**UNITED STATESSECURITIES AND EXCHANGE COMMISSION**

**Washington, D.C. 20549**

 

**FORM 10-Q**

 

 
| **ý**                                                                                                                                                                                        | **QUARTERLY REPORT UNDER  SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934**            |
|---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|--------------------------------------------------------------------------------------------------------|
| ** **                                                                                                                                                                                        | ** **                                                                                             |
| **For Quarterly Period Ended March 31, 2005**                                                                                                                                                |
|                                                                                                                                                                                              |                                                                                                   |
| **Or**                                                                                                                                                                                            |
|                                                                                                                                                                                              |                                                                                                   |
| **o**                                                                                                                                                                                             | **TRANSITION REPORT PURSUANT TO  SECTION 13 OR 15 (d) OF THE SECURITIES EXCHANGE ACT OF****1934** |
| ** **                                                                                                                                                                                        | ** **                                                                                             |
| **For the transition period  from             to             ** |
| ** **                                                                                                                                                                                        | ** **                                                                                             |
| **Commission file number 33-90516**                                                                                                                                                               |

 

 

**NEOPHARM, INC.**

(Exact name of Registrant as specified in itscharter)

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

 

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

 

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

 

As of April 30, 2005 the number of shares outstanding of each ofthe issuer’s classes of common stock was as follows:

 
| **Title of each class**            | ** ** | **Number of shares outstanding** |
|------------------------------------|------------|----------------------------------|
| Common Stock ($.0002145 par value) |       | 23,548,855                       |

 

 

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NEOPHARM, INC.

 

FORM 10-QINDEX

 
| PART I. FINANCIAL  INFORMATION |
|--------------------------------|
|                           | Item 1. | Financial Statements |
|                           |   | Consolidated  Balance Sheets as of March 31, 2005 (Unaudited) and December 31,  2004 |
|                           |   | Consolidated  Statements of Operations for the three month periods ended March 31,  2005 and 2004 (Unaudited) |
|                           |   | Consolidated  Statements of Cash Flows for the three month periods ended March 31,  2005 and 2004 (Unaudited) |
|                           |   | Notes to  Consolidated Financial Statements (Unaudited) |
|                           | Item  2. | Management’s  Discussion and Analysis of Financial Condition and Results of Operations |
|                           | Item  3. | Quantitative  and Qualitative Disclosures About Market Risk |
|                           | Item 4 | Controls and  Procedures |
| PART II. OTHER INFORMATION     |
|                           | Item 1. | Legal Proceedings |
|                           | Item  2. | Unregistered  Sales of Equity Securities and Use of Proceeds |
|                           | Item 3. | Defaults Upon  Senior Securities |
|                           | Item  4. | Submission  of Matters to a Vote of Security-Holders |
|                           | Item 5. | Other Information |
|                           | Item 6. | Exhibits |
| SIGNATURE  PAGE                |

 

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**PART I - FINANCIAL INFORMATION**

 

**Item 1- Financial Statements**

 

**NEOPHARM, INC.Consolidated Balance Sheets**

 
| ** **                                                                                                                                | ** ** | **March 31, 2005** | ** ** | **December 31, 2004** | ** ** |
|-------------------------------------------------------------------------------------------------------------------------------------------|------------|-------------------------|------------|----------------------------|------------|
| ** **                                                                                                                                | ** ** | **(Unaudited)**         | ** ** | ** **                 | ** ** |
| **ASSETS**                                                                                                                                |       |                    |       |                       |       |
| Current assets:                                                                                                                           |       |                    |       |                       |       |
| Cash and cash equivalents                                                                                                                 |       | $                       | 54,364,828 |                       | $          | 63,106,655 |   |
| Trade accounts receivable                                                                                                                 |       | —                  |       | 10,888                     |       |
| Inventories                                                                                                                               |       | 7,360                   |       | 5,736                      |       |
| Prepaid expenses                                                                                                                          |       | 738,621                 |       | 1,108,282                  |       |
| Other receivables                                                                                                                         |       | 334,203                 |       | 308,087                    |       |
| Total current assets                                                                                                                      |       | 55,445,012              |       | 64,539,648                 |       |
| Fixed assets, net of accumulated depreciation                                                                                             |       | 2,561,505               |       | 2,894,723                  |       |
| Total assets                                                                                                                              |       | $                       | 58,006,517 |                       | $          | 67,434,371 |   |
|                                                                                                                                      |       |                    |       |                       |       |
| **LIABILITIES AND STOCKHOLDERS’  EQUITY**                                                                                            |       |                    |       |                       |       |
| Current liabilities:                                                                                                                      |       |                    |       |                       |       |
| Accounts payable                                                                                                                          |       | $                       | 208,440    |                       | $          | 398,505 |   |
| Accrued clinical trial expense                                                                                                            |       | 4,985,107               |       | 4,634,618                  |       |
| Accrued compensation                                                                                                                      |       | 1,312,213               |       | 3,227,230                  |       |
| Other accrued expenses                                                                                                                    |       | 1,059,327               |       | 940,343                    |       |
| Deferred and unearned revenue                                                                                                             |       | 249,400                 |       | —                     |       |
| Total current liabilities                                                                                                                 |       | 7,814,487               |       | 9,204,096                  |       |
|                                                                                                                                      |       |                    |       |                       |       |
| Deferred revenue, less current portion                                                                                                    |       | 1,840,495               |       | —                     |       |
|                                                                                                                                      |       |                    |       |                       |       |
| Stockholders’ equity:                                                                                                                |       |                    |       |                       |       |
| Preferred stock, $0.01 par value; 15,000,000  shares authorized: 0 shares issued and outstanding                                          |       | —                  |       | —                     |       |
| Common stock, $0.0002145 par value; 50,000,000  shares authorized: 23,548,855 and 23,372,755 shares issued and outstanding,  respectively |       | 5,053                   |       | 5,013                      |       |
| Additional paid-in capital                                                                                                                |       | 248,510,783             |       | 247,525,290                |       |
| Accumulated deficit                                                                                                                       |       | (200,164,301            | )          | (189,300,028               | )          |
| Total stockholders’ equity                                                                                                           |       | 48,351,535              |       | 58,230,275                 |       |
| Total liabilities and stockholders’ equity                                                                                           |       | $                       | 58,006,517 |                       | $          | 67,434,371 |   |

 

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

 

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**NEOPHARM, INC.**

 

**Consolidated Statements of OperationsThree Month Periods Ended March 31, 2005 and 2004**(Unaudited)

 

| ** **                                                     | ** ** | **Three Months Ended**  | ** **  |
|----------------------------------------------------------------|------------|-------------------------|-------------|
| ** **                                                     | ** ** | **March 31, 2005** | ** **  | **March 31, 2004** | ** ** |
|                                                           |       |                    |        |   |   |   |   |
| License fee revenue                                            |       | $                       | 27,500      |   | $ | — |   |
| Collaboration revenue                                          |       |                    | 37,500      |   |   | — |   |
| Product revenue                                                |       |                    | 6,300       |   |   | 12,200 |   |
|  

Total revenue                                          |       |                    | 71,300      |   | 12,200 |   |
|                                                           |       |                    |        |   |   |
| Expenses:                                                      |       |                    |        |   |   |
| Cost of product revenue                                        |       | 290                     |        | 244 |   |
| Research and development                                       |       | 8,073,761               |        | 11,249,227 |   |
| Selling, general and administrative                            |       | 3,233,309               |        | 3,200,069 |   |
| Related party expenses                                         |       | —                  |        | 35,364 |   |
| Total expenses                                                 |       | 11,307,360              |        | 14,484,904 |   |
|                                                           |       |                    |        |   |   |
| Loss  from operations                                          |       | (11,236,060             | )           | (14,472,704 | ) |
|                                                           |       |                    |        |   |   |
| Interest income                                                |       | 371,787                 |        | 225,514 |   |
| Net loss          |       | $                       | (10,864,273 | ) | $ | (14,247,190 | ) |
| Net loss per share —                                      |       |                    |        |   |   |
| Basic and diluted                                              |       | $                       | (0.46       | ) | $ | (0.65 | ) |
| Weighted average shares outstanding —                     |       |                    |        |   |   |
| Basic and diluted                                              |       | 23,469,462              |        | 21,911,987 |   |

 

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

 

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**NEOPHARM, INC.**

 

**Consolidated Statements of Cash FlowsThree Month Periods Ended March 31, 2005 and 2004**(Unaudited)
| ** **                                                                                        | ** ** | **Three Months Ended**  | ** **  |
|---------------------------------------------------------------------------------------------------|------------|-------------------------|-------------|
| ** **                                                                                        | ** ** | **March 31, 2005** | ** **  | **March 31, 2004** | ** ** |
| Cash flows from operating activities:                                                             |       |                    |        |   |   |
| Net loss                                                                                          |       | $                       | (10,864,273 | ) | $ | (14,247,190 | ) |
| Adjustments to reconcile net loss to net cash and  cash equivalents used in operating activities: |       |                    |        |   |   |
| Depreciation and amortization                                                                     |       | 333,764                 |        | 329,671 |   |
| Stock-based compensation expense                                                                  |       | 341,072                 |        | 147,814 |   |
| Loss on retirement of equipment and furniture                                                     |       | 6,773                   |        | — |   |
| Changes in assets and liabilities:                                                                |       |                    |        |   |   |
| Decrease in current assets                                                                        |       | 352,809                 |        | 362,511 |   |
| Increase/(decrease) in current liabilities                                                        |       | (1,389,609              | )           | 1,148,331 |   |
| Increase in deferred revenue                                                                      |       | 1,840,495               |        | — |   |
| Net cash and cash equivalents used in operating  activities                                       |       | (9,378,969              | )           | (12,258,863 | ) |
|                                                                                              |       |                    |        |   |   |
| Cash flows from investing activities:                                                             |       |                    |        |   |   |
| Proceeds from maturities of marketable securities                                                 |       | —                  |        | 892,749 |   |
| Proceeds from sales of marketable securities                                                      |       | —                  |        | 2,362,413 |   |
| Purchase of equipment and furniture                                                               |       | (7,319                  | )           | (139,202 | )  |
| Net cash and cash equivalents (used in) provided  by investing activities                         |       | (7,319                  | )           | 3,115,960 |   |
|                                                                                              |       |                    |        |   |   |
| Cash flows from financing activities:                                                             |       |                    |        |   |   |
| Proceeds from issuance of common stock                                                            |       | —                  |        | 73,472,948 |   |
| Proceeds from exercise of stock options                                                           |       | 644,461                 |        | 436,095 |   |
| Net cash and cash equivalents provided by  financing activities                                   |       | 644,461                 |        | 73,909,043 |   |
|                                                                                              |       |                    |        |   |   |
| Net (decrease)/increase in cash and cash  equivalents                                             |       | (8,741,827              | )           | 64,766,140 |   |
| Cash and cash equivalents, beginning of period                                                    |       | 63,106,655              |        | 36,958,941 |   |
| Cash and cash equivalents, end of period                                                          |       | $                       | 54,364,828  |   | $ | 101,725,081 |   |
|                                                                                              |       |                    |        |   |   |
| Supplemental disclosure of cash paid for:                                                         |       |                    |        |   |   |
| Interest                                                                                          |       | $                       | —      |   | $ | — |   |
| Income taxes                                                                                      |       | $                       | —      |   | $ | — |   |

 

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

 

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**NEOPHARM, INC.**

 

**NOTES TO CONSOLIDATED FINANCIAL STATEMENTS**

 

**Note1  Basis of Presentation and NewAccounting Pronouncements**

Thefinancial information herein is unaudited. The balance sheet as of December 31,2004 is derived from audited financial statements.

Theaccompanying unaudited financial statements of NeoPharm, Inc. and subsidiary(the “Company”) have been prepared in accordance with U.S. generally acceptedaccounting principles for interim financial information and with theinstructions to Form 10-Q and Rule 10-01 of Regulation S-X. Accordingly, theydo not contain all of the information and notes required by U.S. generallyaccepted accounting principles for complete financial statements. In theopinion of the Company, the accompanying unaudited interim financial statementscontain all adjustments (consisting of normal recurring adjustments) necessaryto present fairly the Company’s financial position as of March 31, 2005,and the results of their operations and their cash flows for the three monthsended March 31, 2005 and 2004.  Theresults of operations for the three month period ended March 31, 2005 are notnecessarily indicative of operating results for fiscal 2005 or future interimperiods.

Theconsolidated financial statements include the accounts of NeoPharm, Inc. andits wholly owned subsidiary, NeoPharm EU Limited. NeoPharm EU Limited was createdin 2004 to comply with regulatory requirements enacted for clinical trialsconducted in the European Union. This subsidiary has nominal assets and had notconducted any business. All significant intercompany accounts and transactionsare eliminated in consolidation.

Whilethe Company believes that the disclosures presented are adequate to make theinformation not misleading, it is suggested that these financial statements beread in conjunction with the financial statements and notes included in theCompany’s 2004 Annual Report on Form 10-K and Amendment No. 1 filed on Form10-K/A filed with the Securities and Exchange Commission (SEC).

The preparation of financialstatements in conformity with U.S. generally accepted accounting principlesrequires management to make estimates and assumptions that affect the reportedamounts of assets and liabilities and disclosure of contingent assets andliabilities at the date of the consolidated financial statements and thereported amounts of revenue and expense during the reporting period. Actualresults could differ from those estimates.

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

**Note2  Stock-based Compensation**

TheCompany applies the intrinsic-value method of accounting prescribed byAccounting Principles Board (APB) Opinion No. 25, *Accountingfor Stock Issued to Employees*, and related interpretations, to accountfor its fixed-plan stock options.  Underthis method, compensation expense is measured on the date of grant if thecurrent market price of the underlying stock exceeded the exercise price orwhen the number of shares and exercise price are known if both are notdeterminable at the date of grant. Compensation expense for fixed stock optionsis recognized ratably over the vesting period. SFAS No. 123, *Accounting for Stock-BasedCompensation*, established accounting and disclosure requirementsusing a fair-value method of accounting for stock-based employee compensationplans.  As allowed by SFAS No. 123, theCompany has elected to continue to apply the intrinsic-value-based method ofaccounting described above, and has adopted only the disclosure requirements ofSFAS No. 123.

Thefollowing table illustrates the effect on net loss if the fair-value method hadbeen applied in each period:

| ** **                                                                                                      | ** ** | **For the three months ended:** | ** **  |
|-----------------------------------------------------------------------------------------------------------------|------------|---------------------------------|-------------|
| ** **                                                                                                      | ** ** | **March 31,  2005**        | ** **  | **March 31,  2004** | ** ** |
|                                                                                                            |       |                            |        |   |   |
| Net loss, as reported                                                                                           |       | $                               | (10,864,273 | ) | $ | (14,247,190 | ) |
| Add stock-based employee compensation  expense included in reported net loss(1)                                 |       | 152,719                         |        | 147,814 |   |
| Deduct total stock-based employee  compensation expense determined under fair-value-based method for all awards |       | (184,020                        | )           | (1,942,255 | ) |
| Pro forma net loss                                                                                              |       | $                               | (10,832,972 | ) | $ | (16,041,631 | ) |
|                                                                                                            |       |                            |        |   |   |
| Basic and diluted loss per share of common  stock                                                               |       |                            |        |   |   |
| As reported                                                                                                     |       | $                               | (0.46       | ) | $ | (0.65 | ) |
| Pro forma                                                                                                       |       | $                               | (0.46       | ) | $ | (0.73 | ) |

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

 

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**Note 3  CashEquivalents and Investments**

The Company considers all highly liquid investments purchased with anoriginal maturity of three months or less to be cash equivalents. Included withcash are cash equivalents of $53,278,473 and $62,919,437 as of March 31,2005 and December 31 2004, respectively. The carrying value of theseinvestments approximates their fair market value due to their short maturityand liquidity.

**Note 4  Inventory**

Inventoryis comprised solely of finished goods associated with NeoPhectin and is statedat the lower of cost or market, as determined by the first in, first out method(FIFO).  Inventory cost consists ofdirect material and direct labor costs. Since products are currently produced in the Company’s research anddevelopment facilities, the Company has not allocated any overhead costs as aproduct cost.  Application of overhead asa product cost is not material. 

 Inventory at March 31, 2005 and December 31,2004 consisted of the following:
| ** **                  | ** ** | **March 31, 2005** | ** ** | **December 31, 2004** | ** ** |
|-----------------------------|------------|--------------------|------------|-----------------------|------------|
|                        |       |               |       |                  |       |
| Finished goods on hand      |       | $                  | 7,068      |                  | $          | 5,413 |   |
| Inventory subject to return |       | 292                |       | 323                   |       |
|                        |       |               |       |                  |       |
|                        |       | $                  | 7,360      |                  | $          | 5,736 |   |

 

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

 

**Note 5  Fixed Assets**

Fixedassets are recorded at cost and are depreciated using the straight line methodover their estimated useful lives. Maintenance and repairs that do not extendthe life of assets are charged to expense when incurred. When properties aredisposed of, the related costs and accumulated depreciation are removed fromthe accounts and any gain or loss is reported in the period the transactiontakes place. Total depreciation expense for the three month periods ended March31, 2005 and 2004, was $333,764 and $329,671, respectively.

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

**Note 6  Stockholders'Equity**

 

TheCompany maintains a Stockholder Rights Plan whereby rights to purchase sharesof Series A Participating Preferred Stock become exercisable by the Company’sstockholders after any non-excluded party acquires, or announces intentions toacquire, 15% or more of the Company’s outstanding common stock.

 

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

 

**Note 7Revenue Recognition**

** **

The Company recognizes revenue when persuasive evidence of anarrangement exists, delivery has occurred or services have been rendered, theprice is fixed or determinable, and collectibility is reasonably assured.

For product sales not subject to unconditional rights of return, theCompany recognizes revenue upon shipment as title and risk of loss has passedto the customer. For product sales subject to unconditional rights of return,the Company recognizes revenue upon shipment when it can reasonably estimatethe level of returns at the time of shipment. Given the limited sales historyof its products, the Company is currently unable to reasonably estimate thelevel of returns at the time of shipment. Accordingly, revenue related toshipments to distributors that have been granted an unconditional right ofreturn is currently being recognized when the right of return has expired,which occurs upon the earlier of shipment of the product by the distributor toan end user or expiration of the right of return, which is 60-180 daysdepending upon the distributor. The Company warrants its products in a mannerconsistent with industry standards and has not incurred any warranty costsrelated to the sale of NeoPhectin.

TheCompany enters into collaboration and technology licensing arrangements, whichcontain multiple deliverables. Under the provisions of Emerging Issues TaskForce (EITF) No. 00-21, *Accounting forRevenue Arrangements with Multiple Deliverables*, the Companyevaluates whether these deliverables constitute separate units of accounting towhich total arrangement consideration is allocated. A deliverable qualifies asa separate unit of accounting when the item delivered to the customer hasstandalone value, there

 

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is objective and reliable evidence of fair value of items that have notbeen delivered to the customer, and, if there is a general right of return forthe items 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 basis or the residual method if the Company is unable to determine thefair value of all deliverables in the arrangement. Consideration allocated to aunit of accounting is limited to the amount that is not contingent upon futureperformance by the Company. Upon determination of separate units of accountingand allocated consideration, the general criteria for revenue recognition areapplied to each unit of accounting. In instances where an arrangement providesfor up-front non-refundable payments, the Company recognizes these paymentsratably over the term of the contract or expected period of performance,whichever is longer.

 

The Company has entered into collaboration andlicense agreements with third parties. The collaboration agreement provides for an upfront nonrefundablepayment to the Company of $150,000 as well as an additional $350,000, upondelivery of a customized formulation of NeoPhectin to the customer.  The Company received the upfrontnonrefundable payment during the first quarter of 2005 and is recognizing thispayment as revenue ratably over the expected term of the agreement.  The Company has also entered into anagreement with Nippon Kayaku Co., Ltd. in which the development andcommercialization rights in Japan for cintredekin besudotox were licensed.  The Company received a $2 million upfrontnonrefundable fee in January 2005 and is entitled to receive future additionalfees, milestone payments, and royalties. Nippon Kayaku Co., Ltd. is responsible for all development costs inJapan.  The Company has agreed to provideor arrange for contract manufacture of a commercial supply of cintredekinbesudotox upon receipt of marketing approval by Nippon Kayaku Co., Ltd.  The upfront nonrefundable fee received by theCompany is being recognized as revenue ratably over the estimated life of theagreement.

 

**Note 8Loss Per Share**

 

Thefollowing table sets forth the computation of the basic and diluted net lossper share:

| ** **                          | ** ** | **For the  three months ended:** | ** **  |
|-------------------------------------|------------|----------------------------------|-------------|
| ** **                          | ** ** | **March 31,  2005**         | ** **  | **March 31,  2004** | ** ** |
| Numerator:                          |       |                             |        |   |   |
| Net loss                            |       | $                                | (10,864,273 | ) | $ | (14,247,190 | ) |
|                                |       |                             |        |   |   |
| Denominator:                        |       |                             |        |   |   |
| Weighted average shares outstanding |       | 23,469,462                       |        | 21,911,987 |   |
|                                |       |                             |        |   |   |
| Loss per share - basic and diluted  |       | $                                | (0.46       | ) | $ | (0.65 | ) |
|                                |       |                             |        |   |   |
| Potential common share equivalents: |       |                             |        |   |   |
| Stock options                       |       | 3,572,677                        |        | 3,433,091 |   |

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

 

**Note 9  Transactions with Related Parties**

Thefollowing table provides further information about related party expensesreflected in the consolidated statements of operations.

| ** **                   | ** ** | ** **        | ** ** | **For the  three months ended:** | ** ** |
|------------------------------|------------|-------------------|------------|----------------------------------|------------|
| **Related Party**            | ** ** | **Expense  Type** | ** ** | **March 31,  2005**         | ** ** | **March 31,  2004** | ** ** |
| Akorn, Inc.                  |       | Consulting        |       | $                                | —     |   | $ | 3,750 |   |
| E.J. Financial  Enterprises  |       | Consulting        |       | —                           |       | 31,250 |   |
| E.J. Financial Enterprises   |       | Direct  Expenses  |       | —                           |       | 364 |   |
| Total related party expenses |       |              |       | $                                | —     |   | $ | 35,364 |   |

 

Priorto June 30, 2004, the Company received management consulting services from EJFinancial Enterprises, Inc. (“EJ Financial”), a healthcare consulting andinvestment firm in which John N. Kapoor, Ph.D., a member of the Company’s Boardof Directors and the Company’s former Chairman of the Board of Directors, isthe sole stockholder. The consulting agreement with EJ Financial expired onJune 30, 2004 and was not renewed.

The Company had entered into a consulting agreement with an individualwho is also an employee of Akorn, Inc. NeoPharm’s former Chairman of theBoard of Directors and a current Director is also the Chairman of the AkornBoard of Directors. The consulting agreement was terminated in 2004.

In December 2001,NeoPharm entered into a transaction whereby NeoPharm loaned toAkorn, Inc., a Louisiana corporation, $3,250,000 to assist Akorn in thecompletion of its lyophilized products manufacturing facility in Decatur,Illinois. Dr. Kapoor,  a member ofthe Company’s Board of Directors and the Company’s former Chairman of the Boardof Directors, is the Chairman of the Akorn Board of Directors and holds asubstantial stock position in both companies. In connection with the loantransaction, NeoPharm entered into the following agreements: Promissory Note,dated December 20, 2001, in the original principal amount of $3,250,000 byAkorn to NeoPharm; Processing Agreement, dated December 20, 2001, by andbetween Akorn and NeoPharm; Subordination and Intercreditor Agreement, datedDecember 20, 2001, by and between John N. Kapoor, as Trustee under TheJohn N. Kapoor Trust, dated September 20, 1989 and NeoPharm; and a Subordination,Standby and Intercreditor Agreement, dated December 20, 2001, by

 

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andamong Akorn, Akorn (New Jersey), Inc., The Northern Trust Company andNeoPharm. The Promissory Note issued by Akorn was due in December 2006,and accrued interest at a rate equal to that received on the Company’sinvestments in marketable securities, which is lower than the interest ratepaid by Akorn on its other outstanding debt. The Processing Agreement grantsNeoPharm access to at least 15% of the annual lyophilization manufacturingcapacity at Akorn at most favored customer pricing, upon completion of thefacility. The Processing Agreement also provided that Akorn was to beginproviding lyophilization services on or before June 30, 2003. At the timethese transactions were entered into, Akorn represented that the manufacturingfacility would be operational in 2003, approximately the time when NeoPharm originallyanticipated it would need to manufacture its lyophilized drug product candidatesfor Phase II/III clinical trials. In 2001, NeoPharm recorded the PromissoryNote net of a valuation allowance of $1,266,619 reflecting the differencebetween the actual loan amount and the present value of the loan using anestimated market interest rate of 10%. As of December 31, 2002, theCompany determined the Promissory Note was impaired and recorded a charge tofully reserve for the Promissory Note and related accrued interest. OnAugust 18, 2003, NeoPharm presented Akorn with a formal “Notice of Default”on the Promissory Note. Because the carrying value of the Promissory Note waszero, there was no financial statement impact as a result of any event ofdefault under, or non-payment of, the Promissory Note. In September 2003,Akorn advised NeoPharm that it wished to refinance its senior debt with a newsenior lender, which lender would require NeoPharm to subordinate its debt. Inorder to preserve the possibility of collecting Akorn’s debt to NeoPharm,NeoPharm and Akorn entered into an Amended and Restated Promissory Note inconsideration of a higher rate of interest (which would now equal that to becharged by the new senior lender, which is the prime rate plus 175 basispoints) and the possibility of accelerated mandatory repayments once Akorn’s seniordebt was repaid in full. NeoPharm also agreed to waive Akorn’s default, toallow Akorn until October 2004 to provide the required manufacturingrights and to subordinate Akorn’s indebtedness to NeoPharm to Akorn’sindebtedness to its new senior lender. Akorn’s refinancing was completed onOctober 7, 2003. On October 6, 2004, NeoPharm presented Akorn, with aformal “Notice of Default” on the Amended and Restated Promissory Noteresulting from Akorn’s failure to meet its obligations under the ProcessingAgreement. Because the carrying value of the Promissory Note was zero, therewas no financial impact as a result of any event of default under, ornon-payment of, the Promissory Note.

**Note 10 Employee Termination Benefits**

In an effort to decrease expenses, the Company reduced its workforce bya total of 30 employees (approximately 23%) in November 2004, consistingof 26 employees from its research and development groups and 4 employees fromthe administrative group. Terminated employees were eligible to receive salarycontinuation through December 31, 2004, severance, 2004 earned bonus,Company paid insurance benefits and outplacement services. All $1,149,277 ofemployee termination costs were expensed in 2004 and no additional amounts wereexpensed in 2005.  $760,759 oftermination costs accrued as of December 31, 2004 were paid during thefirst quarter of 2005. 

**Note 11 Commitments**

On April 25, 2005, the Company and Mr. Ronald G. Eidell finalizedan employment agreement (Employment Agreement) under which Mr. Eidell isemployed, on an interim basis, as the Company’s President and Chief ExecutiveOfficer (CEO).  Mr. Eidell had been serving as President and CEOsince March 8, 2005 under a principal terms employment agreement (PTA) executedbetween the Company and Mr. Eidell on March 10, 2005, which has nowbeen superceded by the terms of the Employment Agreement.  Under the Employment Agreement,Mr. Eidell will receive a base salary of $260,000.  Under the PTA,Mr. Eidell had agreed to a base salary of $325,000, subject, however, tothe Company entering into a separate agreement with Tatum CFO Partners LLP (Tatum),of which Mr. Eidell continues to be a partner, providing for up to 20% ofMr. Eidell’s base salary and bonus, if any, to be remitted to Tatum. Under the terms of a separate agreement, an annualized amount of $65,000,prorated for the period of Mr. Eidell’s employment by the Company, is tobe paid to Tatum.  The amount of the payment toTatum has been deductedfrom the PTA base salary figure of $325,000, resulting in the new base salaryof $260,000 under the Employment Agreement.  Additionally, Mr. Eidell isentitled to an annual performance-based milestone bonus payment, of which 20%would be payable to Tatum, as per the agreement, and a monthly transportationallowance of $1,500.  On March 10, 2005,Mr. Eidell received a stock option grant of 80,000 shares at an exercise priceequal to the closing price of the Company’s stock on that date.  The stock options shall vest upon thetermination of the Employment Agreement as a result of Mr. Eidell’s resignationto allow a new permanent CEO to take office or, if the Employment Agreement hasnot yet ended, one year from the date of grant, whichever occurs earlier. 

OnJune 17, 2004, NeoPharm entered into an Employment Agreement with GregoryP. Young to serve as the Company’s President, Chief Executive Officer and aDirector. Mr. Young resigned as the Company’s President and CEO, and as adirector, on March 8, 2005, and the Company entered into a Separation Agreementand Full Release of All Claims (the Separation Agreement) with Mr. Young. Underthe terms of the Separation Agreement, Mr. Young will receive a salarycontinuance for 12 months based upon his annual base salary at the time of hisresignation ($325,000) and Company paid insurance premiums under the Company’smedical insurance plan. The salary continuance and medical insurance premiumpayments will cease at such time as Mr. Young accepts full-time employmentor the first date that Mr. Young provides consulting or other services to certainother competing pharmaceutical or biotechnology organizations, other than acharitable entity. Additionally, Mr. Young agreed to serve as a consultantto the Company for a period of up to 12 months or upon the termination of theSeparation Agreement, whichever is earlier, during which time all optionspreviously granted to Mr. Young continue to vest and remain exercisableuntil 90 days after termination as a consultant, resulting in the expected vestingof 62,500 options. All other options granted to Mr. Young are expected tobe forfeited.  For the three month periodended

 

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March 31, 2005, the Company recorded compensation expense of $24,814relating to the options granted to Mr. Young that continue to vest during theterm of the consulting agreement.

On June 17, 2004, James M. Hussey resigned as the Company’sPresident, Chief Executive Officer and a member of the Board of Directors. Inaccepting Mr. Hussey’s resignation, the Board of Directors authorized theCompany to enter into a Separation Agreement and Full Release of all Claims(the “Hussey Agreement”) with Mr. Hussey. Under the terms of the HusseyAgreement, Mr. Hussey will receive a salary continuance for 12 months basedupon his annual base salary at the time of his resignation ($339,768), Companypaid insurance premiums under the Company’s medical insurance plan, plus apayment of 50% of Mr. Hussey’s target milestone bonus when 2004 bonusesare paid to the Company’s employees. The salary continuance and medicalinsurance premium payments will cease at such time as Mr. Hussey acceptsfull-time employment or the first date that Mr. Hussey provides consultingor other services to a competing pharmaceutical or biotechnology organization.Additionally, Mr. Hussey agreed to serve as a consultant to the Companyfor a period of up to 24 months or upon the termination of the HusseyAgreement, whichever is earlier, during which time all options previouslygranted to Mr. Hussey continue to vest and remain exercisable until 90days after termination as a consultant. All compensation expense associatedwith these options was recorded in 2004 due to the acceleration of vesting thatoccurred upon the execution of the Hussey Agreement.On March 11, 2005, the Company entered intoan amendment to the Hussey Agreement in which Mr. Hussey agreed to accept theCompany’s common stock as consideration in lieu of all remaining cash paymentsdue to him under the Hussey Agreement. As of March 10, 2005, the effective dateof the amendment, Mr. Hussey was owed $188,353, which translates, at theclosing price of the Company’s common stock on March 10, 2005, to 23,692 sharesof the Company’s common stock, which were issued to Mr. Hussey. Mr. Hussey willcontinue to provide consulting services to the Company until June, 17, 2006.

 

**Note 12  Contingencies**

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

 

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

 

Thepharmaceutical industry has traditionally experienced difficulty in maintainingproduct liability insurance coverage at desired levels. To date, no significantproduct liability suit has ever been filed against the Company. However, if asuit was filed and a judgment entered against the Company, it could have amaterial adverse effect upon the Company’s operations and financial condition.While the Company maintains insurance to cover the use of its drug productcandidates in clinical trials, the Company does not maintain insurance coveringthe sale of its drug product candidates nor is there any assurance that it willbe able to obtain or maintain such insurance on acceptable terms or withadequate coverage against potential liabilities.

 

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

 

Any statements made by NeoPharm, Inc. (“we”, “us”,“our”, or the “Company”) in this quarterly report that are forward looking aremade pursuant to the safe harbor provisions of the Private SecuritiesLitigation Reform Act of 1995.  TheCompany cautions readers that important factors may affect the Company’s actualresults and could cause such results to differ materially from forward-lookingstatements made by or on behalf of the Company. Such factors include, but are not limited to, those risks anduncertainties relating to difficulties or delays in development, testing,regulatory approval, recruitment of patients, production and marketing of theCompany’s drug candidates, including, but not limited to cintredekin besudotox,including the PRECISE trial, the marketing of non-drug products such asNeoPhectinTM and NeoPhectin-ATTM, the ability of the Company to cut back on itsexpenditures in order to conserve its cash reserves, the ability of the Companyto procure additional future sources of financing, uncertainty regarding theoutcome of class action litigation against the Company, resolution of theongoing SEC investigation, unexpected adverse side effects or inadequatetherapeutic efficacy of the Company’s drug candidates that could slow orprevent products coming to market, the uncertainty of patent protection for theCompany’s intellectual property or trade secrets, and other factors referencedunder “Risk Factors” in the Company’s Annual Report on Form 10-K and Amendment No. 1 filed on Form 10-K/A for the fiscal year ended December 31,2004.

 

Thefollowing should be read in conjunction with the financial statements andrelated notes and Management’s Discussion and Analysis of Financial Conditionand Results of Operations and the Risk Factors section included in the Company’s2004Annual Report onForm 10-K and Amendment No. 1 filed on Form 10-K/A.  The results discussed below are notnecessarily indicative of the results to be expected in any futureperiods.  The following discussioncontains forward-looking statements that are subject to risks and uncertainties,which could cause actual results to differ from statements made. 

 

**Overview**

 

Weare a biopharmaceutical company engaged in the research, development, andcommercialization of drugs for the treatment of various cancers. Our corporatestrategy is to become a leader in the research, development, andcommercialization of new and innovative anti-cancer treatments. We currently operateat two locations, and had 93 full time employees as of March 31, 2005.  Our corporate headquarters and clinicaldevelopment team are located in Lake Forest, Illinois, and our research anddevelopment facility is in Waukegan, Illinois.

 

Sincewe began doing business in June 1990, we have devoted our resourcesprimarily to funding research and product development programs. To date, wehave not received FDA approval of any of our drug product candidates.  We expect to continue to incur losses for theforeseeable future as we continue our research and development activities,which include the sponsorship of human clinical trials for our drug productcandidates.  Until we are able toconsistently generate revenue through the sale of drug or non-drug products, weanticipate that we will be required to fund the development of our pre-clinicalcompounds and drug product candidates primarily by other means, including, butnot limited to, licensing the development rights to some of our drug productcandidates to third parties, collaborating with third parties to developformulations of their compounds using our technology, or selling Company issuedsecurities.

 

Inthe first quarter ended March 31, 2005, management’s efforts were devotedto enrolling patients in the Phase III PRECISE clinical trial for our lead drugproduct candidate, cintredekin besudotox (IL13-PE38QQR), advancing our NeoLipiddrug product candidates (LEP-ETU, LE-SN38, and LErafAON) through the clinicaldevelopment process, engaging potential partners in discussions pertaining topotential licensing of our drug product candidates, and exploring potentialopportunities to reduce expenses in an effort to further lower the amount ofcash used in operations.  Significantevents occurring during the first quarter of 2005 included the resignation offormer President and Chief Executive Officer, Gregory P. Young, and theappointment of Ronald G. Eidell, a member of the Company’s Board of Directors,as interim President and Chief Executive Officer (CEO).  In March 2005, our Board of Directorsinitiated a search for a permanent President and CEO.

 

The PRECISE trial, our Phase III clinical trial forcintredekin besudotox for the treatment of glioblastoma multiforme (GBM), beganin March 2004 with the enrollment of our first patient. As of April 30,2005, 174 patients have been enrolled in the PRECISE trial. If enrollmentcontinues at current levels, we would anticipate the completion of enrollment(approximately 300 patients total) for PRECISE in 2005 and the submission of aBiologics License Application (BLA) with the FDA in late 2006 seeking marketingapproval of the drug. However, there can be no assurance the trial will meetits endpoint in the anticipated time period or that the FDA will approve theBLA without requiring additional supporting data. Assuming that we receiveauthorization to begin selling cintredekin besudotox, we currently anticipatethe first sales of the product in 2007, at the earliest.  Enrollment also continues in our Phase Iclinical trial of cintredekin besudotox for malignant glioma patients atinitial diagnosis.

 During the first quarter of 2005, wecontinued the enrollment of patients in a clinical trial to assess whetherLEP-ETU can be considered bioequivalent to paclitaxel, the active component ofLEP-ETU. If so, we could be allowed to take advantage of a more expeditiouspath to submit an application for approval of LEP-ETU. Additionally, wecontinued our efforts to begin a Phase II clinical trial for LE-SN38 forpatients suffering from colorectal cancer, which is expected to begin later in2005. We also anticipate the completion in 2005 of our Phase I clinical trialof our LErafAON drug product candidate, depending on the number of dose levels

 

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studied.

 

Itis difficult to predict with any certainty the timing of and total estimatedcosts to complete development of drug product candidates in early stage, orPhaseI/II, clinical development, as well as the estimated  date such drug product candidates would beavailable for sale, if approved by the FDA. A number of factors contribute tothis uncertainty, including: side effects encountered in early stage clinicaltrials, ability to scale up manufacturing for commercial supply, and the factthat the size and scope of pivotal Phase III clinical trials are unknown untilsufficient data is available to present a Phase III plan to the FDA forapproval. In addition, our drug product candidates are required to be approvedby the FDA after completing Phase III clinical trials before we can sell thedrugs to generate revenue and, potentially, realize net cash inflows. Becauseour lead drug product candidate, cintredekin besudotox, has entered a Phase IIIclinical trial, we are able to estimate that we will incur further direct expensesof approximately $14 million to complete the Phase III PRECISE study.Additional Phase I and Phase II expenses will also be incurred for cintredekinbesudotox as we are conducting other clinical trials to investigate thepotential to use cintredekin besudotox in other forms of glioblastomamultiforme in addition to recurrent glioblastoma multiforme.

 

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

 

| **Research  Project**                   | ** ** | **Costs Incurred in  Current Quarter** | ** ** | **Total Costs  Incurred Since  Beginning of Project** | ** ** |
|-----------------------------------------|------------|----------------------------------------|------------|-------------------------------------------------------|------------|
| Cintredekin besudotox                   |       | $                                      | 3,635,087  |                                                  | $          | 42,605,694 |   |
| LEP-ETU                                 |       | 791,648                                |       | 4,815,023                                             |       |
| LE-SN38                                 |       | 149,162                                |       | 4,616,752                                             |       |
| LErafAON                                |       | 95,626                                 |       | 7,528,231                                             |       |
| Non-project specific                    |       | 3,402,238                              |       | N/A                                                   |       |
| Total research and development expenses |       | 8,073,761                              |       | N/A                                                   |       |
|                                         |            |                                        |            |                                                       |            |  |  |

 

In order to decrease expenses, we reduced ourworkforce by a total of 30 employees (approximately 23%) in November 2004,consisting of 26 employees from our research and development groups and 4employees from our selling, general, and administrative group. Terminatedemployees were eligible to receive continued salary and insurance benefitsthrough December 31, 2004 (the termination date), 2004 earned bonuspayable in February 2005 (contingent on Board of Directors’ approval ofthe 2004 bonus pool, which was subsequently given), two months severance pay in2005, two months of Company paid medical insurance premiums paid in 2005, andoutplacement services. The reduction in workforce resulted in approximately $0.8million in payroll related savings in the quarter ended March 31, 2005 and it isestimated that the annual payroll related savings will approximate $3.8million. The total costs associated with the reduction in workforce wereapproximately $1.1 million, all of which were expensed in the fourth quarter of2004.

We successfully completed negotiations on twocollaborations in December 2004. The first collaboration resulted in a paymentto us of $150,000 during the first quarter of 2005 and, assuming we are able toprovide a customized NeoPhectin formulation of their proprietary compound toour partner, a privately held biotechnology company, we anticipate receiving another$350,000 later this year. The collaboration allows us to negotiate a licenseagreement for any customized formulation using our NeoPhectin technology thatmay be developed commercially. Additionally, we entered into an exclusivelicense agreement with Nippon Kayaku Co., Ltd. for the Japanese developmentrights for cintredekin besudotox. In addition to the $2 million up-frontlicensing fee we received in January 2005, we have also contracted toreceive future additional license fees, milestone payments and royalties.Nippon Kayaku is responsible for all development costs in Japan.

In addition to our ongoing efforts to enter intoadditional collaborations, we continue to monitor and analyze our expenses inan effort to further reduce our net loss. We currently estimate that the fiscalyear 2005 net loss will be between $38 and $41 million, or $1.60 to $1.75 pershare. However, we now expect that cash used in operations will be between $36and $39 million for 2005. This compares to our fiscal year 2004 net loss ofapproximately $57.6 million, or $2.51 per share, and cash used in operations ofapproximately $52.2 million.

**Results of Operations – Three Month Period Ended March 31, 2005vs. Three Month Period Ended March 31, 2004.**

The Company recorded product revenue of $6,300 for the three monthperiod ended March 31, 2005 as compared to $12,200 for the three month periodended March 31, 2004.  The solesource of product revenue in both periods was from sales of NeoPhectin andNeoPhectin-AT.  During the three monthperiod ended March 31, 2005, we also recognized a total of $65,000 of revenueas we recognized license and collaboration fees received in 2005.  No license fee or collaboration revenue wasrecognized in 2004.

 

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Research and development expense for the three monthperiod ended March 31, 2005 decreased by approximately $3.2 million as comparedto the same period in 2004. The decrease in research and development expenseswas primarily related to a significant reduction in the number of clinicaltrials being conducted by the Company in 2005, resulting in a reduction inexpenses of approximately $1.7 million, reduced research and developmentpayroll related expenses of approximately $0.8 million primarily resulting fromthe 2004 workforce reduction, and a reduction of approximately $0.7 million inexpenses related to non-project specific research.

Selling,general and administrative expenses were approximately $3.2 million for thethree month periods ended March 31, 2005 and March 31, 2004. For thethree months ended March 31, 2005, the Company incurred approximately $0.4million less of selling, general, and administrative expenses, which was offsetby an accrual for costs of $0.4 million related to the separation agreemententered into between the Company and Greg Young, former President and CEO.

 

TheCompany generated interest income on cash and investments of approximately $0.4million and $0.2 million for the three month periods ended March 31, 2005and March 31, 2004, respectively. The increase in interest income in 2005 was primarily due to increasesin short-term interest rates.

 

Asa result of the above items, net loss and basic and diluted loss per share forthe three month periods ended March 31, 2005 and March 31, 2004 were approximately$10.9 million and $14.2 million, respectively, and $0.46 and $0.65,respectively.

 

**Liquidityand Capital Resources**

 

Asof March 31, 2005, we had approximately $54.4 million in cash and cashequivalents and no debt. All excess cash is currently invested in marketablesecurities with less than three months to maturity. We currently believe thatour cash on hand at March 31, 2005, should be adequate to fund ouroperations into at least the fourth quarter of 2006 at current and projectedlevels of development and general corporate activity. In January 2005, wereceived approximately $2.2 million for one time, nonrefundable collaborationand licensing fees. These fees have been recorded as “Deferred Revenue” on theCompany’s Consolidated Balance Sheet at March 31, 2005 and are being recognizedas revenue over the estimated life of the agreements.  

 

The primary use of cash over the next 12-24 monthswill be to fund our clinical and pre-clinical research and development efforts.The most significant expenses will be incurred in relation to the PRECISE trialfor our brain tumor drug product candidate, cintredekin besudotox. At thepresent time, we expect to spend approximately $14 million over the next 21months to complete the PRECISE trial. Additional expenses are also expected tobe incurred as we continue to move our Phase I and Phase II drug productcandidates towards, and potentially into, Phase II and Phase III clinicaltrials.

 

Wemay seek to satisfy our future funding requirements through public or privateofferings of securities, with collaborative or other arrangements withcorporate partners or from other sources. In January 2004, we receivedapproximately $73.5 million, after underwriting fees and expenses, throughthe sale of common stock via a shelf registration.  Currently, the Company has the ability toissue approximately an additional $70 million, but this shelf registration willexpire on December 17, 2005, and is conditioned on the Company’s timelyfiling of all required documents with the SEC. Although we do not currentlyanticipate needing to access our shelf registration prior to August 2005, ourability to do so could be hindered by our late filing in August 2004 of arequest for extension for filing our quarterly report on Form 10-Q, thoughthe report itself was filed within the extension period.  In addition, necessary financing may not beavailable when needed or on terms acceptable to us. If adequate financing isnot available, we may be required to delay, scale back or eliminate certain ofour research and development programs, relinquish rights to certain of ourtechnologies, cancer drugs or products, or license third parties tocommercialize products or technologies that we would otherwise seek to developourselves.

 

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

 

Thefollowing table summarizes our estimated contractual obligations as ofMarch 31, 2005:

 
| ** **                                           | ** ** | **Payments Due by Period** | ** ** |
|------------------------------------------------------|------------|----------------------------|------------|
| **Contractual  Obligations**                         | ** ** | **Total**                  | ** ** | **Less than  1 year ** | ** ** | **1-3 years ** | ** ** | **3-5 years ** | ** ** | **More than  5 years ** | ** ** |
| Operating lease                                      |       | $                          | 1,020,222  |   | $ | 470,822 |   | $ | 546,999 |   | $ | 2,401 |   | $ | — |   |
| Clinical trial monitoring (CRO)  agreements (1)      |       | 2,737,331                  |       | 1,717,230 |   | 1,020,101 |   | — |   | — |   |
| License agreements—milestone based  payments(2) |       | 2,525,000                  |       | 475,000 |   | 600,000 |   | 350,000 |   | 1,100,000 |   |
| Total                                                |       | $                          | 6,282,553  |   | $ | 2,663,052 |   | $ | 2,167,100 |   | $ | 352,401 |   | $ | 1,100,000 |   |

 

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(1)           These amounts include only contractual obligations fordirect expenses for the PRECISE trial, exclusive of clinical trial site costsfor treating patients.

 

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

 

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**Critical Accounting Policies**

 

Inpreparing the Company’s financial statements in conformity with U.S. generallyaccepted accounting principles, management must make a variety of decisionswhich impact the reported amounts and related disclosures. Such decisionsinclude the selection of the appropriate accounting principles to be applied,the assumptions on which to base accounting estimates, and the consistentapplication of those accounting principles. Due to the type of industry in whichthe Company operates and the nature of its business, the following accountingpolicies are those that management believes are most important to the portrayalof the Company’s financial condition and results and that require management’smost difficult, subjective or complex judgments, often as a result of the needto make estimates about the effect of matters that are inherently uncertain.

 

*Income Taxes*

 

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

*** ***

*Contingencies*

** **

To properly account for and provide disclosure ofloss contingencies, management must apply judgment in determining whether aloss contingency is: probable, reasonably possible, or remote. In instancesmanagement 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. Managementmust also apply judgment in determining whether or not disclosure of losscontingencies that have been accrued should be made for the consolidatedfinancial statements not to be misleading.

*Stock-Based Compensation*

 

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

*Revenue Recognition*

* *

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

 

TheCompany provides for general rights of return of products sold to itsdistributors.  Appropriately determiningrevenue recognition when the general right of return exists requires the use ofjudgment in estimating the level of returns. In certain circumstances, management may not be able to develop areasonable estimate of the level of returns. Making such a determination

 

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alsorequires the use of significant judgment. Management has determined that given the limited sales history ofNeoPhectin, the Company is currently unable to develop a reasonable estimate ofthe level of returns.  Accordingly, theCompany is currently recognizing revenue for products shipped to itsdistributors upon the expiration of the right of return which occurs upon theearlier of shipment of product by the distributor to an end-user or, dependingon the distributor, 60 to 180 days. 

 

The Company has recently entered into collaborationand license agreements with third parties that contain multiple deliverables.Under the provisions of EITF 00-21, a determination must be made on eachcontract as to whether a deliverable constitutes a separate accounting unit.The amount of revenue to be recognized is based on the fair value for each unitof accounting within the arrangement. Management judgment is required todetermine, based upon the facts and circumstances of each arrangement, whetheror not each deliverable has standalone value and whether or not there exists asufficient level of objective and reliable evidence of fair value of the deliverables.

The Company has recently entered into collaborationand license agreements with third parties that entitle it to collectnon-refundable up-front payments. These payments are recognized ratably overthe term of the contractual arrangement or expected period of performance,whichever is longer. Management judgment is required to estimate the periodover which recognition of these payments occurs.

 

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

 

Asof March 31, 2005, we did not own any derivative instruments, but we wereexposed to market risks, primarily changes in U.S. interest rates. As ofMarch 31, 2005, we held total cash and cash equivalents of $54,364,828.All cash equivalents have a maturity less than 90 days. Declines in interestrates over time will reduce our interest income from our investments. Basedupon our balance of cash and cash equivalents as of March 31, 2005, adecrease in interest rates of 1.0% would cause a corresponding decrease in ourannual interest income of approximately $543,648.

 

** **

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

 

Asof March 31, 2005, we carried out an evaluation, under the supervision andwith the participation of our management, including our Chief Executive Officerand Chief Financial Officer, of the effectiveness of the design and operationof our disclosure controls and procedures. Based on that evaluation, ourmanagement, including the Chief Executive Officer and Chief Financial Officer,concluded that our disclosure controls and procedures are operating effectivelyas designed.

 

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

 

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**PART II - OTHER INFORMATION**

 

Item 1 - Legal Proceedings

 

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

 

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

 

Item2.                                                           Unregistered Sales of Equity Securities andUse of Proceeds

None

 

Item3.                                                           Defaults Upon Senior Securities

None

 

Item4.                                                           Submission of Matters to a Vote ofSecurity-Holders

None

 

Item 5.                                                           Other Information

None

 

Item6.                                                             Exhibits

 

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

 

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**SIGNATURE PAGE**

 

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

 
|                | NEOPHARM,  INC. |
|---------------------|-----------------|
| Date:  May 10, 2005 | By:             | /s/  Lawrence A. Kenyon |
|                |            | Lawrence  A. Kenyon, |
|                |            | *Chief  Financial Officer  (Principal Accounting Officer and  Principal Financial Officer)* |

 

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