 129,703            |       |
| Ronald G. Eidell |       | 22,218,572    |       | —            |       | 66,029             |       |
| Bernard A. Fox   |       | 22,155,305    |       | —            |       | 129,296            |       |
| Paul E. Freiman  |       | 18,880,086    |       | —            |       | 3,404,515          |       |
| Erick E. Hanson  |       | 21,724,073    |       | —            |       | 560,528            |       |
| John N. Kapoor   |       | 20,898,275    |       | —            |       | 1,386,326          |       |
| Keveh T. Safavi  |       | 21,795,340    |       | —            |       | 489,261            |       |

 

2.     To ratify the appointment of KPMG LLP as theCompany’s independent registered public accountants:

 

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| **Votes For** | ** ** | **Votes Against** | ** ** | **Votes Withheld** | ** ** |
|---------------|------------|-------------------|------------|--------------------|------------|
| 22,273,969    |       | 6,385             |       | 4,247              |       |

 

**Item 5.****                   ****Other Information**

** **

None

 

Item 6.                    Exhibits

 
| Exhibit  31.1 |   | Certification  of the Chief Executive Officer                         |
|---------------|--------|-----------------------------------------------------------------------|
|          |   |                                                                  |
| Exhibit  31.2 |   | Certification  of the Chief Financial Officer                         |
|          |   |                                                                  |
| Exhibit  32.1 |   | Certification  pursuant to section 906 of the Sarbanes-Oxley Act |
|          |   |                                                                  |
| Exhibit  32.2 |   | Certification  pursuant to section 906 of the Sarbanes-Oxley Act |

 

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**SIGNATURE PAGE**

 

**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.**

 
|                  | NEOPHARM,  INC. |
|-----------------------|-----------------|
| Date:  August 9, 2005 | By:             | /s/  Lawrence A. Kenyon |
|                  |            | Lawrence  A. Kenyon, |
|                  |            | *Chief  Financial Officer  (Principal Accounting Officer and  Principal Financial Officer)* |

 

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