**UNITED STATESSECURITIES AND EXCHANGE COMMISSION**

**Washington,D.C. 20549**

**FORM 10-Q**

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

**ForQuarterly Period Ended September 30, 2006**

**Or**

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

**Forthe transition periodfrom             to             **

**Commissionfile number 33-90516**

****

**NEOPHARM, INC.**

(Exact name of Registrantas specified in its charter)

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

 

**1850 Lakeside Drive**

**Waukegan, Illinois 60085**

(Address of principalexecutive offices) (Zip Code)

**(847) 887-0800**

(Registrant’s telephonenumber, including area code)

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

Indicate by check mark whether Registrant is a largeaccelerated filer, an accelerated filer, or a non-accelerated filer. Seedefinition of “accelerated filer and large accelerated filer” in Rule 12b-2 ofthe Exchange Act. (Check one):

| Large accelerated  filer o |   | Accelerated  filer x |   | Non-accelerated  filer o |
|---------------------------------|--------|---------------------------|--------|--------------------------|

 

Indicate by check mark whether the registrant is ashell company (as defined in Rule 12b-2 of the Exchange Act). Yes   o  No  x

As of October 31, 2006, the number of sharesoutstanding of each of the issuer’s classes of common stock was as follows:

| **Title of each class**             |   | **Number  of shares outstanding** |
|-------------------------------------|--------|-----------------------------------|
| Common Stock  ($.0002145 par value) |   | 28,067,089                        |

 

 

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NEOPHARM, INC.

FORM 10-QINDEX
| PART I. FINANCIAL  INFORMATION |
|--------------------------------|
| Item  1.                       |   | Financial  Statements |
|                           |   | Condensed Consolidated Balance Sheets as of September  30, 2006 (unaudited) and December 31, 2005 |
|                           |   | Condensed Consolidated Statements of Operations for  the three and nine months ended September 30, 2006 and 2005 (unaudited) |
|                           |   | Condensed Consolidated Statements of Cash Flows for  the nine months ended September 30, 2006 and 2005 (unaudited) |
|                           |   | Notes to Condensed Consolidated Financial Statements  (unaudited) |
| Item 2.                        |   | Management’s Discussion and Analysis of Financial  Condition and Results of Operations |
| Item 3.                        |   | Quantitative and Qualitative Disclosures About Market  Risk |
| Item  4                        |   | Controls  and Procedures |
| PART  II. OTHER INFORMATION    |
| Item  1.                       |   | Legal  Proceedings |
| Item  1A.                      |   | Risk Factors |
| Item 2.                        |   | Unregistered Sales of Equity Securities and Use of  Proceeds |
| Item 3.                        |   | Defaults Upon Senior Securities |
| Item 4.                        |   | Submission of Matters to a Vote of Security Holders |
| Item  5.                       |   | Other  Information |
| Item 6.                        |   | Exhibits |
| SIGNATURE PAGE                 |

 

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**PART I - FINANCIALINFORMATION**

**Item 1 - FinancialStatements**

**NEOPHARM, INC.Condensed Consolidated Balance Sheets**
| ** **                                                                                                                                | ** ** | **September 30,** | ** ** | **December 31,** | ** ** |
|-------------------------------------------------------------------------------------------------------------------------------------------|------------|------------------------|------------|-----------------------|------------|
| ** **                                                                                                                                | ** ** | **2006**               | ** ** | **2005**              | ** ** |
| ** **                                                                                                                                | ** ** | **(Unaudited)**        | ** ** | ** **            | ** ** |
| **ASSETS**                                                                                                                                |       |                   |       |                  |       |
| Current assets:                                                                                                                           |       |                   |       |                  |       |
| Cash and cash  equivalents                                                                                                                |       | $                      | 3,028,000  |                  | $          | 1,486,000 |   |
| Short-term  investments                                                                                                                   |       | 42,202,000             |       | 28,776,000            |       |
| Trade accounts  receivable, net                                                                                                           |       | —                 |       | 1,000                 |       |
| Inventories                                                                                                                               |       | —                 |       | 6,000                 |       |
| Prepaid expenses  and other                                                                                                               |       | 857,000                |       | 728,000               |       |
| Total current  assets                                                                                                                     |       | 46,087,000             |       | 30,997,000            |       |
| Fixed assets,  net                                                                                                                        |       | 1,494,000              |       | 2,157,000             |       |
| Other assets                                                                                                                              |       | 207,000                |       | 216,000               |       |
| Total assets                                                                                                                              |       | $                      | 47,788,000 |                  | $          | 33,370,000 |   |
|                                                                                                                                      |       |                   |       |                  |       |
| **LIABILITIES AND STOCKHOLDERS’  EQUITY**                                                                                            |       |                   |       |                  |       |
| Current  liabilities:                                                                                                                     |       |                   |       |                  |       |
| Obligations  under capital lease                                                                                                          |       | $                      | 29,000     |                  | $          | — |   |
| Accounts payable                                                                                                                          |       | 2,222,000              |       | 683,000               |       |
| Accrued clinical  trial expense                                                                                                           |       | 2,960,000              |       | 5,370,000             |       |
| Accrued  compensation                                                                                                                     |       | 1,952,000              |       | 1,889,000             |       |
| Other accrued  expenses                                                                                                                   |       | 2,030,000              |       | 1,447,000             |       |
| Total current  liabilities                                                                                                                |       | 9,193,000              |       | 9,389,000             |       |
|                                                                                                                                      |       |                   |       |                  |       |
| Obligations  under capital lease                                                                                                          |       | 113,000                |       | —                |       |
| Deferred revenue                                                                                                                          |       | 2,000,000              |       | 2,000,000             |       |
| Deferred rent                                                                                                                             |       | 36,000                 |       | 36,000                |       |
| Derivative  financial instruments                                                                                                         |       | 383,000                |       | —                |       |
|                                                                                                                                      |       |                   |       |                  |       |
| 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: 28,067,089 and 23,740,051  shares issued and outstanding, respectively |       | 6,000                  |       | 5,000                 |       |
| Additional  paid-in capital                                                                                                               |       | 289,556,000            |       | 249,965,000           |       |
| Accumulated  deficit                                                                                                                      |       | (253,499,000           | )          | (228,025,000          | )          |
| Total stockholders’  equity                                                                                                          |       | 36,063,000             |       | 21,945,000            |       |
| Total liabilities and  stockholders’ equity                                                                                          |       | $                      | 47,788,000 |                  | $          | 33,370,000 |   |

 

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

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**NEOPHARM, INC.**

**CondensedConsolidated Statements of OperationsThree and Nine Months Ended September 30, 2006 and 2005**(Unaudited)
| ** **                                  | ** ** | **Three Months Ended** | ** ** | **Nine Months Ended** | ** ** |
|---------------------------------------------|------------|----------------------------------|------------|---------------------------------|------------|
| ** **                                  | ** ** | **September 30,**           | ** ** | **September 30,**          | ** ** | **September 30,** | ** ** | **September 30,** | ** ** |
| ** **                                  | ** ** | **2006**                         | ** ** | **2005**                        | ** ** | **2006** | ** ** | **2005** | ** ** |
| Collaboration  revenue                      |       | $                                | —     |                            | $          | — |   | $ | — |   | $ | 500,000 |   |
| Product revenue                             |       | 1,000                            |       | 9,000                           |       | 11,000 |   | 35,000 |   |
| Total revenue                               |       | 1,000                            |       | 9,000                           |       | 11,000 |   | 535,000 |   |
|                                        |       |                             |       |                            |       |   |   |   |   |
| Expenses:                                   |       |                             |       |                            |       |   |   |   |   |
| Cost of product revenue                     |       | —                           |       | 1,000                           |       | 1,000 |   | 2,000 |   |
| Research and development                    |       | 4,319,000                        |       | 8,538,000                       |       | 16,200,000 |   | 24,573,000 |   |
| Selling, general, and administrative        |       | 3,702,000                        |       | 2,388,000                       |       | 10,808,000 |   | 8,673,000 |   |
| Change in fair value of derivative          |       |                             |       |                            |       |   |   |   |   |
| financial instruments                       |       | (98,000                          | )          | —                          |       | (1,269,000 | ) | — |   |
| Employee termination costs                  |       | 293,000                          |       | —                          |       | 1,298,000 |   | — |   |
| Facility consolidation costs                |       | 428,000                          |       | —                          |       | 428,000 |   | — |   |
| Recovery of note receivable                 |       | —                           |       | —                          |       | — |   | (2,500,000 | ) |
| Total expenses                              |       | 8,644,000                        |       | 10,927,000                      |       | 27,466,000 |   | 30,748,000 |   |
| Loss from  operations                       |       | (8,643,000                       | )          | (10,918,000                     | )          | (27,455,000 | ) | (30,213,000 | ) |
|                                        |       |                             |       |                            |       |   |   |   |   |
| Interest income,  net                       |       | 639,000                          |       | 385,000                         |       | 1,981,000 |   | 1,158,000 |   |
| Net loss                                    |       | $                                | (8,004,000 | )                               | $          | (10,533,000 | ) | $ | (25,474,000 | ) | $ | (29,055,000 | ) |
| Net loss per  share —                  |       |                             |       |                            |       |   |   |   |   |
| Basic and diluted                           |       | $                                | (0.29      | )                               | $          | (0.45 | ) | $ | (0.92 | ) | $ | (1.23 | ) |
| Weighted average  shares outstanding — |       |                             |       |                            |       |   |   |   |   |
| Basic and  diluted                          |       | 27,934,702                       |       | 23,640,393                      |       | 27,685,928 |   | 23,557,757 |   |

 

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

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**NEOPHARM, INC.**

**CondensedConsolidated Statements of Cash FlowsNine Months Ended September 30, 2006 and 2005**(Unaudited)
| ** **                                                                   | ** ** | **Nine Months Ended** | ** **  |
|------------------------------------------------------------------------------|------------|---------------------------------|-------------|
| ** **                                                                   | ** ** | **September 30,**          | ** **  | **September 30,** | ** ** |
| ** **                                                                   | ** ** | **2006**                        | ** **  | **2005** | ** ** |
| Cash flows from  operating activities:                                       |       |                            |        |   |   |
| Net loss                                                                     |       | $                               | (25,474,000 | ) | $ | (29,055,000 | ) |
| Adjustments to reconcile net loss to net cash used  in operating activities: |       |                            |        |   |   |
| Depreciation and amortization                                                |       | 919,000                         |        | 984,000 |   |
| Stock-based compensation expense                                             |       | 1,535,000                       |        | 469,000 |   |
| Change in fair value of derivative financial  instruments                    |       | (1,269,000                      | )           | — |   |
| Loss on retirement of fixed assets                                           |       | 12,000                          |        | 5,000 |   |
| Non-cash reorganization                                                      |       | 94,000                          |        | — |   |
| Changes in assets and liabilities:                                           |       |                            |        |   |   |
| Increase (decrease) in current assets                                        |       | (98,000                         | )           | 93,000 |   |
| Decrease in other assets                                                     |       | 1,000                           |        | — |   |
| Increase (decrease) in other current liabilities                             |       | (229,000                        | )           | 1,248,000 |   |
| Increase in deferred revenue                                                 |       | —                          |        | 2,000,000 |   |
| Increase in deferred rent                                                    |       | 11,000                          |        | 42,000 |   |
| Net cash and  cash equivalents used in operating activities                  |       | (24,498,000                     | )           | (24,214,000 | ) |
|                                                                         |       |                            |        |   |   |
| Cash flows from  investing activities:                                       |       |                            |        |   |   |
| Proceeds from sales of marketable securities                                 |       | 27,350,000                      |        | 39,450,000 |   |
| Purchase of marketable securities                                            |       | (40,800,000                     | )           | (68,250,000 | ) |
| Purchase of equipment and furniture                                          |       | (200,000                        | )           | (242,000 | ) |
| Net cash and  cash equivalents used in investing activities                  |       | (13,650,000                     | )           | (29,042,000 | ) |
|                                                                         |       |                            |        |   |   |
| Cash flows from  financing activities:                                       |       |                            |        |   |   |
| Proceeds from issuance of common stock, net                                  |       | 38,739,000                      |        | — |   |
| Proceeds from exercise of stock options                                      |       | 856,000                         |        | 1,455,000 |   |
| Proceeds from employee stock purchase plan                                   |       | 114,000                         |        | — |   |
| Repayment of capital lease obligation                                        |       | (19,000                         | )           | — |   |
| Net cash and  cash equivalents provided by financing activities              |       | 39,690,000                      |        | 1,455,000 |   |
|                                                                         |       |                            |        |   |   |
| Net  increase/(decrease) in cash and cash equivalents                        |       | 1,542,000                       |        | (51,801,000 | ) |
| Cash and cash  equivalents, beginning of period                              |       | 1,486,000                       |        | 52,736,320 |   |
| Cash and cash  equivalents, end of period                                    |       | $                               | 3,028,000   |   | $ | 935,320 |   |
|                                                                         |       |                            |        |   |   |
| Supplemental  disclosure of cash paid for:                                   |       |                            |        |   |   |
| Interest                                                                     |       | $                               | 7,000       |   | $ | — |   |
| Income taxes                                                                 |       | $                               | —      |   | $ | — |   |

 

Non-cash investing and financing activities in thenine month periods ending September 30, 2006 and 2005 consisted of a January2006 capital equipment lease totaling $161,000 and, in March 2005, the issuanceof 23,692 shares of our common stock in satisfaction of a liability in theamount of $188,000.

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

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**NEOPHARM, INC.NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS(unaudited)**

**Note 1Basis of Presentation**

The financial information herein is unaudited. Thebalance sheet as of December 31, 2005 is derived from audited financialstatements.

The accompanying unaudited condensed consolidatedfinancial statements of NEOPHARM, Inc. and subsidiary (“we”, “us”, “our”, orthe “Company”) have been prepared in accordance with U.S. generally acceptedaccounting principles, or U.S. GAAP, for interim financial information and withthe instructions to Form 10-Q and Rule 10-01 of Regulation S-X. Accordingly,these financial statements do not contain all of the information and notesrequired by U.S. GAAP for complete financial statements. In the opinion ofmanagement, the accompanying unaudited condensed consolidated interim financialstatements contain all adjustments (consisting of normal recurring adjustments)necessary to a fair presentation. The results of operations for the three andnine month periods ended September 30, 2006 are not necessarily indicative ofour operating results for fiscal 2006 or future interim periods.

The unaudited condensed consolidated financialstatements 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. NEOPHARM EU has nominal assets and has not conducted anybusiness. All significant intercompany accounts and transactions are eliminatedin consolidation.

While we believe that the disclosures presented hereinare adequate to make the information not misleading, it is suggested that thesefinancial statements be read in conjunction with the financial statements andnotes included in the Company’s 2005 Annual Report on Form 10-K filed with theUnited States Securities and Exchange Commission, or SEC.

The preparation of financial statements in conformitywith U.S. GAAP requires management to make estimates and assumptions thataffect 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 reportingperiods. Actual results could differ from those estimates.

Certain 2005 amounts have been reclassified to conformto the current year presentation. In particular, our investments in auctionrate certificates are now classified as short-term investments, rather than theprevious presentation as a cash equivalent. This reclassification affected thepresentation of cash flows from investing activities related to the auctionrate certificates in the Consolidated Statements of Cash Flows for the ninemonths ended September 30, 2005 which now reflects purchases of marketablesecurities of $68,250,000 and proceeds from sales of marketable securities of$39,450,000.

Amounts presented have been rounded to the nearestthousand.

We adopted the provisions of Statement of Financial AccountingStandards (SFAS) No. 123 (revised 2004), “Share-Based Payment”, or SFAS 123(R),which requires the recognition of compensation expense related to the fairvalue of our stock-based compensation awards effective January 1, 2006. Priorto the adoption of SFAS 123(R), we accounted for stock-based awards todirectors, officers, and employees, using the intrinsic value method inaccordance with Accounting Principles Board Opinion No. 25, or APB No. 25,as allowed under Statement of Financial Accounting Standards No. 123, “Accountingfor Stock-Based Compensation”, or SFAS 123. Under the intrinsic valuemethod, compensation expense is measured on the date of grant if the currentmarket price of the underlying stock exceeded the exercise price or when the numberof shares and exercise price are known, if both are not determinable at thedate of grant. Compensation expense for fixed awards was recognized ratablyover the vesting period. SFAS 123 also established accounting anddisclosure requirements using a fair value method of accounting for stock-basedemployee compensation plans. As a result of our adoption of SFAS 123(R) onJanuary 1, 2006, our net loss for the three and nine months ended September 30,2006 are $401,000 and $1,257,000 lower, respectively , than if we had continuedto account for share-based compensation under APB No. 25.

We adopted SFAS 123(R) using the modifiedprospective method. Under this transition method, compensation cost recognizedin the 2006 condensed consolidated statements of operations includes: a)compensation cost for the fair value of the remaining portion of the requisiteservice period for all share-based awards granted prior to, but not vested asof January 1, 2006, and b) compensation cost for the fair value for all share-basedawards granted or modified subsequent to January 1, 2006. In conjunction withthe adoption of SFAS 123(R), we have adopted a policy of recognizingcompensation cost on a straight-line basis. Under the pro forma disclosurerequirements of SFAS 123, in prior periods, we recognized costs on astraight-line basis and considered the effect of forfeitures in the period anaward was cancelled.

In February 2006, the Financial AccountingStandards Board, or FASB, issued SFAS No. 155, *Accountingfor Certain Hybrid Financial Instruments, an amendment of FASB Statements No. 133and 140*, or SFAS 155, to simplify and make more consistent theaccounting for certain financial instruments. SFAS 155 applies to allfinancial instruments acquired or issued after the beginning of an entity’sfirst fiscal year that begins after September 15, 2006 with earlier applicationallowed. The adoption of

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SFAS 155 is notexpected to have a material impact on our consolidated financial position orresults of operations.

In June 2006, the FASB issued FASB Interpretation No. 48,or FIN 48, *Accounting for Uncertainty in Income Taxes, aninterpretation of FASB Statement No. 109.*This interpretationis effective for fiscal years beginning after December 15, 2006 andclarifies the accounting for uncertainty in income taxes by prescribing arecognition threshold and measurement attribute for financial statementrecognition and measurement of a tax position taken or expected to be taken ina tax return as well as provides guidance on derecognition, classification,interest and penalties, accounting in interim periods, disclosure andtransition. Adoption of FIN 48 is not expected to have a material impact on theCompany’s consolidated financial position or results of operations.

In September 2006, the FASB issued SFAS No. 157, *Fair Value Measurement*, or SFAS 157. SFAS 157defines fair value, establishes a framework for measuring fair value under U.S.GAAP, and expands disclosures about fair value measurements. SFAS 157 iseffective for financial statements for fiscal years beginning after November15, 2007 and interim periods within those fiscal years. We do not expect theadoption of SFAS 157 to have a material impact on our consolidatedfinancial position or results of operations.

In September 2006, the SEC issued Staff AccountingBulletin, or SAB, No. 108, *Considering the Effects ofPrior Year Misstatements when Quantifying Current Year Misstatements*.SAB No. 108 requires analysis of misstatements using both an incomestatement (rollover) approach and a balance sheet (iron curtain) approach inassessing materiality and provides for a one-time cumulative effect transitionadjustment. SAB No. 108 is effective for fiscal years beginning afterNovember 15, 2006. We do not expect the adoption of SAB No. 108 tohave a material impact on our consolidated financial position or results ofoperations.

**Note 2Loss Per Share**

The following table sets forth the computation ofbasic and diluted net loss per share:

|                                          | ** ** | **Three Months Ended** | ** ** | **Nine Months Ended** | ** ** |
|------------------------------------------|------------|----------------------------------|------------|---------------------------------|------------|
| ** **                               | ** ** | **September 30,**           | ** ** | **September 30,**          | ** ** | **September 30,** | ** ** | **September 30,** | ** ** |
| ** **                               | ** ** | **2006**                         | ** ** | **2005**                        | ** ** | **2006** | ** ** | **2005** | ** ** |
| Numerator:                               |       |                             |       |                            |       |   |   |   |   |
| Net loss                                 |       | $                                | (8,004,000 | )                               | $          | (10,533,000 | ) | $ | (25,474,000 | ) | $ | (29,055,000 | ) |
|                                     |       |                             |       |                            |       |   |   |   |   |
| Denominator:                             |       |                             |       |                            |       |   |   |   |   |
| Weighted average shares outstanding      |       | 27,934,702                       |       | 23,640,393                      |       | 27,685,928 |   | 23,557,757 |   |
|                                     |       |                             |       |                            |       |   |   |   |   |
| Loss per share —  basic and diluted |       | $                                | (0.29      | )                               | $          | (0.45 | ) | $ | (0.92 | ) | $ | (1.23 | ) |
|                                     |       |                             |       |                            |       |   |   |   |   |
| Potential common  share equivalents:     |       |                             |       |                            |       |   |   |   |   |
| Stock options                            |       | 2,320,337                        |       | 3,499,387                       |       | 2,320,337 |   | 3,393,307 |   |

 

As we have incurred net losses in each of the periodspresented, basic and diluted loss per share amounts are the same, as the effectof common share equivalents is anti-dilutive.

**Note 3Share-based Compensation and Non-Employee Stock Options**

We currently sponsor the following share-based paymentplans:

*2006 Plan*

On June 19, 2006, our stockholders approved theNEOPHARM, Inc. 2006 Equity Incentive Plan, or the 2006 Plan. The 2006 Planprovides for the issuance of stock options, non-vested stock, performance unitsor performance share awards to employees, directors and consultants convertibleto up to 1,000,000 shares of our common stock. Awards under the 2006 Plangenerally consist of stock options having an exercise price equal to the averageof the lowest and highest reported sale prices of our common stock on the dateof grant; vest ratably over four years; have a 10 year term; and are subject tocontinuous employment. Stock awards granted to our non-employee directors underthe 2006 Plan typically vest one year from the date of grant. Awards under the2006 Plan vest immediately upon a change in control, as defined in the 2006Plan. Although the 2006 Plan provides for the issuance of performance units andperformance shares, we have not made grants of these types of awards and the2006 Plan limits to 500,000 the shares of common stock which may be issuedpursuant to restricted stock or bonus stock awards. As of September 30, 2006,836,917 shares were available for issuance under the 2006 Plan.

*2006 EmployeeStock Purchase Plan*

On June 19, 2006, our shareholders also approved the2006 Employee Stock Purchase Plan, or the Purchase Plan, under which eligibleemployees may purchase shares of common stock quarterly through payrolldeductions. An aggregate of 100,000 shares of common stock may be issued underthe Purchase Plan. The price per share under the Purchase Plan is 85% of thelower of the closing price of the common stock on (i) the first businessday of the plan period or (ii) the purchase date. The Purchase Plan

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imposes a limitation upona participant’s right to acquire common stock if immediately after or prior topurchase the employee owns 5% or more of the total combined voting power orvalue of the our common stock. In the nine-months ended September 30, 2006,26,005 shares were issued under the Purchase Plan resulting in compensationexpense of $23,000 and $36,000 during the three- and nine-month periods endedSeptember 30, 2006, and 73,995 shares remained available for issuance.

*The 1998 Plan*

Our 1998 Equity Incentive Plan, or the 1998 Plan,provided for the grant of awards, primarily stock options, to employees,directors, and consultants to acquire up to 4,600,000 shares of our commonstock. As a result of the June 2006 shareholder approval of the 2006 Plan, nofurther awards will be made under the 1998 Plan. Option awards under the 1998Plan were generally granted with an exercise price equal to the closing priceof our common stock on the date of grant, but may have been granted with anexercise price of not less than 85% of the fair market value of our commonstock. Option awards under the 1998 Plan typically had a 10-year life andvested ratably on the first four anniversaries of the grant, subject tocontinuous employment. Stock awards granted to our non-employee directors underthe 1998 Plan typically vested one year from the date of grant. Outstandingawards issued under the 1998 Plan vested immediately upon a change in control,as defined in the 1998 Plan.

Amounts recognized in the condensed consolidatedfinancial statements with respect to our share based compensation plans were asfollows:

|                                                        | ** ** | **Three Months Ended** | ** ** | **Nine Months Ended** | ** ** |
|--------------------------------------------------------|------------|----------------------------------|------------|---------------------------------|------------|
| ** **                                             | ** ** | **September 30,**           | ** ** | **September 30,**          | ** ** | **September 30,** | ** ** | **September 30,** | ** ** |
| ** **                                             | ** ** | **2006**                         | ** ** | **2005**                        | ** ** | **2006** | ** ** | **2005** | ** ** |
|                                                   |       |                             |       |                            |       |   |   |   |   |
| Research and  development                              |       | $                                | 163,000    |                            | $          | — |   | $ | 551,000 |   | $ | — |   |
| Selling, general  and administrative                   |       | 335,000                          |       | 81,000                          |       | 984,000 |   | 443,000 |   |
| Total cost of  share-based payment plans during period |       | $                                | 498,000    |                            | $          | 81,000 |   | $ | 1,535,000 |   | $ | 443,000 |   |

 

We have never capitalized share-based compensation.

For fiscal periods prior to our January 2006 adoptionof SFAS 123(R), we used the APB 25 intrinsic-value method of accountingfor share-based compensation. The following table illustrates the effect on ournet loss in prior periods as if the SFAS 123 fair-value method ofaccounting had been applied:

|                                                                                                                 | ** ** | **Three months ended** | ** **  | **Nine months ended**  | ** ** |
|-----------------------------------------------------------------------------------------------------------------|------------|----------------------------------|-------------|----------------------------------|------------|
| ** **                                                                                                      | ** ** | **September 30, 2005** | ** **  | **September 30, 2005** | ** ** |
| Net loss as  reported                                                                                           |       | $                                | (10,533,000 | )                                | $          | (29,055,000 | ) |
| Add: stock-based  employee compensation expense included in reported net loss (1)                          |       | 81,000                           |        | 443,000                          |       |
| Less: total  stock-based employee compensation expense determined under fair value based  method for all awards |       | (315,000                         | )           | (922,000                         | )          |
|                                                                                                            |       |                             |        |                             |       |
| Pro forma net  loss                                                                                             |       | $                                | (10,767,000 | )                                | $          | (29,534,000 | ) |
|                                                                                                            |       |                             |        |                             |       |
| Basic and  diluted loss per common share                                                                        |       |                             |        |                             |       |
| As reported                                                                                                     |       | $                                | (0.45       | )                                | $          | (1.23 | ) |
| Pro forma                                                                                                       |       | $                                | (0.46       | )                                | $          | (1.25 | ) |

----

(1)             Valueof restricted stock granted to non-employee directors and compensation expenserelating to options granted to an executive at 85% of fair value.

8

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The following table summarizes employee stock optionawards during the nine months ended September 30, 2006:

|                                     | ** ** | ** ** | ** ** | ** **                | ** ** | **Weighted Average** | ** ** | **Aggregate** | ** ** |
|-------------------------------------|------------|------------|------------|---------------------------|------------|---------------------------|------------|---------------|------------|
| ** **                          | ** ** | ** ** | ** ** | **Weighted Average** | ** ** | **Remaining**             | ** ** | **Intrinsic** | ** ** |
| ** **                          | ** ** | **Shares** | ** ** | **Exercise Price**   | ** ** | **Contractual Term** | ** ** | **Value**     | ** ** |
| Outstanding at  December 31, 2005   |       | 3,571,132  |       | $                         | 13.07      |                      |       |          |       |   |
|                                |       |       |       |                      |       |                      |       |          |       |
| Granted                             |       | 392,400    |       | $                         | 10.61      |                      |       |          |       |   |
| Granted out of the money            |       | 30,000     |       | $                         | 6.51       |                      |       |          |       |   |
| Exercised                           |       | (180,000   | )          | $                         | 3.75       |                      |       |          | $          | 225,000 |   |
| Forfeited, expired and or cancelled |       | (1,708,645 | )          | $                         | 11.13      |                      |       |          |       |   |
|                                |       |       |       |                      |       |                      |       |          |       |
| Outstanding at  September 30, 2006  |       | 2,104,887  |       | $                         | 12.42      |                      | 6.28       |          | $          | — |   |
|                                |       |       |       |                      |       |                      |       |          |       |
| Exercisable at  September 30, 2006  |       | 1,184,591  |       | $                         | 15.78      |                      | 4.34       |          | $          | — |   |

 

Based on awards outstanding on September 30, 2006, weexpect to recognize $4.2 million of unrecognized share-based compensationover a weighted-average period of two years.

In the prior year nine month period, we granted516,085 options with a weighted average fair value of $5.74 and 319,211 optionswere exercised with an aggregate intrinsic value of $2,173,000.

On June 19, 2006, we granted 58,083 non-vested sharesof common stock to non-employee directors with a weighted average fair value of$6.37 and one year vesting. In June 2005, we granted 36,010 shares ofnon-vested common stock to non-employee directors with a weighted average fairvalue of $9.76, all shares of which vested on June 16, 2006. As of September30, 2006, there were 58,083 non-vested shares outstanding, with $265,000 ofunrecognized compensation expense to be recognized over a weighted averageperiod of nine months. No stock options were granted to non-employee directorsduring the nine months ended September 30, 2006.

*Stock Option*ValuationInformation

We have estimated the fair value of our share-basedcompensation using the Black-Scholes option-pricing model. This model requiresthe use of subjective assumptions that have a significant impact on the fairvalue estimate. The weighted-average estimated fair value of employee stockoptions granted during the three and nine months ended September 30, 2006 ascalculated using the Black Scholes model and the related weighted-averageassumptions follow:

|                                                                          | ** ** | **Three months ended** | ** ** | **Nine months ended**  | ** ** |
|--------------------------------------------------------------------------|------------|----------------------------------|------------|----------------------------------|------------|
| ** **                                                               | ** ** | **September 30, 2006** | ** ** | **September 30, 2006** | ** ** |
| Expected  volatility                                                     |       | 71.0                             | %          | 71.2                             | %          |
| Risk-free  interest rate                                                 |       | 4.9                              | %          | 4.5                              | %          |
| Expected term  (in years)                                                |       | 6.25                             |       | 6.25                             |       |
| Expected  dividend yield                                                 |       | 0.0                              | %          | 0.0                              | %          |
|                                                                     |       |                             |       |                             |       |
| Weighted average  estimated fair value of employee stock options granted |       | $                                | 3.50       |                             | $          | 6.70 |   |
|                                                                          |            |                                  |            |                                  |            |  |  |

 

We have based our assumptions regarding expectedvolatility on the historic volatility of our common stock, the risk-freeinterest rate on the U.S. Treasury yield curve in effect at the time of grant, andthe expected term of options using the “Simplified Method” in accordance withSEC Staff Accounting Bulletin, or SAB, No. 107, Share Based Payment.Assumptions used in the Black-Scholes option-pricing model for calculating theweighted average fair value of options granted in first nine months of 2005were as follows: expected volatility was 70.5%, weighted average risk-freeinterest rate was 4.0%, weighted average expected term was 6.25 years, andthere was no expected dividend yield. No options were granted during the threemonths ended September 30, 2005.

9

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*DerivativeFinancial Instruments*

Prior to 2000, we granted common stock options tocertain non-employee consultants as compensation related to research anddevelopment activities. As of January 1, 2006, the effective date ofSFAS123(R), options granted to certain non-employees to purchase 234,025 sharesof our common stock were vested and outstanding. Upon adoption of SFAS 123(R),these non-employee common stock options were accounted for as derivativeinstruments in accordance with SFAS 133 and recorded as a liability.

We calculated the estimated fair value of theoutstanding options granted to non-employees as of January 1, 2006 to be$1,652,000 and reclassified this amount from additional paid-in-capital to aliability. The estimated fair value of the non-employee options is remeasuredeach reporting period with any change in estimated fair value recorded as acomponent of loss from operations in the accompanying Condensed ConsolidatedStatements of Operations. As of September 30, 2006 158,125 non-employeeoptions remained outstanding. During the three and nine months ended September 30,2006, we recorded the benefit of the change in fair value of $99,000 and$1,269,000, respectively, resulting primarily from a decline in our stockprice.

The Company uses the Black-Scholes option-pricingmodel to estimate the fair value of the non-employee option grants over theremaining contractual terms of the outstanding options, which ranged from 23months to 39 months at September 30, 2006.

**Note4 Cash and Cash Equivalents and Short-term Investments**

We consider all highly liquid investments purchasedwith an original maturity of three months or less to be cash equivalents. Cashequivalents totaled $604,000 and $104,000 as of September 30, 2006 andDecember 31, 2005, respectively. The carrying value of cash equivalents closelyapproximates their fair market value due to their short maturity and highliquidity.

Short-term investments represent investments inauction rate certificates and have been classified as available-for-salesecurities and are as follows:

|                               | ** ** | **September 30,** | ** ** | **December 31,** | ** ** |
|-------------------------------|------------|------------------------|------------|-----------------------|------------|
| ** **                    | ** ** | **2006**               | ** ** | **2005**              | ** ** |
| State government  agencies    |       | $                      | 42,150,000 |                  | $          | 28,700,000 |   |
| Total short-term  investments |       | $                      | 42,150,000 |                  | $          | 28,700,000 |   |

 

The carrying value of our short-term investmentsincludes accrued interest income of $52,000 and $76,000 at September 30,2006 and December 31, 2005, respectively.

Short-term investments are stated at cost, whichapproximates fair value due to their variable interest rates, which typicallyreset every 7 to 35 days. As of September 30, 2006, our investmentsin auction rate certificates have contractual maturities of greater than tenyears. As we have the ability to quickly convert these securities to cash, ifnecessary, these securities have been classified as a current asset in theaccompanying Condensed Consolidated Balance Sheets.

**Note5 Inventory**

Our inventory at December 31, 2005, totaling $6,000,was comprised solely of direct labor and material charges attributable toNeoPhectinTM finished goods under the first-in, first-out, or FIFO, inventorymethod stated at the lower of cost or fair-market value. We had no commercialinventory on hand on September 30, 2006.

**Note6 Fixed Assets**

We record fixed assets at cost and record depreciationusing the straight-line method over the related asset’s estimated useful life.Expenditures that do not extend the life or improve the productivity of assetsare charged to expense when incurred. When fixed assets are disposed of, therelated costs and accumulated depreciation are removed from the accounts andany gain or loss is recorded. Depreciation and amortization expense for thethree and nine months ended September 30, 2006 totaled $243,000 and$919,000, respectively. Total depreciation and amortization expense for thethree and nine months ended September 30, 2005 was $303,000 and $984,000,respectively. During the nine months ended September 30, 2006, the Companyacquired office equipment under a five-year capital lease for $161,000.

Long-lived assets are reviewed for impairment whenchanges in circumstances indicate the carrying amount of an asset may not berecoverable. Recoverability of assets to be held and used is measured by acomparison of the carrying amount of the assets to estimated undiscounted cashflows expected to be generated by the assets. If the carrying amount of anasset were to exceed its estimated future cash flows, an impairment chargewould be recognized by the amount by which the carrying amount of the assetexceeds the fair value of the asset.

10

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**Note7 Capital Lease**

Minimum future lease payments under capital lease asof September 30, 2006 are as follows:

| For the period October 1,  2006 through December 31, 2006 |   | $       | 9,000   |   |
|-----------------------------------------------------------|--------|---------|---------|--------|
| For the year ending  December 31, 2007                    |   | 38,000  |    |
| For the year ending  December 31, 2008                    |   | 38,000  |    |
| For the year ending  December 31, 2009                    |   | 38,000  |    |
| For the year ending  December 31, 2010                    |   | 38,000  |    |
| Subsequent to 2010                                        |   | 3,000   |    |
|                                                      |   |    |    |
| Total minimum lease  payments                             |   | 164,000 |    |
| Less amount representing  interest                        |   | (21,000 | )       |
| Present value of minimum lease payments                   |   | $       | 143,000 |   |

 

**Note 8Employee Termination and Facility Consolidation Costs**

During the first nine months of 2006, we have reducedour workforce by 26 associates under an organizational restructuringinitiative. Personnel terminated under this initiative were generally eligibleto receive up to three months pay, half of their 2006 bonus target, two monthsmedical coverage and outplacement services. Additionally, in June 2006, weentered into a separation and consulting agreement with our former ChiefFinancial Officer, Mr. Larry Kenyon. Under this agreement, Mr. Kenyon isscheduled to receive nine-month salary continuation, reimbursement of medicaland dental coverage and his previously granted options continue to vest duringthe consulting period. Also, in May 2006, Dr. Imran Ahmad resigned as theCompany’s Executive Vice President and Chief Scientific Officer and, inaccordance with the terms of his original offer letter, Dr. Ahmad is scheduledto receive twelve-month salary continuation and $20,000. Aggregate employeeseverance costs related to the reorganization and separation agreements, whichwere recorded in the applicable period of termination, were $293,000 and$1,298,000 in the three months and nine month periods ended September 30,2006, respectively. Accrued but unpaid employee severance costs at September 30,2006 totaled $541,000 and are expected to be paid over the next eight months.

In the three months ended September 30, 2006, werecorded a $334,000 charge for estimated lease exposure related to our formerLake Forest, Illinois office space and wrote off $94,000 in related equipmentand leasehold improvements. As of September 30, 2006, this cost reductioninitiative is largely complete.

|                                  | ** ** | ** **               | ** ** | **Accrued**     | ** ** |
|----------------------------------|------------|--------------------------|------------|-----------------|------------|
| ** **                       | ** ** | **Lease Cost/Fair** | ** ** | **Termination** | ** ** |
| ** **                       | ** ** | **Value Reserve**   | ** ** | **Costs**       | ** ** |
| Balance, January 1,  2006   |       | $                        | —     |            | $          | — |   |
|                             |       |                     |       |            |       |
| Accrued costs                    |       | 334,000                  |       | 1,298,000       |       |
| Accretion                        |       | 4,000                    |       | —          |       |
| Payments                         |       | (42,000                  | )          | (757,000        | )          |
|                             |       |                     |       |            |       |
| Balance, September 30, 2006 |       | $                        | 296,000    |            | $          | 541,000 |   |

 

**Note9 Stockholders’ Equity**

On January 10, 2006, we issued 4,025,000 sharesof our common stock in a public offering, which resulted in net proceeds of$39,002,000, after underwriting discounts and commissions of $2,053,000 andbefore expenses of $263,000.

We maintain a Stockholder Rights Plan whereby rightsto purchase shares of Series A Participating Preferred Stock become exercisableby our stockholders in the event a non-excluded party acquires, or attempts toacquire, 15% or more of our outstanding common stock.

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**Note10 Revenue Recognition**

The Company recognizes revenue when persuasiveevidence of an arrangement exists, delivery has occurred or services have beenrendered, the price is fixed or determinable, and collectibility is reasonablyassured.

For product sales not subject to unconditional rightsof return, the Company recognizes revenue upon shipment as title and risk ofloss has passed to the customer. For product sales subject to unconditionalrights of return, the Company recognizes revenue upon shipment when it canreasonably estimate the level of returns at the time of shipment. Given thelimited sales history of its products, the Company is currently unable toreasonably estimate the level of returns at the time of shipment. Accordingly,revenue related to shipments to distributors that have been granted anunconditional right of return is currently being recognized when the right ofreturn has expired, which occurs upon the earlier of shipment of the product bythe distributor to an end user or expiration of the right of return, which is60-180 days depending upon the distributor. The Company warrants its productsin a manner consistent with industry standards and has not incurred anywarranty costs related to the sale of NeoPhectinTM.

The Company enters into collaboration and technologylicensing arrangements, which contain multiple deliverables. Under theprovisions of Emerging Issues Task Force (EITF) No. 00-21, *Accounting for Revenue Arrangements with MultipleDeliverables*, the Company evaluates whether these deliverablesconstitute separate units of accounting to which total arrangementconsideration is allocated. A deliverable qualifies as a separate unit ofaccounting when the item delivered to the customer has standalone value, thereis objective and reliable evidence of fair value of items that have not beendelivered to the customer, and, if there is a general right of return for theitems delivered to the customer, delivery or performance of the undelivereditems is considered probable and substantially in the control of the Company.Arrangement consideration is allocated to units of accounting on a relativefair-value basis or the residual method if the Company is unable to determinethe fair value of all deliverables in the arrangement. Consideration allocatedto a unit of accounting is limited to the amount that is not contingent uponfuture performance by the Company. Upon determination of separate units ofaccounting and allocated consideration, the general criteria for revenuerecognition are applied to each unit of accounting.

The Company has entered into an agreement with NipponKayaku Co., Ltd (“Nippon”) in which the development and commercializationrights in Japan for CINTREDEKIN BESUDOTOX were licensed. The Company received a$2 million upfront nonrefundable fee in January 2005 and is entitledto receive future additional fees, milestone payments and royalties. Nippon isresponsible for all development costs in Japan. The Company has agreed toprovide or arrange for contract manufacture of a commercial supply ofCINTREDEKIN BESUDOTOX upon receipt of marketing approval by Nippon. Theup-front nonrefundable fee received by the Company will be recognized ratablyas revenue once the general criteria for revenue recognition has been met forthe unit of accounting to which the fee has been allocated.

**Note11 Contingencies**

NeoPharm, Inc. and certain of our current and formerofficers and directors have been named in a consolidated amended complaint,which alleges various violations of the federal securities laws in connectionwith our public statements regarding our LEP drug product candidate during theperiod from October 31, 2001 through April 19, 2002. On November 4,2002, we moved to have the complaint dismissed. Our motion to dismiss wasgranted in part and denied in part in February 2003. InNovember 2004, the plaintiffs filed a motion to amend and a motion forsummary adjudication. The motion to amend seeks to include certain pre-classperiod statements in the complaint. The motion for summaryadjudication asks the Court to rule that certain statements made in anarbitration award regarding the LEP drug product candidate be deemed factsestablished in this proceeding. We have filed oppositions to both motions onwhich the Court has not yet ruled. No trial date has been set and discovery isongoing. We intend to vigorously defend each and every claim in the complaint.Management is unable to reasonably or accurately estimate the potential outcomeor range of possibilities, if any. In addition, we believe that the Company’sinsurance coverage would mitigate the financial impact of any potential loss.

On March 26, 2004, we received a letter from theSEC stating that the SEC was initiating a formal investigation of the Company.The SEC stated in its letter that it had made no determination of any violationof law by the Company or any individual at this time. We have fully cooperatedwith the SEC and believe the investigation is an outgrowth of our arbitrationregarding development of LEP. We cannot ascertain or predict with certainty theeventual outcome of the investigation, and are therefore unable to determinewhether the results of the investigation may have a material adverse impact onour results of operations or financial position.

We are from time to time subject to claims andlitigation arising in the ordinary course of business. We intend to defend vigorouslyany such litigation that may arise under all defenses that would be availableto us. In the opinion of management, the ultimate outcome of those proceedingsof which management is aware, even if adverse to us, will not have a materialadverse effect on our consolidated financial position or results of operations.While we maintain insurance to cover the use of our drug product candidates inclinical trials, we do not presently maintain insurance covering the potentialcommercial use of our drug product candidates and there is no assurance that wewill be able to obtain or maintain such insurance on acceptable terms.

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**Item 2 -Management’s Discussion and Analysis of Financial Condition and Results ofOperations**

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. We caution readers that important factors may affect ouractual results and could cause such results to differ materially fromforward-looking statements made by or on our behalf. Such factors include, butare not limited to, those risks and uncertainties relating to difficulties ordelays in development, testing, manufacturing, regulatory approval, recruitmentof patients, production and marketing of the Company’s drug candidates,including, but not limited to: our lead drug product candidate IL13-PE38QQR, orCINTREDEKIN BESUDOTOX, including the Phase III PRECISE trial for CINTREDEKINBESUDOTOX, and our lead NeoLipidTM product candidates LE-SN38 and LEP-ETU; ourability to make, or the timing of, a filing of a Biologics License Application,or BLA, for approval of CINTREDEKIN BESUDOTOX with the United States Food and DrugAdministration, or FDA; the performance of third-party contractors; uncertaintyregarding the outcome of certain legal and regulatory investigations againstus, unexpected adverse side effects or inadequate therapeutic efficacy of ourdrug product candidates, including, but not limited to, CINTREDEKIN BESUDOTOX,that could slow or prevent our drug product candidates coming to market; theuncertainty of patent protection for our intellectual property and tradesecrets; our ability to raise additional funds at all or on terms acceptable tous; and other factors referenced under Item 1A, “Risk Factors” in Part II ofthis Quarterly Report on Form 10-Q.

The following should be read in conjunction with ourcondensed consolidated financial statements and related notes and withManagement’s Discussion and Analysis of Financial Condition and Results ofOperations and the Risk Factors section included as Item 1A herein and in theCompany’s 2005 Annual Report on Form 10-K. The results discussed below are notnecessarily indicative of the results to be expected in any future periods. Thefollowing discussion contains forward-looking statements that are subject torisks and uncertainties, which could cause actual results to differ fromstatements made.

**Overview**

We are a biopharmaceutical company engaged in theresearch, development, and commercialization of drugs for the treatment ofvarious cancers. Our goal is to become a leader in the research, development,and commercialization of new and innovative anti-cancer treatments. As of September 30,2006, we had 66 full time employees operating in our combined research andcorporate facility in Waukegan, Illinois.

Since we began business in June 1990, we havedevoted our resources primarily to funding research and product developmentprograms. To date, we have not received FDA approval for any of our drugproduct candidates. We expect to continue to incur losses for the foreseeablefuture as we continue our research and development activities, which includethe sponsorship of human clinical trials for our drug product candidates, andwork to commercialize our lead drug product candidate, CINTREDEKIN BESUDOTOX.Until we are able to consistently generate profitable revenue through the saleof drug or non-drug products, we anticipate that we will be required to fundthe development of our pre-clinical compounds and drug product candidatesprimarily by other means, including, but not limited to, issuing equity orother securities, licensing drug product candidates to third parties andcollaborating with third parties to develop formulations of their compoundsusing our technology.

In 2006, our primary focus has been on developing andimplementing a commercial strategy for CINTREDEKIN BESUDOTOX, preparing for apotential submission of a CINTREDEKIN BESUDOTOX BLA filing with the FDA,furthering development of our NeoLipid® liposomal drug product candidates andreducing and refocusing our expenditures to lessen the amount of cash used inthe development and commercialization of our drug product candidates.

*CINTREDEKINBESUDOTOX*

CINTREDEKIN BESUDOTOX, our most advanced drug productcandidate, targets Glioblastoma multiforme, or GBM, the most common type ofmalignant primary brain tumor in adults. According to the Central Brain TumorRegistry of the United States, or CBTRUS, GBM tumors typically affect men morecommonly than women, particularly men between the ages of 60 and 85 years.According to the CBTRUS, approximately 10,000 people are diagnosed annuallywith malignant glioma (GBM and anaplastic astrocytoma) and this disease iseventually fatal for most patients. Survival time for GBM patients ranges fromsix months for recurrent disease to 12 months with newly diagnosed diseasedespite aggressive treatments including surgery, radiation therapy andchemotherapy. GBM tumors mainly arise in the cerebral hemispheres (the mainportions of the brain), but they can also occur in the brainstem, cerebellum,or spinal cord. Symptoms of a GBM can include headaches that are caused byincreased intracranial pressure, neurological deficits such as weakness,sensory loss, coordination difficulties, visual impairment, cognitiveimpairment affecting memory and language, seizures, and personality changes

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CINTREDEKIN BESUDOTOX is a recombinant proteinconsisting of a single molecule composed of two parts: a tumor-targetingmolecule (Interleukin-13 or IL13) and a cytotoxic agent (Pseudomonas Exotoxin,or PE38). IL13 receptors are present in appreciable numbers on malignant gliomacells, but only minimally, if at all, on healthy brain cells. The cancer cellappears to latch onto and absorb the IL13 and the attached PE38, causingdestruction of the cancer cell. Healthy brain cells appear to be unharmed becausethey do not internalize the PE. The drug is delivered via Convection EnhancedDelivery, or CED, a novel drug delivery system using catheters placed followingtumor resection (removal), in areas with microscopic tumor spread or at risk oftumor spread around the tumor resection cavity.

CINTREDEKIN BESUDOTOX has received Orphan Drugdesignation and Fast Track designation from the FDA. CINTREDEKIN BESUDOTOX wasalso accepted into the FDA’s Continuous Marketing Application, or CMA, Pilot 2Program. CINTREDEKIN BESUDOTOX has also received Orphan Drug designation inEurope.

*Phase IIIRandomized Evaluation of Convection Enhanced Delivery of IL13-PE38QQR withSurvival Endpoint, or PRECISE*

PRECISE is our randomized, controlled Phase IIIclinical trial originally designed to enroll up to 300 patients in order toobtain 270 patients with confirmed GBM at first recurrence at study entrysurgical resection for the intent-to-treat patient population, and compareoverall survival, drug safety and quality of life of patients receivingCINTREDEKIN BESUDOTOX with patients receiving Gliadel® Wafer in the treatmentof first recurrent GBM following surgical tumor resection. PRECISE achieved the270 patient intent-to-treat milestone (276 intent-to-treat) in December 2005after enrolling 294 patients. Patients were randomized so that two patientsreceived CINTREDEKIN BESUDOTOX via CED for every one patient that receivedGliadel Wafer placed in the resection cavity at the time of resection. Thefinal efficacy analysis of the PRECISE trial is based on the CINTREDEKINBESUDOTOX trial arm achieving a statistically significant improvement inoverall patient survival as compared to the Gliadel® arm.

In June 2006, the PRECISE trial’s independent DataMonitoring Committee, or iDMC, completed the FDA-mandated PRECISE interimefficacy analysis after 160 patient deaths, recommending that PRECISE continueto the planned final efficacy analysis at 215 deaths. The interim efficacyassessment required interim trial data achieve a p-value, or confidenceinterval, of less than or equal to 0.005 as compared to the overall, originallyplanned PRECISE trial p-value objective of less than or equal to 0.048. Inconjunction with its interim analysis, the iDMC reported no treatment relatedadverse or serious adverse events that differed from previous reports and thosenormally associated with GBM and reported that compliance in terms of catheterplacement guidelines was over 80%. While we are blinded to the data andinformation in the PRECISE trial, we currently anticipate PRECISE’s finalefficacy analysis to occur in the first quarter of 2007, although it could bebefore or after that date.

Additionally, enrollment was completed in June 2006,pending drug safety assessment, in a Phase I clinical trial of CINTREDEKINBESUDOTOX for malignant glioma patients at initial diagnosis.

We are currently preparing for a possible submissionof a BLA to the FDA to seek U.S. marketing approval for CINTREDEKIN BESUDOTOX,should the PRECISE trial achieve a statistically significant improvement inoverall survival as compared to Gliadel®. However, there can be no assurancethat the PRECISE trial will meet its endpoint in the time anticipated, that theFDA will approve the BLA or that the FDA will not require additional data or testing.

*NeoLipid® Platform*

In 2006, we have reassessed and reprioritized ourNeoLipid® platform and strategy to focus development efforts on LEP-ETU,LE-SN38 and LE-DT.

LEP-ETU is a liposomal formulation of paclitaxel theactive ingredient in the widely used cancer drug Taxol® which is approved inthe U.S. for the treatment of breast, lung and ovarian cancers. We arepreparing to submit our LEP-ETU Phase III clinical trial plans to the FDA inthe fourth quarter of 2006 and we hope to commence enrollment in 2007.

LE-SN38 is a liposomal formulation of SN-38; theactive metabolite of irinotecan, or Pfizer’s Camptosar®, a chemotherapeuticpro-drug used in the treatment of first- and second-line colorectal cancer.During the second quarter of 2006, we initiated enrollment in a Phase IIclinical trial for LE-SN38 in metastatic colorectal cancer patients and expectto reach an interim analysis of this trial in the 2007 second quarter.

Pre-clinical work also advances on our earlier stageliposomal formulation of the anti-cancer agent docetaxel (LE-DT).

It is difficult to predict with any certainty thetiming of and total estimated costs to complete development of drug product candidatesin early stage, or Phase I, clinical development, as well as the estimated datesuch drug product candidates would be available for sale, if approved by theFDA. A number of factors contribute to this uncertainty, including: sideeffects 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

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to generate revenue and,potentially, realize net cash inflows. Because our lead drug product candidate,CINTREDEKIN BESUDOTOX, has now completed enrollment in the Phase IIIPRECISE study, we estimate that we will incur further direct expenses ofapproximately $2 million to close out the study. Additional clinical trialexpenses are expected to be incurred for CINTREDEKIN BESUDOTOX as we conductadditional clinical trials to investigate its potential use in other forms andstages of malignant glioma, in addition to recurrent glioblastoma multiforme.We also expect to incur additional expenses related to the preparation for apossible CINTREDEKIN BESUDOTOX BLA submission.

The table below includes a summary of identifieddirect project costs incurred to date for our clinical research and developmentprojects. Generally, identified project costs include expenses incurredspecifically for clinical trials and pre-clinical studies we conduct, andexclude expenses incurred for salaries paid to our professional staff, overheadexpenses for our former Lake Forest facility and our current Waukegan facility andgeneral laboratory supplies used in our research, which are included withnon-project specific.

|                                          | ** ** | **Total Direct Costs** | ** ** |
|------------------------------------------|------------|----------------------------------|------------|
| ** **                               | ** ** | ** **                       | ** ** | ** ** | ** ** | **Cumulative costs** | ** ** |
| ** **                               | ** ** | **Three months ended** | ** ** | **Nine months ended** | ** ** | **through** | ** ** |
| **Research Project**                | ** ** | **September 30, 2006** | ** ** | **September 30, 2006** | ** ** | **September 30, 2006** | ** ** |
| CINTREDEKIN  BESUDOTOX                   |       | $                                | 2,158,000  |   | $ | 7,835,000 |   | $ | 62,559,000 |   |
| LEP-ETU                                  |       | 191,000                          |       | 806,000 |   | 7,512,000 |   |
| LE-SN38                                  |       | 51,000                           |       | 173,000 |   | 5,146,000 |   |
| Non-project  specific                    |       | 1,919,000                        |       | 7,386,000 |   | N/A |   |
|                                     |       |                             |       |   |   |   |   |
| Total research  and development expenses |       | $                                | 4,319,000  |   | $ | 16,200,000 |   | N/A |   |
|                                          |            |                                  |            |  |  |  |  |  |  |  |

 

**Resultsof Operations — Three Months Ended September 30, 2006 vs. Three Months EndedSeptember 30, 2005.**

Our sole source of product revenue in each of the 2006and 2005 third quarters was from sales of NeoPhectinTM and NeoPhectin-ATTM.Generally, our results of operations for the three months ended September 30,2006 reflect the benefit of our recent cost rationalization initiative, theDecember 2005 completion of enrollment in the PRECISE trial and our activities,and the timing of those activities to prepare CINTREDEKIN BESUDOTOX forcommercialization in the event it is approved. Accordingly, the mix of expenseshas shifted reflecting our transition toward a fully integrated biopharmaceuticalcompany preparing for the potential commercial launch of its first product.

Research and development, or R&D, expenses were$4.3 million in the three months ended September 30, 2006, a decrease of $4.2million versus the same period in 2005. The reduction in 2006 R&D spendingwas primarily due to the completion of enrollment in the PRECISE trial inDecember 2005 combined with recent headcount reductions.

Selling, general, and administrative, or SG&A,expenses were $3.7 million and $2.4 million for the three month periods endedSeptember 30, 2006 and 2005, respectively, with the increase due primarily toadvancement of our commercialization preparations for CINTREDEKIN BESUDOTOX andto $0.3 million in 2006 stock-based compensation expense due to our January 1,2006 adoption of SFAS 123(R).

We recorded a benefit of $0.1 million in the threemonths ended September 30, 2006 related primarily to the impact of a decreasein our stock price on the estimated fair value of derivative financialinstruments, principally stock options previously granted to non-employeeconsultants.

Employee severance, lease and fixed asset write-offsrelated to August 2006 organizational changes and the July consolidation of ourfacilities resulted in a $0.7 million charge in the three months endedSeptember 30, 2006.

We generated interest income on cash and investmentsof $0.6 million and $0.4 million for the three months ended September 30, 2006and 2005, respectively. The increase in interest income during the 2006 periodwas primarily due to an increase in average cash and short-term investmentbalances as a result of our January 2006 stock offering and to higher 2006interest rates on our short-term investments.

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**Results ofOperations — Nine months Ended September 30, 2006 vs. Nine months EndedSeptember 30, 2005.**

The sole source of product revenue in both the 2006and 2005 year-to-date periods was from sales of NeoPhectinTM and NeoPhectin-ATTM.During the nine month period ended September 30, 2005, we also recognized $0.5million in revenue from NeoPhectinTM collaboration fees.

Generally, our results of operations for the ninemonths ended September 30, 2006 reflect the benefit of our recent costrationalization initiative, the December 2005 completion of enrollment in thePRECISE trial and our activities, and the timing of those activities, toprepare CINTREDEKIN BESUDOTOX for commercialization in the event it isapproved. Accordingly, the mix of expenses has shifted reflecting ourtransition toward a fully integrated biopharmaceutical company preparing forthe potential commercial launch of its first product.

R&D expense for the nine months ended September30, 2006 decreased by $8.4 million as compared to the same period in 2005 dueprimarily to the December 2005 completion of patient enrollment in the PRECISEtrial and to 2006 reprioritization of R&D spending and resulting headcountreductions.

SG&A expenses increased $2.1 million, to $10.8million, in the nine months ended September 30, 2006 due primarily topreparation of commercialization efforts for CINTREDEKIN BESUDOTOX and to $1.0million in stock-based compensation expense resulting from our adoption of SFAS123(R) in the first quarter of 2006, partially offset by $0.5 million inexpenses in the 2005 period related to our licensing of CINTREDEKIN BESUDOTOXrights in Japan to Nippon.

We recorded a $1.3 million benefit due primarily tothe impact of a decline in our stock price on the estimated fair value ofderivative financial instruments, relating to stock options previously grantedto non-employee consultants, following our 2006 adoption of SFAS No. 123(R).

Employee severance, lease and fixed asset write-offsrelated to the 2006 organizational changes and the July 2006 consolidation ofour facilities resulted in a $1.7 million charge in the nine months endedSeptember 30, 2006.

On May 16, 2005, we accepted $2.5 million as paymentin full for all outstanding principal and interest due and owing on apromissory note that we had previously determined to be impaired. As a resultof the payment, we recorded a $2.5 million benefit as Recovery of NoteReceivable during the nine months ended September 30, 2005.

The Company generated interest income on cash andinvestments of $2.0 million and $1.2 million in the nine months ended September30, 2006 and 2005, respectively. The 2006 increase in interest income wasprimarily due to an increase in average cash and short-term investment balancesas a result of our public stock offering completed in January 2006 and tohigher short-term interest rates in 2006 than in 2005.

**Liquidity andCapital Resources**

Our primary source of cash has been proceeds fromissuance of our common stock.

As of September 30, 2006, we had $3.0 million incash and cash equivalents and $42.2 million in short-term investments, consistingsolely of auction rate certificates, which we believe provide us liquiditycharacteristics very similar to cash equivalents.

We currently believe that our cash, cash equivalentsand short-term investments on hand at September 30, 2006 are sufficient to fundour currently projected level of activities into 2008. Our primary use of cashover the next 12-24 months is expected to be to fund advancement of our clinical,regulatory and commercial efforts and our NeoLipid® clinical and pre-clinicalresearch and development efforts. The most significant expenses are expected torelate to a possible CINTREDEKIN BESUDOTOX BLA submission and to establishmentof a commercial CINTREDEKIN BESUDOTOX infrastructure and capability.

We may seek to meet future funding requirementsthrough public or private offerings of securities or with collaborative orother development or licensing arrangements with corporate partners. Additionalfinancing may not be available when needed or on terms acceptable to us, if atall. If adequate financing is not available, we may be required to delay, scaleback, or eliminate certain of our research and development programs, relinquishrights to certain of our technologies, drugs or products, or license ourproducts or technologies to third parties that we would otherwise seek todevelop ourselves.

We have no exposure to off-balance sheet arrangements,no special purpose entities, or activities that include non-exchange-tradedcontracts accounted for at fair value.

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**Outlook**

The Company currently projects a net loss forfull-year 2006 in a range around $35 million, or approximately $1.25 per share.The Company estimates that the 2006 projected net loss will result in cash usedin operations of less than $34 million with cash and short-term investments onhand at December 31, 2006 expected to approximate $35 million. Theseprojections reflect both the ongoing benefit of recent cost initiatives and theCompany’s anticipation of increased fourth quarter 2006 spending for activitiesaround BLA preparation and commercial and clinical development activities. NEOPHARMbelieves that cash and short-term investments on hand at September 30, 2006 aresufficient to fund the Company’s activities into 2008 at currently projectedlevels of activity.

**CriticalAccounting Policies**

In preparing our financial statements in conformitywith U.S. generally accepted accounting principles, or GAAP, we must make avariety of decisions and estimates that impact reported results and relateddisclosures. Such decisions include the selection of the appropriate accountingprinciples to be applied, the assumptions on which our accounting estimates arebased, and the consistent application of those accounting principles. Due tothe industry in which we operate and the nature of our business, the followingaccounting policies are those that we believe are most important to theportrayal of our financial condition and results and that require the mostdifficult, subjective or complex judgments, often as a result of the need tomake estimates about the effect of matters that are inherently uncertain.

*IncomeTaxes*

In assessing the realizability of deferred tax assets,management considers whether it is more likely than not that some portion orall of the deferred tax assets will not be realized. The ultimate realizationof deferred tax assets is dependent upon the generation of future taxableincome during the periods in which those temporary differences becomedeductible. Management considers the scheduled reversal of deferred taxliabilities, projected future taxable income, and tax planning strategies inmaking this assessment. Significant judgments are required to estimate thegeneration of future taxable income and the timing of the reversal of deferredtax liabilities.

*Contingencies*

To properly account for and provide disclosure of losscontingencies, management must apply judgment in determining whether a losscontingency is: probable, reasonably possible, or remote. In instances wheremanagement has determined that a loss contingency is probable, it must make useof estimates to determine the amount of probable loss. Management must applyjudgment in determining whether or not it can make a reasonable estimate.Management must also apply judgment in determining whether or not disclosure ofloss contingencies that have been accrued should be made for the consolidatedfinancial statements not to be misleading.

*Stock-BasedCompensation*

The Company accounts for stock-based compensation inaccordance with SFAS No. 123R, *Share-BasedPayment*. Under the fair value recognition provisions of thisstatement, we measure stock-based compensation cost at the grant date basedupon the fair value of the award and recognize the cost of awards that areexpected to ultimately vest as expense over the requisite service period.Management judgment and the use of estimates are required in determining theinputs to an option pricing model used to estimate fair value of stock-basedawards. Management judgment and the use of estimates are also required inestimating the number of stock-based awards that are will ultimately vest.Additionally, management judgment and the use of estimates may be required indetermining the requisite service period over which to recognize thecompensation cost as expense.

*RevenueRecognition*

The Company follows the provisions as set forth bycurrent accounting rules, which primarily include Staff Accounting Bulletin (“SAB”)104, *Revenue Recognition,*andEmerging Issues Task Force (“EITF”) No. 00-21, *Accounting for 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.

The Company provides for general rights of return ofproducts sold to its distributors. Appropriately determining revenuerecognition 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 a reasonable estimate of the level ofreturns. Making such a determination requires the use of significant judgment.Management has determined that given the limited sales history of NeoPhectinTM,the Company is unable to develop a reasonable estimate of the level of returns.Accordingly, the Company is currently recognizing

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revenue for productsshipped to its distributor upon the expiration of the right of return, which occursupon the earlier of the shipment by the distributor to an end user or,depending on the distributor, 60 to 180 days.

The Company has entered in collaboration and licenseagreements with third parties that contain multiple deliverables. Under theprovisions of EITF 00-21, a determination must be made on each contract as towhether a deliverable constitutes a separate unit of accounting. The amount ofrevenue to be recognized is based on the fair value for each unit of accountingwithin the arrangement. Management’s judgment is required to determine, basedupon the facts and circumstances of each arrangement, whether or not eachdeliverable has standalone value and whether or not there exists a sufficientlevel of objective and reliable evidence of fair value of the undelivereditems. Additionally, units of accounting may be delivered over an indeterminateperiod of time. Management judgment is required to estimate the period overwhich recognition of allocated revenue occurs.

**Item 3 —Quantitative and Qualitative Disclosures about Market Risk**

As of September 30, 2006, we were exposed to marketrisks, limited primarily to the impact of changes in U.S. interest rates on ourcash and short-term investments. As of September 30, 2006, we held total cashand cash equivalents of $3.0 million and short-term investments in auction ratecertificates of $42.2 million. All cash equivalents have a maturity less than90 days. Declines in future interest rates would reduce interest income onour investments. Based upon our balance of cash, cash equivalents andshort-term investments at September 30, 2006, a 1.0% decline in interest rateswould decrease our annual interest income by approximately $0.5 million.

**Item 4 — Controlsand Procedures**

As of September 30, 2006, we carried out anevaluation, under the supervision and with the participation of our management,including our Chief Executive Officer and Chief Financial Officer, of theeffectiveness of the design and operation of our disclosure controls andprocedures. Based on that evaluation, our management, including the ChiefExecutive Officer and Chief Financial Officer, have concluded, as a result ofthe material weakness in internal control over financial reporting whichimpacted our first-quarter results and as further discussed below, ourdisclosure controls and procedures were not effective to ensure thatinformation required to be disclosed by us in the reports we file or submitunder the Exchange Act is recorded, processed, summarized, accumulated,communicated and reported, within the time periods specified in the Securitiesand Exchange Commission’s rules and forms.

In May 2006, management concluded that a controldeficiency with respect to the review and verification of the accuracy of thecalculation estimating the fair value of non-employee stock options in thefirst quarter of 2006 constituted a material weakness in internal control overfinancial reporting. A material weakness is a control deficiency, orcombination of control deficiencies, that results in more than a remotelikelihood that a material misstatement of the annual or interim financialstatements will not be prevented or detected. This control deficiency resultedin an adjustment to the unaudited interim condensed consolidated financialstatements for the quarter ended March 31, 2006 affecting derivative financialinstruments and the change in fair value of derivative financial instruments.

Management has revised its policies and procedureswith respect to its controls over the review and verification of the accuracyof the calculation estimating the fair value of non-employee stock options toensure that all reasonable steps have been taken to correct this materialweakness. As part of the remediation process, additional reviews and controlswere implemented by management over the review and verification of the accuracyof the calculation estimating the fair value of non-employee stock options. Thedeficiency will not be considered remediated until the new internal controlsare operational for a period of time and are tested and management hasconcluded that the controls are operating effectively. Until it is remediated,the identified control deficiency could result in a misstatement in thederivative financial instruments and the change in fair value of derivativefinancial instruments balances that would not be prevented or detected.

Procedures were undertaken enabling management toconclude that reasonable assurance exists regarding the reliability offinancial reporting and of the preparation of the condensed consolidatedfinancial statements contained in this filing. Accordingly, management believesthat the condensed consolidated financial statements included in this Form 10-Qfairly present, in all material respects, the Company’s financial position,results of operations and cash flows for the periods presented.

There have been no significant changes in our internalcontrol over financial reporting that occurred during the three months endedSeptember 30, 2006, other than the ongoing controls established to remediatethe identified first-quarter material weakness described above, that havematerially affected, or are reasonably likely to materially affect, ourinternal control over financial reporting.

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**PART II - OTHERINFORMATION**

**Item 1 - LegalProceedings**

NeoPharm, Inc. andcertain of our current and former officers and directors have been named in aconsolidated amended complaint, which alleges various violations of the federalsecurities laws in connection with our public statements regarding our LEP drugproduct candidate during the period from October 31, 2001 throughApril 19, 2002. On November 4, 2002, we moved to have the complaintdismissed. Our motion to dismiss was granted in part and denied in part inFebruary 2003. In November 2004, the plaintiffs filed a motion toamend and a motion for summary adjudication. The motion to amend seeks toinclude certain pre-class period statements in the complaint. The motion for summaryadjudication asks the Court to rule that certain statements made in anarbitration award regarding the LEP drug product candidate be deemed factsestablished in this proceeding. We have filed oppositions to both motions onwhich the Court has not yet ruled. No trial date has been set and discovery isongoing. We intend to vigorously defend each and every claim in the complaint.Management is unable to reasonably or accurately estimate the potential outcomeor range of possibilities, if any. In addition, we believe that the Company’sinsurance coverage would mitigate the financial impact of any potential loss.

On March 26, 2004,we received a letter from the United States Securities and Exchange Commission,or SEC, stating that the SEC was initiating a formal investigation of theCompany. The SEC stated in its letter that it had made no determination of anyviolation of law by the Company or any individual at this time. We have fullycooperated with the SEC and believe the investigation is an outgrowth of ourarbitration regarding development of LEP. We cannot ascertain or predict withcertainty the eventual outcome of the investigation, and are therefore unableto determine whether the results of the investigation may have a materialadverse impact on our results of operations or financial position.

We are from time to timesubject to claims and litigation arising in the ordinary course of business. Weintend to defend vigorously any such litigation that may arise under alldefenses that would be available to us. In the opinion of management, theultimate outcome of those proceedings of which management is aware, even ifadverse to us, will not have a material adverse effect on our consolidatedfinancial position or results of operations. While we maintain insurance tocover the use of our drug product candidates in clinical trials, we do notpresently maintain insurance covering the potential commercial use of our drugproduct candidates and there is no assurance that we will be able to obtain ormaintain such insurance on acceptable terms.

**Item 1A. RiskFactors**

You should carefullyconsider the following risk factors, in addition to the other information setforth in this document as well as other information contained in the periodicreports we file with the SEC. Each of these risk factors could adversely affectour business, operating results and financial condition, as well as the valueof an investment in our common stock.

**If we are unableto develop, obtain regulatory approvals for, and then market our drug productcandidates, our business would be harmed.**

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

We currently have threedrug product candidates in various stages of clinical development, havingdecided, based on our review of clinical and commercial data for LE-rafAON, notto pursue further development of that drug product candidate at this time. Eachcurrent drug product candidate is the subject of an effective Investigation NewDrug application, or IND, that we filed with FDA. The protocols for anyclinical trials we perform under these INDs must have institutional reviewboard, or IRB, approval, and the trials must comply with the FDA’s goodclinical practices, or GCP, and other regulations. There is no assurance thatthe clinical trials we may seek to conduct under these INDs will obtain IRBapproval. There is also no assurance that FDA will allow us to continue theclinical trials that we have begun. FDA may suspend a clinical trial at anytime if the agency believes that the patients participating in the study are orwill be exposed to unacceptable health risks. FDA may also terminate an IND andrequire the sponsor to end all clinical trials under that IND, if it findsdeficiencies in the IND or in the conduct of a trial under the IND. An IRB alsomay suspend or terminate a clinical trial. Some of our clinical trials areconducted in foreign countries, and the regulatory authorities of thosecountries have comparable authority to suspend and terminate clinical trials.Suspension or termination of the clinical trials of our drug product candidatescould substantially delay or even prevent regulatory approval of the drugproduct candidates. There is no guarantee that clinical studies, if performed,will demonstrate the safety and efficacy of any drug product candidate we havein development.

Sales of our drug productcandidates will be subject to pre-market approval requirements in the UnitedStates and in other countries. These requirements vary widely from country tocountry. We cannot assure you that we will receive approval to market any ofour drug product candidates in any country, or that any approval we obtain willbe on commercially viable terms. We have yet

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to submit an applicationfor marketing approval for any of the drug product candidates we currently haveunder development. We cannot predict with certainty if or when we might submitany of these drug product candidates for regulatory review. We cannot assureyou that once we submit a drug product candidate for review, the FDA or anyother regulatory agency will approve that product on a timely basis or at all.

Approval of our drugproduct candidates in the United States or a foreign country may depend on ouragreement to perform burdensome and expensive post-marketing studies or ouragreement to a burdensome risk management plan that could interfere withphysician and patient acceptance of our product. We cannot assure you that wewill agree to perform such additional studies or to accept such a riskmanagement plan. If we agree to perform post-market studies and then fail toconduct those studies with due diligence, or if those studies fail to verifythe product’s clinical benefit, the FDA may withdraw its approval of theproduct. The FDA may also withdraw its approval of the product if itdetermines, based on other information, that the product does not present anacceptable balance of benefits and risks

If the FDA or a foreignregulatory authority approves one of our drug product candidates, we will needto manufacture, or contract with third parties to manufacture, a sufficientvolume of that product to meet market demand. This will require accurateforecasting of market demand. There is no guarantee that we will accuratelyforecast the market demand for any of our drug product candidates or that therewill be any market demand. There is also no assurance that we will be able tosuccessfully manufacture, or find a third party to manufacture, adequatequantities of any of our drug product candidates to meet any market demand.

Our most advanced drugproduct candidate is CINTREDEKIN BESUDOTOX (IL13-PE38QQR), which we believe haspotential to be used as a treatment for malignant glioma. InSeptember 1997, we exclusively licensed worldwide rights to CINTREDEKINBESUDOTOX from the National Institute of Health, or NIH, and FDA. Our Phase Iclinical trials to date involving this drug product candidate have enrolledapproximately 100 patients. On the basis of our preliminary Phase I clinicaltrial findings for this drug product candidate, we initiated the PRECISE trial,a pivotal Phase III multi-center, multi-national clinical trial that enrolled atotal of 294 patients, of whom, in accordance with the trial protocol,approximately 196 patients were randomly selected to receive CINTREDEKINBESUDOTOX. While a final efficacy analysis is currently expected early in 2007,there are no assurances that CINTREDEKIN BESUDOTOX will prove to be safe andeffective or receive regulatory approval for any indication.

We also have two otherdrug product candidates in clinical development for the treatment of variouscancers: LE-SN38 and LEP-ETU. We have initiated enrollment, currently ongoing,in a Phase II clinical trial for LE-SN38 and have completed two Phase Iclinical trials and we are currently planning a Phase III clinical trial forLEP-ETU. There are no assurances that any of these drug product candidates willproceed to the next phase of clinical development, or prove to be safe andeffective, or that any of them will receive regulatory approval for thetreatment of the indications which we may pursue.

Even if we receiveregulatory approval for one of our drug product candidates in the United Statesor a foreign country, there are no assurances that the product will prove to becommercially successful or profitable.

**We are highlydependent on achieving success in the clinical testing, manufacturing,regulatory approval, and commercialization of our most advanced drug productcandidate, CINTREDEKIN BESUDOTOX, which may never be approved for commercialuse. If we are unable to commercialize CINTREDEKIN BESUDOTOX, our ability togenerate revenues would be impaired and our business would be harmed.**

We have invested asignificant portion of our time and financial resources in the development ofCINTREDEKIN BESUDOTOX, and we anticipate that for the foreseeable future, ourpotential to achieve revenues from drug product sales will be dependent on itssuccessful clinical testing, regulatory approval in the United States, andsuccessful commercialization. Development, approval, and successfulcommercialization of new drug products is a highly uncertain process.

We may suffer significantsetbacks in our Phase III clinical trial of CINTREDEKIN BESUDOTOX, the PRECISEtrial, even after achieving potentially promising results in earlier clinicaltrials. In the fourth quarter of 2005, we completed enrollment in the PRECISEtrial for patients suffering from first recurrent glioblastoma multiformetumors. Patients in the PRECISE trial received treatment either with CINTREDEKINBESUDOTOX or with Gliadel® Wafers, a product currently approved to treat thisdisease. The primary endpoint of the study is to determine if there is astatistically significant overall patient survival difference between patientstreated with CINTREDEKIN BESUDOTOX and patients treated with Gliadel® Wafers.While the final efficacy analysis for the PRECISE Trial is currently expectedin early 2007, the results from this clinical trial may not demonstrate astatistically significant difference. If the results from the PRECISE trial donot demonstrate a statistically significant difference, the FDA could determinethat additional clinical trials are necessary, which could delay or evenprevent approval and commercialization.

Even if we conclude that theresults from our clinical trial demonstrate a statistically significantdifference, the FDA may not agree with us, for example, because it may evaluatethe data using a different method. The FDA could also conclude that theclinical trial results are not clinically meaningful, that there were humanerrors in the conduct of the clinical trial, or that for some other reason theclinical trial results are inadequate to support approval of CINTREDEKINBESUDOTOX. Even if the FDA agrees that the results from the PRECISE trialdemonstrate a statistically significant difference, the FDA may requirestatistically significant results in a second Phase III trial before it willapprove CINTREDEKIN BESUDOTOX. Even if we believe that we have submitted all ofthe data and information necessary to satisfy FDA requirements for approval ofthe BLA, there is a risk that the FDA will require additional

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data and information thatwe are unable to provide. Finally, even if the results are statisticallysignificant, adverse safety findings in the PRECISE trial could delay orprevent regulatory approval.

Even if the results ofthe PRECISE trial are statistically significant, prior to commercialization ofCINTREDEKIN BESUDOTOX in the United States, we will have to submit, and the FDAwill have to approve, a Biologics License Application, or BLA, for CINTREDEKINBESUDOTOX. A BLA is a lengthy, complex submission to the FDA, which must complyin format and content with elaborate and detailed FDA requirements. We havenever submitted a BLA before. The FDA may refuse to accept a BLA for filing ifit is incomplete. The length and outcome of the FDA’s review of the BLA isuncertain. The FDA’s approval is contingent on many factors, including itsevaluation of our preclinical and clinical trial results, its assessment of themanufacturing process we propose as well as the process controls, its review ofour drug substance specifications and proposed analytical procedures, the datawe provide on the drug’s stability, and its inspection of the facilities whereCINTREDEKIN BESUDOTOX is manufactured. The FDA may ask an advisory committeefor its recommendations on the BLA, and we cannot predict the outcome of theadvisory committee process.

We rely heavily on thirdparties with respect to, among other things, the production and testing ofCINTREDEKIN BESUDOTOX. We have engaged several third parties to performservices, including: PPD Development, LP, or PPD, to oversee the PRECISE trial;Advance Clinical Services to oversee data management; and Diosynth RTP, Inc.,or Diosynth, to manufacture drug substance. The failure of any of these thirdparties to fulfill their contractual obligations or otherwise perform key tasksappropriately or in a timely manner, or their failure to comply with applicablegovernment regulations, could require us to seek alternative third parties tofulfill these functions and could significantly slow the filing of the BLA,preclude its timely approval or even preclude its approval altogether. Forexample, as part of the work that will be required to support a BLA forCINTREDEKIN BESUDOTOX, we have contracted with Diosynth to assist in thedevelopment of manufacturing processes in connection with the scale-up ofmanufacturing of CINTREDEKIN BESUDOTOX from preclinical testing and clinicaldevelopment to commercial-scale operations, including the preparation andfiling of documents for process development, method development, and processvalidation. These programs must be developed in compliance with applicablegovernment regulations, including the FDA’s current good manufacturingpractice, or cGMP, requirements for biological products, which are extremelycomplex and require considerable time, resources, and ongoing investment tocomply with. Manufacturing establishments, including contract manufacturerssuch as Diosynth, are subject to inspections by the FDA for compliance withcGMP. Any errors or omissions in completing the process or method developmentor process validation, if not promptly corrected by us and/or Diosynth, couldsignificantly delay our BLA filing. If FDA approval is delayed, or the FDArequires additional clinical testing or other information, or the FDA does notapprove the BLA, our ability to achieve revenues from product sales may beimpaired and our stock price would be materially and adversely affected.

Even though the FDA hasawarded orphan drug designation to CINTREDEKIN BESUDOTOX, a competitor couldobtain orphan drug designation for the same drug for the same indication andcomplete its clinical trials before we complete ours. The FDA could approvethat competitor’s product first and give it seven years of market exclusivity.In this case, we might not be allowed to market our product in the UnitedStates for seven years. This would have a material adverse effect on ourbusiness. The law would permit the FDA to approve our product during the sevenyears if certain conditions were met, but there is no assurance we couldsatisfy these conditions. We might be able to market the product outside theUnited States, if certain conditions were met, but there is no guarantee thatwe would be able to satisfy those conditions. The export process can becomplex, and there are no assurances that export would be permitted or thatanother country would accept the product. Even if the FDA approves CINTREDEKINBESUDOTOX as an orphan drug and awards it seven years of exclusivity, the lawpermits the FDA, in certain situations, to approve a competitor’s product. Thiscould have a material adverse effect on the commercial success of our product.

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

We do not have theinternal infrastructure to conduct clinical trial management or certain otheraspects of clinical testing ourselves. On September 30, 2006, we had 66full-time employees. We therefore rely on third parties to perform a variety offunctions with respect to the clinical development of our drug productcandidates, including clinical trial management and manufacturing of our drugproduct candidates. If we develop additional drug product candidates withcommercial potential, we will have to either hire additional personnel skilledin clinical testing or engage third parties to perform such services.

We have engaged PPD tooversee our PRECISE trial for CINTREDEKIN BESUDOTOX. Our agreement with PPDobligates us to compensate PPD on a monthly basis and make milestone paymentsas the trial progresses. We have engaged other companies on a per study basisfor assistance in the management and testing for our Phase I and Phase IIclinical trials. To oversee data management in our clinical trials we havecontracted, on a per study basis, with Advanced Clinical Services. To conductour large animal testing, we have engaged, again on a per study basis, SouthernResearch Institute.

While we have beensatisfied with the performance of these various organizations, we do notdirectly control them. We depend on these organizations to apply theappropriate expertise and resources to expeditiously and competently performthe services for which they have been retained. If any of these third partieswith whom we contract breaches its agreement with us or fails to comply

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with an applicablegovernment regulation, we might be required to find a satisfactory alternativeservice provider. In addition, our drug development efforts could be delayed orimpaired. We are aware of other entities that could offer similar services tothose offered by each of PPD Development and Advanced Clinical Services andother entities offering services similar to those provided by Southern ResearchInstitute. We frequently change vendors and consider such items as price,vendor capabilities to meet our needs, and ease of transition in choosing newvendors.

In order to commercializeour drug product candidates successfully, we, or third parties with whom wecontract, must be able to manufacture products in commercial quantities incompliance with the FDA’s cGMP requirements at acceptable costs and in a timelymanner. We do not currently have commercial scale cGMP compliant manufacturingcapacity for any of the drug product candidates we are developing. Currently,all of our liposome compounds are produced at the Center for Advanced DrugDevelopment, the center, which is affiliated with the University of IowaPharmacy School. The Center has indicated that it is currently able to meet ourneeds for research and clinical trials, but we cannot be sure that it will beable to meet our needs in a timely manner or on a cost-effective basis in thefuture. If the Center were unable to meet our needs in the future, we cannot besure that suitable alternatives could be found in a timely manner, if at all.

We have an agreement withDiosynth RTP, Inc., or Diosynth, pursuant to which Diosynth producedCINTREDEKIN BESUDOTOX for our Phase III PRECISE clinical trial, ismanufacturing drug product substance for a potential regulatory submission andwould supply our initial commercial requirements, if CINTREDEKIN BESUDOTOX iseventually approved.  In addition, wewill need to contract with a suitable third party to provide fill and finishservices for CINTREDEKIN BESUDOTOX. While we are currently negotiating with third parties to provide theseservices, we have not as of yet entered into a definitive agreement.

If either the Center forAdvanced Drug Development or Diosynth were to breach its agreement with us orfail to comply with any applicable governmental requirement or fail to deliverdrug product substance in a timely manner, or we fail to secure third partyservices for the filling and finishing of our drug product, such actions couldsignificantly delay or impair our drug development and/or BLA or submissionefforts and we might be required to find satisfactory alternative serviceproviders. Although we are currently aware of alternative manufacturers andservice providers who might be able to supply us with our requirements for ourdrug product candidates, having to utilize alternative providers would resultin significant delays in the development, filing for approval, and potentialapproval by the FDA of our drug product candidates, particularly forCINTREDEKIN BESUDOTOX.

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

**Because all of ourdrug product candidates are in pre-clinical or clinical development, there is ahigh risk that further development and testing will demonstrate that our drugproduct candidates are not approvable or suitable for commercialization, whichcould cause our business to suffer.**

None of our drug productcandidates has received regulatory approval for commercial sale. Before we canobtain regulatory approval for the commercial sale of any of our drug productcandidates, we must demonstrate through pre-clinical testing and clinicaltrials that the drug product candidate is safe and effective. Conductingpre-clinical and clinical testing is a lengthy, expensive, and uncertainprocess and may take several years or more. Success in pre-clinical testingdoes not assure success in clinical trials, and positive results in early phaseclinical trials do not assure a positive outcome in later trials.

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

·       ourinability to manufacture, or secure third party sources to manufacture, sufficientquantities of drug compounds for use in clinical trials;

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

·       ourinability to locate, recruit, and qualify a sufficient number of patients forour trials;

·       negativeor ambiguous results regarding the effectiveness of the drug product candidate;

·       undesirableside effects that delay or extend the trials, or other unforeseen orundesirable safety issues that make the drug product candidate not medically orcommercially viable;

·       ourfailure, or the failure of any third party with whom we contract, to complyfully with the investigational new drug

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regulations and other regulations applicable toclinical trials;

·       delays,suspension, or termination of trials imposed by us or an independentinstitutional review board for a clinical trial site, or a clinical hold placedupon the trial by the FDA;

·       regulatorydelays or other regulatory actions, including changes in regulatoryrequirements;

·       ourinability to adequately follow patients after treatment; and

·       delaysin importing or exporting clinical trial materials.

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

**Our business is subjectto extensive governmental regulation, and failure to comply with thoseregulations can lead to unanticipated delays in product development andapproval and can prevent commercialization.**

The FDA regulates theresearch, development, and testing of our drug product candidates. If any ofour drug product candidates is approved for marketing and introduced into themarket, the FDA will continue to regulate the manufacturing, labeling,distribution, marketing, and advertising activities of that product. Publichealth authorities in foreign countries have comparable authority. Compliancewith these requirements before and after approval is expensive and timeconsuming. Failure to comply can lead to regulatory action that would have anegative impact on our business.

In order to market a newtherapeutic product in the United States, we must prove that the product issafe and effective for its intended uses and that the product is manufacturedin compliance with current Good Manufacturing Practices, or cGMP. Completingthe pre-clinical and clinical testing necessary to prove the safety andeffectiveness of a new therapeutic product, and establishing the capability tocomply with cGMP, can take many years, be very costly, and still beunsuccessful. The results of pre-clinical testing and Phase I and II studiesare not necessarily indicative of the results in larger patient populations, asevaluated in Phase III studies.

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

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

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

·       itinterprets the data from our pre-clinical testing and clinical trialsdifferently than we do;

·       itdetermines that our manufacturing processes or facilities, or the processes orfacilities of third parties involved in the manufacture of our drug productcandidates, do not comply with cGMP;

·       itchanges its approval policies or adopts new regulations; or

·       Congressamends the Food, Drug and Cosmetics Act, the Public Health Service Act, orother applicable laws.

The process of obtainingapprovals in foreign countries is subject to uncertainty, delay, and failurefor similar reasons.

In addition, the FDA (andforeign regulatory authorities) may approve a drug product candidate for fewerthan all the indications requested or require that the drug product be labeledin a way that differs from our proposed labeling. Even if the FDA (or a foreignregulatory authority) approves one of our drug product candidates, it mayrequire that we perform burdensome post-marketing studies and it may imposeother burdensome requirements, including the requirement that we institute andmaintain a special risk management plan to monitor and manage potential safetyissues. These requirements could reduce or eliminate the drug product’s marketpotential.

A drug product and itsmanufacturer are subject to strict regulation after product approval by the FDAand comparable foreign authorities. The FDA regulates manufacturing, labeling,distribution, and promotional activities after product approval, as docomparable foreign regulatory agencies. We must also report certain adverseevents and manufacturing issues involving our drug products to these agencies.Application holders must submit new or supplemental applications and obtain FDAapproval for certain

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changes to the approvedproduct, product labeling or manufacturing process. In addition to FDArequirements, sales, marketing and scientific/education grant programs mustcomply with the anti-fraud and abuse provision of the Social Security Act, theFalse Claims Act and similar state laws, each as amended. Pricing and rebateprograms must comply with the Medicaid rebate requirements of the OmnibusBudget Reconciliation Act of 1990, and the Veteran’s Health Care Act of 1992,each as amended. If products are made available to authorized users of theFederal Supply Schedule of the General Services Administration, additional lawsand requirements apply. All of these activities are also potentially subject tofederal and state consumer protection and unfair competition laws.

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

Previously unidentifiedadverse events or an increased frequency of adverse events that may occurpost-approval could result in the FDA, or other agencies, requiring us toconduct further clinical research, which could be expensive and could lead tonew and unfavorable information about the safety or the effectiveness of ourproduct. New safety or effectiveness information after approval can result in achange in the labeling of our drug products, new or more extensive distributionrestrictions, a new or expanded risk management program, product recalls,withdrawal of the drug product from the market, or withdrawal of productapproval, any of which could materially affect the commercial success of theproduct. Any unforeseen problems with one of our drug product candidates afterapproval could preclude successful commercialization of that product and harmour business and stock price.

**We havea history of operating losses, expect to continue to incur losses for theforeseeable future, and may never be profitable.**

We have a limitedoperating history, and our operations consist primarily of the development ofour drug product candidates and the sponsorship of research and clinicaltrials. Over the past three fiscal years ended December 31, 2005, we haveincurred aggregate net losses of $149.1 million. We expect to incuradditional losses and, as our development and commercialization efforts andclinical testing activities continue, our losses may increase. We also expectto experience negative cash flows for the foreseeable future as we fund ourlosses and capital expenditures. Our losses have adversely impacted, and willcontinue to adversely impact, our working capital, total assets andstockholders’ equity. To date, we have not sold or received approval to sellany drug product candidates, and it is possible that revenues from drug productsales will never be achieved. We have generated only very limited revenue fromlicense fees and sales of products based upon our NeoPhectinTM technology (a novel cationiccardiolipin liposome based technology), and it is expected that additionallicense revenue and/or revenue from sales of NeoPhectinTM products will continue to be of limited significance. Wecannot at this time predict when or if we will be able to develop other sourcesof revenue or when or if our operations will become profitable, even if we areable to commercialize some of our drug product candidates.

**Budgetconstraints may force us to delay our efforts to develop certain drug productcandidates in favor of developing others, which may prevent us fromcommercializing all drug product candidates as quickly as possible.**

Because we are a smallcompany with limited resources, and because research and development is anexpensive process, we must regularly assess the most efficient allocation ofour research and development budget. As a result, we may have to furtherprioritize development activities and may not be able to fully realize thevalue of some of our drug product candidates in a timely manner, as they willbe delayed in reaching the market, if at all. We recently completed areprioritization of the NeoLipid® program in an effort to substantiallydecrease our expenses, including a restructuring of our workforce and a reductionin research and development spending not related to our lead drug productcandidate, CINTREDEKIN BESUDOTOX. If we are not successful in maintaining theplanned level of spending, our efforts to commercialize CINTREDEKIN BESUDOTOXmay be delayed. Additionally, the reduction in spending on our other drugproduct candidates could delay our commercialization efforts and negativelyimpact our strategy to diversify our development risk across a broad portfolioof drug product candidates.

**Competitionin the biopharmaceutical field is intense and subject to rapid technologicalchange. Our principal competitors have substantially greater resources todevelop and market products that may be superior to ours.**

If we obtain regulatoryapproval for any of our drug product candidates, the extent to which theyachieve market acceptance will depend, in part, on competitive factors.Competition in our industry is intense, and it is increased by the rapid paceof technological development. Existing drug products or new drug productsdeveloped by our competitors may be more effective or have fewer side effects,or may be more effectively marketed and sold, than any that we may develop.Many of our principal competitors have substantially greater research anddevelopment capabilities and experience and greater manufacturing, marketing,financial, and managerial resources than we do. Competitive drug compounds mayrender our technology and drug product candidates obsolete or noncompetitiveprior to our recovery of research, development, or commercialization expensesincurred through sales of any of our drug product candidates. The FDA’s policyof granting “fast track” approval for cancer therapies may also expedite theregulatory approval of our competitors’ drug product candidates.

Each of the drug productcandidates currently in clinical development will face competition from drugproducts currently on the

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market or underdevelopment. The following table lists our current principal competitors andtheir products which compete with the listed drug product candidates wecurrently have under development:
| **Our drug  product candidate** | ** ** | **Principal competitor** | ** ** | **Competitor’s product** |
|---------------------------------|------------|--------------------------|------------|-------------------------------|
| CINTREDEKIN  BESUDOTOX          |       | MGI PHARMA, Inc.    |       | Gliadel® Wafer           |
| LEP-ETU                         |       | Bristol-Myers Squibb Co. |       | Taxol®(1)                |
| LE-SN38                         |       | Pfizer Inc.              |       | Camptosar®               |

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(1)             Thisproduct is currently off-patent and generics are available.

Additionally, other drugcompanies are currently conducting clinical trials, which are in variousstages, for numerous drug compounds that, if ultimately approved for marketing,could be competitive with our drug product candidates, including, but notlimited to, clinical trials involving drug compounds for the treatment ofglioblastoma multiforme which, if approved, could compete with CINTREDEKINBESUDOTOX, if it is eventually approved for the treatment of that disease.

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

**Ourstock price has been and is likely to continue to be volatile, and aninvestment in our common stock could decline in value.**

The stock market hasexperienced significant price and volume fluctuations, which often have beenunrelated to the operating performance of particular companies. In addition,the market price of our common stock has been highly volatile and is likely tocontinue to be so. For example, during the first nine months of 2006, themarket price of our common stock fluctuated between $4.32 and $12.67 per sharewhile during 2005, the market price of our common stock fluctuated between$15.47 and $7.16 per share.

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

·       thesuccess or failure of our clinical trials, including, but not limited to, thePRECISE trial involving our lead compound, CINTREDEKIN BESUDOTOX, or those ofour competitors;

·       ourability to prepare, file and obtain approval of a BLA for CINTREDEKIN BESUDOTOXin a timely manner;

·       announcementsof technological innovations or new drug products by us or our competitors;

·       litigation,including, but not limited to, current class action lawsuits and resolution ofthe ongoing SEC investigation of the Company;

·       actualor anticipated fluctuations in our financial results;

·       ourability to obtain financing, when needed;

·       economicconditions in the US and abroad;

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

·       adverseregulatory actions or decisions;

·       lossesof key management;

·       changinggovernmental regulations;

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

·       developmentsor disputes concerning patents or other proprietary rights;

·       productor patent litigation; and

·       publicconcern as to the safety of products developed by us.

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

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

**We willneed to raise additional capital in the future. If additional capital is notavailable, or can not be obtained on favorable terms, we may have to curtail orcease operations.**

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We estimate that as ofSeptember 30, 2006, our then existing cash reserves, should be sufficient tofinance our operations at current and projected levels of development andgeneral corporate activity into 2008. We can offer no assurance that we will beable to generate revenues from product sales in the near term or in the future,at a rate sufficient to fund our operations. Even though we were successful inraising additional capital in January 2006, we will need additional futurefinancing depending on a number of factors, including, but not limited to, thefollowing:

·       ourdegree of success in commercializing our drug product candidates;

·       therate of progress and cost of research and development and clinical trialactivities relating to our drug product candidates;

·       apossible obligation to pay damages arising from the ongoing consolidated classaction lawsuit or fines arising from the SEC investigation, to the extent thesepossible damages or fines exceed, or are not covered by, our insurance;

·       thecosts of preparing, filing and prosecuting patent applications, maintaining andenforcing our patent claims and other intellectual property rights andinvestigating and defending against infringement claims asserted against us byothers;

·       emergenceof competing technologies and other adverse market developments;

·       changesin or terminations of our existing licensing arrangements;

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

·       thecosts of acquiring or licensing new technology, products or businesses if wedesire to expand our product portfolio; and

·       thecost of manufacturing scale-up and development of marketing operations, if weundertake those activities.

Additional financing maynot be available when we need it or be on terms acceptable to us. If adequatefinancing is not available, we may be required to delay, scale-back, oreliminate certain of our research and development programs, to relinquish rightsto some of our technologies or products, or to grant licenses to third partiesto commercialize products or technologies that we would otherwise seek todevelop ourselves. We could also be required to cease operations. If additionalcapital is raised through the sale of equity, our stockholders’ ownershipinterest could be diluted and such securities may have rights, preferences, orprivileges superior to those of our other stockholders. The terms of any debtsecurities we may sell to raise additional capital may place restrictions onour operating activities. Failure to secure additional financing may cause usto delay or abandon some or all of our development programs.

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

All new drugs, includingour drug product candidates under development, are subject to extensive andrigorous regulation by the FDA and comparable foreign authorities. Theseregulations govern, among other things, the development, pre-clinical andclinical testing, manufacturing, labeling, storage, pre-market approval,advertising, promotion, sale, and distribution of our drug product candidates.We rely on third parties to perform a variety of functions, including researchand development, clinical trial management and testing, and manufacturing ofour drug product candidates. We currently obtain the necessary raw materialsfor our drug product candidates, as well as certain services, such as testing,from third parties. We currently contract with suppliers and service providersthat are required to comply with strict standards established by us. Certainsuppliers and service providers are required to follow Good LaboratoryPractices, or GLP, Good Clinical Practices, or GCP, and cGMP requirements andare subject to routine unannounced periodic inspections by the FDA and bycertain state and foreign regulatory agencies for compliance with thoserequirements and other applicable regulations. There can be no assurance thatthe FDA and other regulatory agencies will find the manufacturing process orfacilities or other operations of our suppliers and other service providers tobe in compliance with GLP, GCP, cGMP, or other applicable requirements.

While to our knowledgenone of our principal suppliers or service providers has been found to be outof compliance with GLP, GCP, cGMP, or other applicable requirements withrespect to the goods or services they provide to us, failure of any of ourprincipal third party suppliers or service providers to maintain satisfactorycompliance with applicable requirements could have a material adverse effect onour ability to develop, market, and distribute our drug product candidates inthe future and, in the most serious cases, could result in the issuance ofwarning letters, seizure or recall of drug products, criminal prosecution,civil penalties, or closure of such manufacturing facilities until complianceis achieved.

**We havelimited sales and marketing personnel and do not yet have distributionorganizations, processes or capabilities in place, which means we must eitherenter into agreements with third parties to provide such capabilities or wemust develop such capabilities ourselves.**

We currently have limitedinternal sales and marketing, and do not have distribution resources. If wereceive the required regulatory approvals, we could elect to market and sellour drug product candidates through distribution, co-marketing, co-promotion,

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or licensing arrangementswith third parties. If we elect to market our drug product candidates directly,significant additional expenditures and management resources will be requiredto develop an internal marketing or sales force. We have no historicalexperience in establishing or maintaining an effective sales or marketingeffort. If we decide to perform sales and marketing activities ourselves, wecould face a number of additional risks, including, but not limited to:

·       theinability to attract and retain a marketing or sales force with relevantpharmaceutical experience;

·       thecosts of establishing a marketing or sales force may not be recoverable ifproduct revenues are lower than expected; and

·       therecould be delays in product launch due to the time needed to develop and trainan effective marketing organization or sales force.

On the other hand, to theextent that we enter into arrangements with third parties for the marketing andsale of our drug product candidates, any economic benefit [i.e. MAY NOT BE INFORM OF “REVENUE”] we receive will depend primarily on the efforts of thesethird parties, and the resulting economic benefit received may be lower than ifwe marketed our drug products directly. In addition, we may not be successfulin entering into sales and distribution relationships with third parties and,even if we are successful, we may not control the amount and timing ofmarketing resources such third parties devote to our drug product candidates.

There can be no assurancethat we would be able to establish an effective marketing or sales force shouldwe choose to do so. The inability to successfully employ qualified marketingand sales personnel or to develop other sales and marketing capabilities throughthird parties would be harmful to our overall business operations.

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

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

**The SEChas initiated a formal investigation of the Company. We believe that thisinvestigation was initiated as a consequence of our arbitration proceeding, nowconcluded, involving Pharmacia’s development of LEP and LED and the classaction lawsuits involving our public statements regarding LEP.**

On March 26, 2004,we received a letter from the Securities and Exchange Commission stating thatthe SEC is conducting a formal investigation of the Company. The SEC stated inits letter that it had made no determination of any violation of law by theCompany or any individual at this time. Previously, this matter had been thesubject of an informal SEC inquiry. We have fully cooperated with the SEC. Webelieve the investigation is an outgrowth of the arbitration claim filed by theCompany against Pharmacia (now Pfizer) regarding the development of our LEP andLED drug product candidates, which was concluded in April 2004, and theongoing class action lawsuits which have been filed against us relating topublic statements regarding the development of LEP. We cannot predict withcertainty the direction the investigation will take or its ultimate outcome,and therefore are unable to determine whether the results of the investigationwill have a material adverse impact on our results of operations and financialposition.

**Ourlack of operating experience may cause us difficulty in managing our growth.**

We have no historicalexperience in selling pharmaceutical or other products or in manufacturing orprocuring drug products in commercial quantities in compliance with FDA rulesand we have only limited experience in negotiating, establishing andmaintaining collaborative relationships and conducting later stage phases ofthe regulatory approval process. Our ability to manage our growth, if any, willpotentially require us to maintain, improve and expand our management and ouroperational and financial systems and controls. If our management is unable tomanage growth effectively, our business and financial condition would beadversely affected. In addition, if rapid growth occurs, it may strain ouroperational, managerial and financial resources, which are limited.

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

Our business depends onour technology, which is based in part on patents and patent applicationslicensed from third parties.

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Those third-party licenseagreements impose obligations on us, such as payment obligations andobligations to diligently pursue development of commercial products under thelicensed rights. Our license agreement regarding CINTREDEKIN BESUDOTOX requiresus to engage in clinical trials of the compound in patients with renal cellcarcinoma. Previous trials demonstrated that CINTREDEKIN BESUDOTOX is toxic inthose patients. However, we have instead focused on developing this compoundfor treating patients with glioblastoma multiforme. We have informed thegovernmental agency from which we licensed these patents of this change, and wereceived no objections to it.

Because of our dependenceon intellectual property rights licensed to us by third parties, any adversedevelopment in our relationship with these licensors, including a disputeregarding our rights under the agreements or the grant of rights by ourlicensors to others, could materially and adversely affect our right tocommercialize the products we are developing or preclude others fromcommercializing these products.

If a licensor believesthat we have failed to meet our obligations under a license agreement, thelicensor could seek to limit or terminate our licensed rights, which could leadto costly and time-consuming litigation and, potentially, a loss of thelicensed rights. During the period of any such litigation, our ability to carryout the development and commercialization of potential products could besignificantly and negatively affected. If our licensed rights were restrictedor ultimately lost, our ability to continue our business based on the affectedtechnology platform would be adversely affected.

We depend in large parton our licensors to have and maintain the patent rights licensed to us. Whereour licensors cannot license technologies to us to the exclusion of thirdparties, our competitive position could be impaired. In this regard, weunderstand that co-rights to the technologies exclusively licensed to us by NIHrelating to CINTREDEKIN BESUDOTOX are claimed by one of the inventors, who hassubsequently entered into an agreement assigning such rights as he may have toa third party. We are in the process of determining the nature of his claimedrights and whether or not this assignment is valid.

We have been granted “orphandrug” status with respect to the use of CINTREDEKIN BESUDOTOX for malignantgliomas (a class of brain tumors which includes glioblastoma multiforme), andwe are thus potentially eligible to receive orphan drug exclusivity uponapproval. In order to receive orphan drug exclusivity, we must be the firstCINTREDEKIN BESUDOTOX product approved for malignant glioma. If we receiveorphan drug exclusivity, it would prevent the FDA for a period of seven yearsfrom approving another sponsor’s marketing application for the same drug forthe same indication, except that a subsequent applicant with the same drugcould be approved if it demonstrated its product were clinically superior toour product or if we were unable to manufacture sufficient supplies of product.If it were determined that we do not have exclusive rights to the technologylicensed to us by NIH, we might be unable to preclude third parties - during orafter any period of orphan drug exclusivity - from commercializing a drug basedon CINTREDEKIN BESUDOTOX for other indications. Competing CINTREDEKIN BESUDOTOXproducts, if suitable, could be prescribed by physicians for malignant glioma,even though not FDA-approved for that use. This could cause our business to suffer.Moreover, if it were determined that we do not have exclusive rights to thetechnology licensed to us by NIH, a third party might be able to develop aCINTREDEKIN BESUDOTOX based drug for the treatment of malignant glioma. If thiscompetitor completed its clinical trials before we complete ours, the FDA couldapprove that competitor’s product first and give it seven years of marketexclusivity. In such a case, we might not be allowed to market our product inthe United States for seven years. Further, even if we receive seven years ofmarket exclusivity, other applicants could receive approval of compounds otherthan CINTREDEKIN BESUDOTOX for malignant glioma, which would compete with ourproduct. 

It should be noted that,even if it were determined at a future date that we do not have exclusivitywith respect to the patents and patent applications licensed from NIH, we havealso filed various additional patent applications related to the methods ofadministration and use of CINTREDEKIN BESUDOTOX which are not part of the NIHpatents. While we believe that patents that may eventually be granted underthese patent applications would provide us with additional exclusivity of usefor CINTREDEKIN BESUDOTOX, these patent applications are still pending, may notbe granted, and are subject to the risks described herein relating to patentsin general.

**If weare unable to adequately protect our proprietary technologies this could harmour competitive position and have a material adverse effect on our business.**

The success of ourbusiness depends, in part, on our ability to obtain patents and maintainadequate protection of our intellectual property for our proprietary technologyand products in the United States and other countries. The laws of some foreigncountries do not protect proprietary rights to the same extent as the laws ofthe United States, and many companies have encountered significant problems inprotecting their proprietary rights in these foreign countries. These problemscan be caused, for example, by a lack of rules and processes allowing formeaningful defense of intellectual property rights. If we do not adequatelyprotect our intellectual property, competitors may be able to use ourtechnologies and impair our competitive position, with the result that ourbusiness and operating results could be harmed.

The patent positions ofpharmaceutical companies, including our patent positions, are often uncertainand involve complex legal and factual questions. We will be able to protect ourproprietary rights from unauthorized use by third parties only to the extentthat our proprietary technologies are covered by valid and enforceable patentsor are effectively maintained as trade secrets. We apply for patents coveringour technologies and drug product

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candidates, as we deemappropriate. Currently, we either own or have obtained licenses to more than 50United States patents and patent applications relating to our technology,compounds, and drug product candidates, many of which have foreign counterpartseither as issued patents or pending patent applications. However, we may notobtain patents on all inventions for which we seek patents, and any patents weobtain may be challenged and may be narrowed in scope or extinguished as aresult of such challenges. Our existing patents and any future patents weobtain may not be sufficiently broad to prevent others from practicing ourtechnologies or from developing competing products. Others may independentlydevelop similar or alternative technologies or design around our patentedtechnologies or drug product candidates. These companies would then be able todevelop, manufacture, and sell products, which compete directly with our drugproduct candidates. In that case, our revenues and operating results would decline.

We rely upon trade secretprotection for certain of our confidential information, including certain ofour trade secrets, know-how, technology advances and processes. While we havetaken measures to protect our confidential information, and to date have notexperienced any difficulties in maintaining the confidentiality of ourinformation, these measures may not provide adequate protection for our tradesecrets, know-how or other confidential information in the future. We seek toprotect our confidential information by entering into confidentialityagreements with employees, collaborators, and consultants. Nevertheless,employees, former employees, collaborators, or consultants may still discloseor misuse our confidential information, and we may not be able to meaningfullyprotect our trade secrets. In addition, others may independently developsubstantially equivalent information or techniques or otherwise gain access toour trade secrets. Disclosure or misuse of our confidential information wouldharm our competitive position and could cause our revenues and operatingresults to decline.

**We maybe sued for infringing on the intellectual property rights of others.**

Our commercial successalso depends in part on ensuring that we do not infringe the patents orproprietary rights of third parties. The biotechnology industry has produced aproliferation of patents, and it is not always clear to industry participants,including us, which patents cover various types of products. The coverage ofpatents is subject to interpretation by the courts, and the interpretation isnot always uniform. While we have not been sued for infringing the intellectualproperty rights of others, there can be no assurance that the drug productcandidates that we have under development do not or will not infringe on thepatent or proprietary rights of others. Third parties may assert that we areemploying their proprietary technology without authorization. We know ofpatents issued to third parties relating to antisense and oligonucleotidetechnology, including patents about which such third parties have communicatedwith us suggesting possible infringement, but the claims of which we believe wedo not infringe or are invalid. Moreover, United States patent applicationsfiled in recent years are confidential for 18 months, while olderapplications are not published until the patent issues. Further, someapplications are kept secret during the entire length of their pendency byrequest of the applicant in special circumstances. As a result, there may bepatents of which we are unaware, and avoiding patent infringement may bedifficult. Patent holders sometimes send communications to a number ofcompanies in related fields, suggesting possible infringement, and we, like anumber of biotechnology companies, have received this type of communication. Ifwe are sued for patent infringement, we would need to demonstrate that weeither do not infringe the patent claims of the relevant patent and/or that thepatent claims are invalid, which we may not be able to do. Proving invalidity,in particular, is difficult since it requires a showing of clear and convincingevidence to overcome the presumption of validity enjoyed by issued patents.Parties making claims against us may be able to obtain injunctive or otherequitable relief that could effectively block our ability to further develop,commercialize and sell products, and such claims could result in the award ofsubstantial damages against us. In the event of a successful claim ofinfringement against us, we may be required to pay damages and obtain one ormore licenses from third parties. We may not be able to obtain these licensesat a reasonable cost, if at all. In that event, we could encounter delays inproduct introductions while we attempt to develop alternative methods orproducts or be required to cease commercializing affected products and ouroperating results would be harmed.

In the future, others mayfile patent applications covering technologies that we may wish to utilize withour proprietary technologies, or products that are similar to productsdeveloped with the use of our technologies. If these patent applications resultin issued patents and we wish to use the claimed technology, we would need toobtain a license from the third party, and this would increase our costs ofoperations and harm our operating results.

**We mayin the future be a party to patent litigation, which could be expensive anddivert our management’s attention.**

The field ofbiotechnology has been characterized by extensive litigation regarding patentsand other intellectual property rights, and companies in the industry have usedintellectual property litigation to gain a competitive advantage. We may becomea party to patent infringement claims and litigation or interferenceproceedings declared by the US Patent and Trademark Office to determine thepriority of inventions. The defense and prosecution of these matters are bothcostly and time consuming. We may need to commence proceedings against othersto enforce our patents, trade secrets or other know-how or defend againstclaims of infringement asserted against us, which would require investigationand determination of the enforceability, scope and validity of the respectiveproprietary rights. These proceedings could result in substantial expense to usand significant diversion of efforts by our technical and management personnel.

**If welose key management personnel or are unable to attract and retain the talentrequired for our business, our business could be harmed.**

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We are highly dependenton the principal members of our management staff, our President and ChiefExecutive Officer, Mr. Guillermo A. Herrera, our Executive Vice President,or EVP and Chief Financial Officer, Ronald E. Pauli, our EVP and Chief MedicalOfficer, Dr. Jeffrey W. Sherman and our EVP, Commercial Operations, Timothy P.Walbert. These principal members of our management and scientific staff, otherthan Mr. Herrera, accepted employment on the basis of written offers which setforth the salary and benefits to be provided, including, but not limited to,salary continuation payments upon termination of employment. Mr. Herrerahas a written employment contract with us. We do not have key man insurance onany of our management. If we were to lose the services of Mr. Herrera, orother principal members of our management staff, and were unable to replacethem, our product development and the achievement of our strategic objectivescould be delayed. In addition, our success will depend on our ability toattract and retain qualified commercial, scientific, technical, and managerialpersonnel. While we have not experienced unusual difficulties to date inrecruiting and retaining personnel, there is intense competition for qualifiedstaff and no assurance can be given that we will be able to retain existingpersonnel or attract and retain qualified staff in the future.

**Thedemand for our drug product candidates, if any, may be adversely affected byhealth care reform and potential limitations on third-party reimbursement.**

In recent years, therehave been numerous proposals to change the health care system in the U.S.. Someof these proposals have included measures that would limit or eliminatepayments for medical procedures and treatments or subject the pricing ofpharmaceutical products to government control. We cannot predict the effectthat health care reforms may have on our business, and it is possible that suchreforms will hurt our business. In addition, in both the U.S. and elsewhere,sales of prescription pharmaceutical products are dependent in part on theavailability of reimbursement to the consumer from third party payors, such asgovernment and private insurance plans. Third party payors are increasinglychallenging the prices charged for medical products and services with respectto new drug products in particular. If we succeed in bringing any of our drugproduct candidates to the market, we cannot be certain that our products willbe considered cost effective or that reimbursement to the consumer will beavailable or will be sufficient to allow us or our collaborators to sell ourproducts on a competitive basis.

In addition, many healthmaintenance organizations and other third party payors use formularies, orlists of drugs for which coverage is provided under a health care benefit plan,to control the costs of prescription drugs. Each payor that maintains a drugformulary makes its own determination as to whether a new drug will be added tothe formulary and whether particular drugs in a therapeutic class will havepreferred status over other drugs in the same class. This determination ofteninvolves an assessment of the clinical appropriateness of the drug andsometimes the cost of the drug in comparison to alternative products. We cannotbe assured that:

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

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

·       theformulary decisions will be conducted in a timely manner.

We may also decide toenter into discount or formulary fee arrangements with payors, which couldresult in us receiving lower or discounted prices for drug products we maydevelop in the future.

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

Even if approved formarketing, our drug product candidates may not achieve market acceptance. Thedegree of market acceptance of our drug product candidates will depend upon anumber of factors, including:

·       theestablishment and demonstration in the medical community of the safety andclinical efficacy of our drug product candidates and their potential advantagesover existing therapeutic products, including non-liposomal forms of the activeagents included in our drug products; and

·       pricingand reimbursement policies of government and third party payors such asinsurance companies, health maintenance organizations and other planadministrators.

**Materialweaknesses or deficiencies in our internal control over financial reportingcould harm stockholder and business confidence in our financial reporting, ourability to obtain financing, and other aspects of our business.**

As of September 30 2006,management concluded that a control deficiency with respect to the review andverification of the accuracy of the calculation estimating the fair value ofnon-employee stock options constituted a material weakness in internal controlover financial reporting. A material weakness is a control deficiency, orcombination of control deficiencies that results in more than a remotelikelihood that a material misstatement of the annual or interim financialstatements will not be prevented or detected. This control deficiency resultedin an adjustment to the unaudited interim condensed consolidated financialstatements for the quarter ended March 31, 2006 affecting derivative financialinstruments and change in fair value of derivative financial instruments.

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Management has revisedits policies and procedures with respect to its controls over the review andverification of the accuracy of the calculation estimating the fair value ofnon-employee stock options to ensure that all reasonable steps will be taken tocorrect this material weakness. The deficiency will not be consideredremediated until the new internal controls are operational for a period of timeand are tested, and management has concluded that the controls are operatingeffectively. Until it is remediated, the identified control deficiency couldresult in a misstatement in the derivative financial instruments and change infair value of derivative financial instruments balances that would not beprevented or detected. While management believes it has taken the appropriatesteps to remediate this control deficiency, we may not be able to remediate theidentified control deficiency prior to management’s assessment and the audit ofour assessment as of December 31, 2006. A failure on our part to properlyremediate the control deficiency could materially and adversely affect ourbusiness, our financial condition and the market value of our securities. Inaddition, our ability to obtain additional financing could be materially or adverselyaffected. 

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

**Ourinvestments could lose market value and consequently harm our ability to fundcontinuing operations.**

The primary objective ofour investment activities is to preserve principal while at the same timemaximizing yields without significantly increasing risk. To achieve thisobjective, we maintain our portfolio of cash, cash equivalents and short-terminvestments in a variety of securities, including government and corporateobligations and money market funds. The market values of these investments mayfluctuate due to market conditions and other conditions over which we have nocontrol. Fluctuations in the market price and valuations of these securitiesmay require us to record losses due to impairment in the value of thesecurities underlying our investment. This could result in future charges toour earnings. All of our investment securities are denominated in US dollars.

Investments in bothfixed-rate and floating-rate interest earning instruments carry varying degreesof interest rate risk. Fixed-rate securities may have their fair market valueadversely impacted due to a rise in interest rates. In general, securities withlonger maturities are subject to greater interest rate risk than those withshorter maturities. While floating-rate securities generally are subject toless interest rate risk than fixed-rate securities, floating-rate securitiesmay produce less income than expected if interest rates decrease. Due in partto these factors, our investment income may fall short of expectations or wemay suffer losses in principal if securities are sold that have declined inmarket value due to changes in interest rates.

**Wehandle hazardous materials and must comply with environmental laws andregulations, which can be expensive and restrict how we do business. We couldalso be liable for damages, penalties, or other forms of censure if we areinvolved in a hazardous waste spill or other accident.**

Our research anddevelopment processes involve the controlled storage, use, and disposal ofhazardous materials and biological hazardous materials. We are subject tofederal, state, and local laws and regulations governing the use, manufacture,storage, handling, and disposal of hazardous materials and certain wasteproducts. Although we believe that our safety procedures for handling anddisposing of these hazardous materials comply with the standards prescribed bylaw and regulation, the risk of accidental contamination or injury fromhazardous materials cannot be completely eliminated. In the event of anaccident, even by a third party, we could be held liable for any damages thatresult, and such liability could exceed our current general liability insurancecoverage of $1,000,000 and our financial resources. In the future, we may notbe able to maintain insurance on acceptable terms, or at all. We could also berequired to incur significant costs to comply with current or futureenvironmental laws and regulations.

**We mayhave product liability exposure, and insurance against such claims may not beavailable to us at reasonable rates or at all.**

While we maintaininsurance to cover the use of our drug product candidates in clinical trials,we currently do not have any product liability insurance for marketed humantherapeutic products. Although we plan to obtain product liability insurancewhen and if any of our drug product candidates become commercially available,we cannot assure you that we will be able to obtain or maintain this insuranceon acceptable terms or that any insurance we obtain will provide us withadequate coverage against potential liabilities. Claims or losses in excess ofany liability insurance coverage we obtain could have a material adverse effecton our business.

**Anti-takeoverprovisions could make a third party acquisition of us or the removal of ourboard of directors or management more difficult.**

In June 2003, weadopted a stockholder rights plan that provided for the issuance of rights topurchase shares of our Series A Participating Preferred Stock, theSeries A Preferred. Under the plan, we distributed one preferred sharepurchase right for each outstanding share of common stock. Each purchase rightentitles the holder to purchase from us one one-thousandth (1/1000th) of a

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share of Series APreferred at a price of $112.00 per share, subject to adjustment. The rightsbecome exercisable, with certain exceptions, ten business days after any party,without prior approval of our Board of Directors, acquires, or announces anoffer to acquire, beneficial ownership of 15% or more of our common stock. Anexception to this policy exists in the case of our largest shareholder,Dr. John N. Kapoor, who, along with parties affiliated with him, ispermitted to acquire up to 30% of our common stock without triggering therights issuance. In the event that any party acquires 15% or more of our commonstock (other than Dr. Kapoor for whom the threshold is 30%), we areacquired in a merger or other business combination, or 50% or more of ourassets are sold after the time that the rights become exercisable, the rightsprovide that each right holder will receive, upon exercise, shares of thecommon stock of the surviving or acquiring company, as applicable, having amarket value of twice the exercise price of the right. The stockholder rightsplan may discourage or prevent certain types of transactions involving anactual or potential change in control, which transactions may be beneficial toour shareholders, by causing substantial dilution to a party that attempts toacquire us on terms not approved by our Board of Directors. In addition,Section 203 and other provisions of the Delaware General Corporation Lawas well as provisions of our charter and by-laws could make a takeover of us orthe removal of the members of the board of directors or management moredifficult.

**Theissuance of preferred stock could adversely affect the holders of our commonstock.**

Our board of directorshas the authority, without further stockholder approval, to issue from time totime shares of preferred stock in one or more designated series or classes.Depending upon the rights and preferences which may be granted to any class ofpreferred shares which we may elect to issue, issuance of preferred stock couldadversely affect the voting power of holders of our common stock and reduce thelikelihood that our common stockholders will receive dividend payments andpayments upon liquidation. The issuance of preferred stock could also decreasethe market price of our common stock, or have terms and conditions that coulddiscourage a takeover or other transaction that might involve a premium pricefor our shares or that our stockholders might believe to be in their bestinterests.

**If thereare substantial sales of common stock, the market price of our common stockcould decline.**

Sales of substantialnumbers of shares of common stock could cause a decline in the market price ofour stock. We have filed Form S-8 registration statements registeringshares issuable pursuant to our equity compensation plans. Any sales byexisting stockholders or holders of options may have an adverse effect on ourability to raise capital and may adversely affect the market price of ourcommon stock.

**Item 2.**                          UnregisteredSales of Equity Securities and Use of Proceeds

None

**Item 3.**                          DefaultsUpon Senior Securities

None

**Item 4.**                          Submissionof Matters to a Vote of Security Holders

None

**Item 5.**                          OtherInformation

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**

**Pursuant to therequirements of the Securities Exchange Act of 1934, the Registrant has dulycaused this report to be signed on its behalf by the undersigned, thereuntoduly authorized.**
|                        | NEOPHARM, INC. |
|------------------------|----------------|
|                   |           |   |
| Date: November 9, 2006 | By:            | /s/ Ronald E. Pauli |   |
|                   |           | Ronald E. Pauli, |
|                   |           | *Chief Financial Officer* |
|                   |           | *(Principal Accounting Officer and* |
|                   |           | *Principal Financial Officer)* |

 

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