**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 September 30, 2003**                                                                                                                                            |
|                                                                                                                                                                                               |                                                                                                    |
| **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 whetherthe registrant (1) has filed all reports required to be filed bySection 13 or 15(d) of the Securities Exchange Act of 1934 during thepreceding 12 months (or for such shorter period that the registrant wasrequired to file such reports), and (2) has been subject to such filingrequirements for the past 90 days.  Yes  ý   No  o

 

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

 

As of October 31, 2003 thenumber of shares outstanding of each of the issuer’s classes of common stockwas as follows:

 

| **Title of  each class**           |   | **Number of  shares outstanding** |
|------------------------------------|--------|-----------------------------------|
| Common Stock ($.0002145 par value) |   | 18,840,268                        |

 

 

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NEOPHARM, INC.(A DELAWARE CORPORATION)FORM 10QINDEX

 
| PART I. FINANCIAL INFORMATION |
|-------------------------------|
|                          | Item 1. | Financial Statements |
|                          |   | Balance  Sheets as of September 30, 2003 (Unaudited) and December 31, 2002 |
|                          |   | Statements of Operations for the three and nine months ended  September 30, 2003 and 2002 (Unaudited) |
|                          |   | Statements of Cash Flows for the nine months ended September 30,  2003 and 2002 (Unaudited) |
|                          |   | Notes to Financial Statements (Unaudited) |
|                          | Item 2. | Management’s Discussion and Analysis of  Financial Condition and Results of Operations |
|                          | Item 3. | Quantitative and Qualitative Disclosures  About Market Risk |
|                          | Item 4 | Controls and Procedures |
| PART II. OTHER INFORMATION    |
|                          | Item 1. | Legal Proceedings |
|                          | Item 2. | Changes in Securities and Use of Proceeds |
|                          | Item 3. | Defaults Upon Senior Securities |
|                          | Item 4. | Submission of Matters to a Vote of  Security-Holders |
|                          | Item 5. | Other Information |
|                          | Item 6. | Exhibits and Reports on Form 8-K |
| SIGNATURE  PAGE               |

 

2

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**PART I - FINANCIAL INFORMATION**

 

**Item 1 - FinancialStatements**

 

**NEOPHARM, INC.(A Delaware Corporation)Balance Sheets**

 
|                                                                                                                                      |   | **September 30,  2003** |       | **December 31,  2002** |   |
|-------------------------------------------------------------------------------------------------------------------------------------------|--------|------------------------------|------------|-----------------------------|--------|
|                                                                                                                                      |   | **(Unaudited)**              |       |                        |   |
| **ASSETS**                                                                                                                                |   |                         |       |                        |   |
| Current assets:                                                                                                                           |   |                         |       |                        |   |
| Cash and cash equivalents                                                                                                                 |   | $                            | 51,055,135 |                        | $      | 87,591,975 |   |
| Short-term investment in  marketable securities                                                                                           |   | 2,497,073                    |       | 3,508,222                   |   |
| Prepaid expenses                                                                                                                          |   | 1,051,084                    |       | 454,893                     |   |
| Other receivables                                                                                                                         |   | 331,321                      |       | 137,954                     |   |
| Total  current assets                                                                                                                     |   | 54,934,613                   |       | 91,693,044                  |   |
| Equipment and furniture:                                                                                                                  |   |                         |       |                        |   |
| Equipment                                                                                                                                 |   | 4,635,071                    |       | 4,192,551                   |   |
| Furniture                                                                                                                                 |   | 868,580                      |       | 801,783                     |   |
| Leasehold improvements                                                                                                                    |   | 594,007                      |       | 428,708                     |   |
| Less accumulated depreciation                                                                                                             |   | (1,982,849                   | )          | (1,178,765                  | )      |
| Total equipment and  furniture, net                                                                                                       |   | 4,114,809                    |       | 4,244,277                   |   |
| Total assets                                                                                                                              |   | $                            | 59,049,422 |                        | $      | 95,937,321 |   |
|                                                                                                                                      |   |                         |       |                        |   |
| **LIABILITIES AND STOCKHOLDERS’ EQUITY**                                                                                             |   |                         |       |                        |   |
| Current liabilities:                                                                                                                      |   |                         |       |                        |   |
| Accrued clinical trial  expense                                                                                                           |   | $                            | 3,249,197  |                        | $      | 1,611,100 |   |
| Accrued compensation                                                                                                                      |   | 1,322,554                    |       | 478,026                     |   |
| Accrued legal expenses                                                                                                                    |   | 1,130,544                    |       | 1,018,414                   |   |
| Accounts payable                                                                                                                          |   | 478,410                      |       | 492,816                     |   |
| Other accrued expenses                                                                                                                    |   | 254,670                      |       | 427,971                     |   |
| Total current liabilities                                                                                                                 |   | 6,435,375                    |       | 4,028,327                   |   |
|                                                                                                                                      |   |                         |       |                        |   |
| 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: 18,840,268 and 18,804,258 shares issued  and outstanding, respectively |   | 4,038                        |       | 3,509                       |   |
| Additional paid-in capital                                                                                                                |   | 171,425,893                  |       | 170,805,705                 |   |
| Accumulated deficit                                                                                                                       |   | (118,815,884                 | )          | (78,900,220                 | )      |
| Total stockholders’ equity                                                                                                           |   | 52,614,047                   |       | 91,908,994                  |   |
| Total liabilities and  stockholders’ equity                                                                                          |   | $                            | 59,049,422 |                        | $      | 95,937,321 |   |

 

The accompanying notes are an integral part of these financialstatements.

 

3

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**NEOPHARM,INC.(A Delaware Corporation)Statements of OperationsThree and Nine Months Ended September 30, 2003 and 2002**(Unaudited)

 
|                                        |   | **Three Months Ended**       |        | **Nine Months Ended**        |   |
|---------------------------------------------|--------|------------------------------|-------------|------------------------------|--------|
|                                        |   | **September 30,  2003** |        | **September 30,  2002** |   | **September 30,  2003** |   | **September 30,  2002** |   |
| Revenues                                    |   | $                            | —      |                         | $      | — |   | $ | — |   | $ | — |   |
| Expenses:                                   |   |                         |        |                         |   |   |   |   |   |
| Research and development                    |   | 9,164,262                    |        | 8,978,572                    |   | 25,040,104 |   | 21,620,967 |   |
| General and administrative                  |   | 3,168,363                    |        | 1,841,795                    |   | 15,453,434 |   | 5,197,662 |   |
| Related party expenses                      |   | 35,587                       |        | 45,798                       |   | 110,188 |   | 157,351 |   |
| Total expenses                              |   | 12,368,212                   |        | 10,866,165                   |   | 40,603,726 |   | 26,975,980 |   |
| Loss from operations                        |   | (12,368,212                  | )           | (10,866,165                  | )      | (40,603,726 | ) | (26,975,980 | ) |
|                                        |   |                         |        |                         |   |   |   |   |   |
| Interest income                             |   | 148,615                      |        | 602,200                      |   | 688,062 |   | 1,888,379 |   |
| Net loss                                    |   | $                            | (12,219,597 | )                            | $      | (10,263,965 | ) | $ | (39,915,664 | ) | $ | (25,087,601 | ) |
| Net loss per share —                   |   |                         |        |                         |   |   |   |   |   |
| Basic and diluted                           |   | $                            | (0.65       | )                            | $      | (0.55 | ) | $ | (2.12 | ) | $ | (1.34 | ) |
| Weighted average shares  outstanding — |   |                         |        |                         |   |   |   |   |   |
| Basic and diluted                           |   | 18,832,741                   |        | 18,714,058                   |   | 18,822,903 |   | 18,701,306 |   |

 

The accompanying notes are an integral part of these financialstatements.

 

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**NEOPHARM,INC.(A Delaware Corporation)Statements of Cash FlowsNine Months Ended September 30, 2003 and 2002**(Unaudited)

 
|                                                                         |   | **Nine Months Ended**        |        |
|------------------------------------------------------------------------------|--------|------------------------------|-------------|
|                                                                         |   | **September 30,  2003** |        | **September 30,  2002** |   |
| Cash flows from operating  activities:                                       |   |                         |        |   |   |
| Net loss                                                                     |   | $                            | (39,915,664 | ) | $ | (25,087,601 | ) |
| Adjustments to reconcile net  loss to net cash used in operating activities: |   |                         |        |   |   |
| Depreciation and amortization                                                |   | 804,084                      |        | 978,550 |   |
| Stock-based compensation  expense                                            |   | 434,215                      |        | 79,600 |   |
| Changes in assets and  liabilities:                                          |   |                         |        |   |   |
| Increase in current assets                                                   |   | (789,558                     | )           | (1,109,001 | ) |
| Increase in current  liabilities                                             |   | 2,407,048                    |        | 3,984,231 |   |
| Net cash and cash equivalents  used in operating activities                  |   | (37,059,875                  | )           | (21,154,221 | ) |
|                                                                         |   |                         |        |   |   |
| Cash flows from investing  activities:                                       |   |                         |        |   |   |
| Proceeds from maturities of  marketable securities                           |   | 3,508,362                    |        | 25,981,513 |   |
| Proceeds from sales of  marketable securities                                |   | —                       |        | 9,168,783 |   |
| Purchase of marketable  securities                                           |   | (2,497,213                   | )           | (23,381,239 | ) |
| Purchase of equipment and  furniture                                         |   | (674,616                     | )           | (2,173,257 | ) |
| Net cash and cash equivalents  provided by investing activities              |   | 336,533                      |        | 9,595,800 |   |
|                                                                         |   |                         |        |   |   |
| Cash flows from financing activities:                                        |   |                         |        |   |   |
| Cash paid in lieu of  fractional shares for stock dividend                   |   | (9,060                       | )           | — |   |
| Proceeds from issuance of  common stock                                      |   | 195,562                      |        | 937,782 |   |
| Net cash and cash equivalents  provided by financing activities              |   | 186,502                      |        | 937,782 |   |
|                                                                         |   |                         |        |   |   |
| Net decrease in cash and cash  equivalents                                   |   | (36,536,840                  | )           | (10,620,639 | ) |
| Cash and cash equivalents,  beginning of period                              |   | 87,591,975                   |        | 106,525,864 |   |
| Cash and cash equivalents,  end of period                                    |   | $                            | 51,055,135  |   | $ | 95,905,225 |   |
|                                                                         |   |                         |        |   |   |
| Supplemental disclosure of  cash paid for:                                   |   |                         |        |   |   |
| Interest                                                                     |   | $                            | —      |   | $ | — |   |
| Income taxes                                                                 |   | $                            | —      |   | $ | — |   |

 

The accompanying notes are an integral part of these financialstatements.

 

5

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**NEOPHARM, INC.(A Delaware Corporation)**

**NOTES TO FINANCIALSTATEMENTS****September 30, 2003**

 

**Note 1  Basis of Presentation**

 

The financial information herein is unaudited. The balance sheet as ofDecember 31, 2002 is derived from audited financial statements.

 

The accompanying unaudited financial statements of NeoPharm, Inc. (the“Company”) have been prepared in accordance with generally accepted accountingprinciples for interim financial information and with the instructions to Form10-Q and Rule 10-01 of Regulation S-X. Accordingly, they do not contain all ofthe information and footnotes required by accounting principles generallyaccepted in the United States of America for complete financial statements. Inthe opinion of the Company, the accompanying unaudited interim financialstatements contain all adjustments (consisting of normal recurring adjustments)necessary to present fairly the Company’s financial position as ofSeptember 30, 2003, and the results of its operations and its cash flowsfor the three and nine months ended September 30, 2003 and 2002.

 

While the Company believes that the disclosures presented are adequateto make the information not misleading, it is suggested that these financialstatements be read in conjunction with the financial statements and notesincluded in the Company’s 2002 Annual Report on Form 10-K filed with theSecurities and Exchange Commission.

 

On May 13, 2003, the Company’s Board of Directors declared a 15%common stock dividend to stockholders of record on June 3, 2003, which wasissued on June 10, 2003.  All shareinformation for prior periods has been restated to reflect the stock dividend.

 

**Note 2  Stock-based Compensation**

 

The Company applies APB Opinion No. 25 “Accounting for Stock Issued toEmployees”, and related interpretations, in accounting for stock options andrestricted stock granted to its employees under its 1998 Equity Incentive Planand applies the disclosure requirements of Statement of Financial AccountingStandards No. 123 “Accounting for Stock Issued to Employees” (“SFAS 123”).  Equity instruments issued to non-employeesare accounted for in accordance with SFAS 123.

 

The following table illustrates the effect on net loss and loss pershare for the three and nine months ended September 30, 2003 and 2002 ifthe Company had applied the fair value recognition provisions of SFAS 123 tostock-based employee compensation.

 
|                                                                                                             |   | **For the  three months ended:** |        | **For the  nine months ended:** |   |
|------------------------------------------------------------------------------------------------------------------|--------|----------------------------------|-------------|---------------------------------|--------|
|                                                                                                             |   | **September 30,  2003**     |        | **September 30,  2002**    |   | **September 30,  2003** |   | **September 30,  2002** |   |
|                                                                                                             |   |                             |        |                            |   |   |   |   |   |
| Net loss, as  reported                                                                                           |   | $                                | (12,219,597 | )                               | $      | (10,263,965 | ) | $ | (39,915,664 | ) | $ | (25,087,601 | ) |
| Add stock-based  employee compensation expense included in reported net loss                                     |   | 94,867                           |        | —                          |   | 192,825 |   | — |   |
| Deduct total  stock-based employee compensation expense determined under fair-value-based  method for all awards |   | (1,990,321                       | )           | (1,360,357                      | )      | (5,825,541 | ) | (6,026,618 | ) |
| Pro forma net  loss                                                                                              |   | $                                | (14,115,051 | )                               | $      | (11,624,322 | ) | $ | (45,548,380 | ) | $ | (31,114,219 | ) |
|                                                                                                             |   |                             |        |                            |   |   |   |   |   |
| Basic and  diluted loss per share of common stock                                                                |   |                             |        |                            |   |   |   |   |   |
| As reported                                                                                                      |   | $                                | (0.65       | )                               | $      | (0.55 | ) | $ | (2.12 | ) | $ | (1.34 | ) |
| Pro forma                                                                                                        |   | $                                | (0.75       | )                               | $      | (0.62 | ) | $ | (2.42 | ) | $ | (1.66 | ) |

 

The effects of applying SFAS 123 in this pro forma disclosure are notindicative of future amounts.  SFAS 123did not apply to awards prior to 1995. Additional awards in future periods are anticipated.

 

6

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**Note 3 Loss Per Share**

 

The following table sets forth the computation of the basic and dilutednet loss per share:

 
|                                |   | **For the  three months ended:** |        | **For the  nine months ended:** |   |
|-------------------------------------|--------|----------------------------------|-------------|---------------------------------|--------|
|                                |   | **September 30,  2003**     |        | **September 30,  2002**    |   | **September 30,  2003** |   | **September 30,  2002** |   |
| Numerator:                          |   |                             |        |                            |   |   |   |   |   |
| Net loss                            |   | $                                | (12,219,597 | )                               | $      | (10,263,965 | ) | $ | (39,915,664 | ) | $ | (25,087,601 | ) |
|                                |   |                             |        |                            |   |   |   |   |   |
| Denominator:                        |   |                             |        |                            |   |   |   |   |   |
| Weighted average shares outstanding |   | 18,832,741                       |        | 18,714,058                      |   | 18,822,903 |   | 18,701,306 |   |
|                                |   |                             |        |                            |   |   |   |   |   |
| Loss per share - basic and diluted  |   | $                                | (0.65       | )                               | $      | (0.55 | ) | $ | (2.12 | ) | $ | (1.34 | ) |
|                                |   |                             |        |                            |   |   |   |   |   |
| Potential common share equivalents: |   |                             |        |                            |   |   |   |   |   |
| Stock options                       |   | 3,305,916                        |        | 2,959,640                       |   | 3,307,663 |   | 2,885,182 |   |

 

As the Company has incurred a net loss for all periods presented, basicand diluted per share amounts are equivalent as the effect of all potentialcommon share equivalents is anti-dilutive.

 

**Note 4  Transactions with Related Parties**

 

The following table provides further detail of the related partyexpenses reflected in the statements of operations.

 
|                            |   |              |   | **For the  three months ended:** |   | **For the  nine months ended:** |   |
|---------------------------------|--------|-------------------|--------|----------------------------------|--------|---------------------------------|--------|
| **Related Party**               |   | **Expense  Type** |   | **September 30,  2003**     |   | **September 30,  2002**    |   | **September 30,  2003** |   | **September 30,  2002** |   |
| Akorn,  Inc.                    |   | Consulting        |   | $                                | 3,750  |                            | $      | 7,669 |   | $ | 15,169 |   | $ | 23,006 |   |
| E.J.  Financial Enterprises     |   | Consulting        |   | 31,250                           |   | 31,250                          |   | 93,750 |   | 93,750 |   |
| E.J. Financial Enterprises      |   | Direct Expenses   |   | 587                              |   | 54                              |   | 1,269 |   | 1,216 |   |
| Unicorn Pharma Consulting, Inc. |   | Consulting        |   | —                           |   | 6,825                           |   | — |   | 39,379 |   |
| Total related party expenses    |   |              |   | $                                | 35,587 |                            | $      | 45,798 |   | $ | 110,188 |   | $ | 157,351 |   |

 

In December 2001, NeoPharmentered into a transaction whereby NeoPharm loaned to Akorn, Inc., a Louisianacorporation, $3,250,000 to assist Akorn in the completion of its lyophilizedproducts manufacturing facility in Decatur, Illinois.  Dr. John N. Kapoor, NeoPharm’s Chairman of the Board ofDirectors, is, and was in December 2001, also the Chairman of the Akorn Boardof Directors and holds a substantial stock position in both companies.  In connection with the loan transaction,NeoPharm entered into the following agreements:  Promissory Note, dated December 20, 2001, in the originalprincipal amount of $3,250,000 by Akorn to NeoPharm; Processing Agreement,dated December 20, 2001, by and between Akorn and NeoPharm; Subordination andIntercreditor Agreement, dated December 20, 2001, by and between John N.Kapoor, as Trustee under The John N. Kapoor Trust, dated September 20, 1989 andNeoPharm; and a Subordination, Standby and Intercreditor Agreement, datedDecember 20, 2001, by and among Akorn, Akorn (New Jersey), Inc., The NorthernTrust Company and NeoPharm.  The PromissoryNote issued by Akorn was due in December 2006, and accrued interest at a rateequal to that received on the Company’s investments in marketable securities,which is lower than the interest rate paid by Akorn on its other outstandingdebt.  The Processing Agreement grantsNeoPharm access to at least 15% of the annual lyophilization manufacturingcapacity at Akorn at most favored nations 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 time thesetransactions were entered into, Akorn represented that the  manufacturing facility would beoperational  in 2003, approximately thetime when NeoPharm anticipated it would need to manufacture its lyophilizedproducts for Phase II/III clinical trials.   In 2001, NeoPharm recorded the Promissory Note net of a valuationallowance of $1,266,619 reflecting the difference between the actual loanamount and the present value of the loan using an estimated market interestrate of 10%.  As of December 31, 2002,Akorn had not published financial statements for the third and fourth quarterof 2002.  Primarily as a result of thelack of published financial information by Akorn, the Company determined thePromissory Note was impaired and recorded a charge to fully reserve for thePromissory Note and accrued interest as of December 31, 2002.  In May 2003, Akorn published financialstatements for the periods through March 31, 2003.  On August 18, 2003, after NeoPharm had confirmed a breach of theProcessing Agreement, and therefore the Promissory Note, due to Akorn’s failureto provide lyophilization manufacturing capacity by June 30, 2003, NeoPharmpresented Akorn with a formal “Notice of Default” on the Promissory Note.  Because the carrying value of the PromissoryNote is zero, there is no financial statement impact as a result of any eventof default under, or non-payment of, the Promissory Note.

7

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**Note 5  Investments**

 

TheCompany considers all highly liquid investments purchased with an originalmaturity of three months or less to be cash equivalents. The carrying value ofthese investments approximates the fair market value. Short -term investment inmarketable securities includes liquid investments purchased with an originalmaturity of between three months and one year. As provided by SFASNo. 115, the Company has elected to treat all of its investments inmarketable securities as “available-for-sale”, which requires these investmentsto be recorded at fair market value. Unrealized gains and losses, net ofrelated tax effect, on available-for-sale securities deemed to be temporary areexcluded from earnings and are reported as a separate component of othercomprehensive income until realized. Realized gains and losses from the sale ofavailable-for-sale securities are determined on a specific identificationbasis. A decline in market value of available-for-sale securities that isdeemed to be other than temporary, results in the reduction of the carryingamount to fair value. The impairment is charged to earnings and a new costbasis for the security is established. At September 30, 2003, theCompany’s investments in marketable securities consisted primarily ofcommercial paper, which are recorded at cost plus accrued interest as thisapproximated the fair market value of the securities held. Dividend andinterest income are recognized when earned. No investments were sold during thethree and nine month periods ended September 30, 2003.  Realized gain on investments sold during thethree and nine month periods ended September 30, 2002 was $3,117 andrealized loss on investments sold was $29,873.

 

**Note 6  Contingencies**

 

OnApril 19, 2002, the Company filed a Demand for Arbitration with the AmericanArbitration Association in accordance with the terms of its License Agreementdated February 19, 1999 (the “License Agreement”) with PharmaciaCorporation (now Pfizer), Pharmacia and Upjohn, Inc. and Pharmacia andUpjohn Company (collectively, “Pharmacia”), for the purpose of resolving adispute with Pharmacia concerning delays in the development programs for LEP(Liposome Encapsulated Paclitaxel) and LED (Liposome Encapsulated Doxorubicin)which were being conducted by Pharmacia. The Company contends that Pharmaciafailed in its duty under the License Agreement to use reasonable efforts todevelop LEP and LED and that such failure constitutes a breach of the LicenseAgreement. The Company further contends

 

8

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thatPharmacia breached its duty to consult with NeoPharm on the progress of thedrug development program and thereby impaired NeoPharm’s ability to monitor thedevelopment of these compounds. The Company is seeking all damages to which itis entitled. NeoPharm believes that these damages are substantial. OnMay 16, 2002, Pharmacia responded by denying the Company’s allegations,asserting various counterclaims and seeking restitution of monies paid,reimbursement of out-of-pocket expenses and substantial punitive damages.Subsequently, Pharmacia stated in a letter dated November 19, 2002, thatit did not intend to move forward with the clinical development of NeoPharm’sNeoLipidTM LEP (LEP-ETU) because of its contention that NeoPharm had not providedPharmacia with sufficient product data and test samples, a claim which NeoPharmdenies. Pharmacia also stated that it would not continue to develop the earlierformulations of LEP and LED. Although Pharmacia indicated that it did notintend to continue with the clinical development of LEP and LED, Pharmacia didnot indicate that it had terminated the License Agreement. As a result, inNovember 2002, NeoPharm terminated the License Agreement in order to allowNeoPharm to continue with the further development of NeoLipidTM formulations ofLEP, as well as LED. Pharmacia disputes the propriety of the termination andhas included the termination as part of the arbitration hearing. InJanuary 2003, NeoPharm reached an agreement with Pharmacia that allowsNeoPharm to reference Pharmacia’s LEP Investigational New Drug application(IND) and start human clinical trials with LEP-ETU. The arbitration proceedingis currently ongoing and no prediction can be made as to the outcome of theclaims that the Company and Pharmacia have asserted against each other, or theamounts, if any, which either party may be awarded against the other, whichrecoveries or liabilities could be substantial. The arbitration hearing beganon May 28, 2003, was adjourned on June 27, 2003, and reconvened onAugust 25, 2003. The Arbitral Panel has indicated that the taking ofevidence will conclude before the end of 2003. NeoPharm has completedpresenting its case to the panel.

 

In January 2002, at Pharmacia’s request and in an attempt to assistPharmacia in moving forward with its development efforts, the Company agreed toapply NeoPharm’s NeoLipidTM technology to paclitaxel.  NeoLipidTM technology is a new technology developed by the Company forits other liposomal compounds, was developed subsequent to the execution of theagreement with Pharmacia and has never been licensed to Pharmacia. Although NeoPharmhad no obligation to assist in the development of liposomal paclitaxel,NeoPharm agreed to attempt to formulate a NeoLipidTM formulation of paclitaxel (LEP-ETU). NeoPharm incurredexpenses during 2002 related to its efforts to develop LEP-ETU. The Company hassent invoices totaling over $1,500,000 to Pharmacia for work conducted byNeoPharm to develop LEP-ETU. NeoPharm has not received payment on the invoicessent to Pharmacia and these amounts have not been included in the results ofoperations. NeoPharm asserts that it is entitled to payment on these invoices.

 

TheCompany was also 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. The original lawsuits also named as individualdefendants John N. Kapoor, Chairman of the Company, and James M. Hussey, theCompany’s President and CEO, and Dr. Aquilur Rahman, a former director andexecutive officer of the Company. The first of these Class Action Suits wasfiled on April 26, 2002 and all of the Class Action Suits have been filedin the United States District Court for the Northern District of Illinois,Eastern Division. On September 16, 2002, a consolidated amended complaintwas filed against NeoPharm in this matter. The amended complaint shortened theclass period to October 31, 2001 through April 19, 2002, removedDr. Rahman as a defendant, and added Dr. Imran Ahmad, the Company’scurrent Chief Scientific Officer and Senior Vice President of Research andDevelopment, as a defendant. The Company intends to vigorously defend each andevery claim in the class action suits and, on November 4, 2002, moved tohave the complaint dismissed. The Company’smotion to dismiss was granted in part and denied in part inFebruary 2003.  Dr. Kapoor wasdismissed from the lawsuit at that time. No trial date has been set. In the opinion of management, resolution ofthis litigation is not currently expected to have a material adverse impact onthe results of operations or financial position of the Company, as the Companycurrently maintains insurance covering its officers and directors.

 

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, though itshould be noted that while the Company's drug compounds are administered topatients in the Company's ongoing clinical trials, the Company does not at thistime have any products which are approved for sale to the general public. If aproduct liability suit were filed and a judgment entered against the Company,it could have a material adverse effect upon the Company’s operations andfinancial condition. While the Company maintains insurance to cover the use ofits products in clinical trials, at this time the Company does not maintaininsurance covering the sale of its products nor is there any assurance that itwill be able to obtain or maintain such insurance on acceptable terms or withadequate coverage against potential liabilities.

 

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**Note 7  SubsequentEvents**

 

On October 1, 2003, the Company filed aregistration statement with the Securitites and Exchange Commission for theproposed offering from time to time of up to $125 million of NeoPharm commonstock, preferred stock or a combination of these securities. The Company has noimmediate plans to sell any securities under this registration statement, andthese securities may not be sold, nor may offers to buy be accepted, prior tothe time the registration statement is declared effective.

 

On October 7, 2003, NeoPharm entered into an Amended and RevisedPromissory Note, an Amendment to the Processing Agreement and a Subordinationand Intercreditor Agreement with LaSalle Bank, N.A., in connection with Akorn’sconsummation of a new loan and credit facility with LaSalle. Pursuant to theAmended and Restated Promissory Note, NeoPharm agreed to waive current Eventsof Default under the original Promissory Note and Akorn agreed to increase theinterest rate  to prime rate plus 175basis points and to  provide a repaymentschedule more favorable to NeoPharm. Under the terms of the Amendment to the Processing Agreement and theAmended and Restated Promissory Note, Akorn committed to be prepared to provide lyophilization manufacturingcapacity by October 1, 2004. Finally, under the terms of the Subordination andIntercreditor Agreement with LaSalle, Neopharm agreed to subordinate collectionof amounts outstanding under the Amended and Restated Promissory Note toLaSalle’s collection of amounts outstanding under LaSalle’s loan and creditfacility with Akorn.

 

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

 

Thefollowing should be read in conjunction with the financial statements andrelated footnotes and Management’s Discussion and Analysis of FinancialCondition and Results of Operations included in the Company’s Annual Report onForm 10-K.  The results discussed beloware not necessarily indicative of the results to be expected in any futureperiods.  The following discussioncontains forward-looking statements that are subject to risks and uncertaintieswhich could cause actual results to differ from statements made. See “ForwardLooking Statements” below.

 

**Overview**

 

We area 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. Since we begandoing business in June 1990, we have devoted our resources primarily tofunding research and productdevelopment programs. We expect to continue to incur losses as we continue ourresearch and development activities, which include the sponsorship of humanclinical trials for our compounds.

 

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Duringthe quarter ended September 30, 2003, we continued to advance our PhaseI/II compounds towards Phase II/III clinical trials. The compounds currently inclinical development include: IL13-PE38 for the treatment of glioblastomamultiforme; LE-SN38 (liposomal SN38) for the treatment of colorectal and othercancers; LEM (liposomal mitoxantrone) for the treatment of prostate cancer; and,LErafAON (liposomal craf antisense oligonucleotide) for the treatment ofradiation and/or chemotherapy resistant tumors. In addition, we began a Phase Ibridging study in August 2003 for LEP-ETU, our new NeoLipidTM formulationof liposomal paclitaxel.  We nowanticipate the enrollment of the first patient in our pivotal Phase IIIclinical trial for our lead compound, IL13-PE38, in the fourth quarter of 2003or the first quarter of 2004.

 

Researchand development expenses increased by approximately 2% in the third quarter of2003 as compared to the third quarter of 2002, and increased approximately 16%during the first nine months of 2003 versus the first nine months of 2002.  The Company’s revised estimates for 2003called for total research and development expenses to increase approximately 8%for the third quarter of 2003 over the third quarter of 2002, resulting intotal research and development expenses approximately 18% higher for the firstnine months of 2003 versus the same period in 2002.  The difference between projected and actual research anddevelopment expenses in the third quarter of 2003 was primarily due to lowerthan expected clinical drug supply spending during the quarter.  However, these expenses are expected to beincurred in the fourth quarter of 2003. In addition, we expect to accelerate approximately $250,000 of planned2004 expenses for the Phase III IL13-PE38 clinical trial into the fourthquarter of 2003 in preparation for the initiation of the Phase III clinicaltrial.

 

It isdifficult to predict with any certainty the timing, estimated costs to completedevelopment and anticipated completion dates of compounds in Phase I clinicaldevelopment. A number of factors contribute to this uncertainty, including;side effects encountered in early stage clinical trials, ability to scale upmanufacturing for commercial supply, size and scope of pivotal Phase IIIclinical trials are unknown until enough data is available to present a PhaseIII plan to the FDA for approval.   Inaddition, our drug compounds are required to be approved by the FDA aftercompleting Phase III clinical trials before we can sell the drugs to generaterevenue and, potentially, net cash inflows. Because our lead compound, IL13-PE38, is currently about to enter aPhase III clinical trial, we are able to make some estimates regarding thecompletion of Phase III.  Our currentestimates anticipate further expenses of approximately $35 - $40 million tocomplete the Phase III clinical trial. Assuming that the first patient is enrolled during the fourth quarter of2003 or first quarter of 2004, we anticipate being able to submit a BiologicLicense Application (BLA) to the FDA in 2006 seeking marketing approval of thedrug.  However, there can be noassurance that the FDA will approve the BLA. Assuming that we receive authorization to begin selling IL13-PE38, weanticipate the first sales of the product in 2007.

 

                The table below includes a summary ofidentified project costs incurred to date for our major research anddevelopment projects. Generally, identified project costs include expensesincurred specifically for clinical trials and pre-clinical studies we conduct onour drug compounds, and exclude expenses incurred for salaries paid to ourprofessional staff, overhead expenses for our Lake Forest and Waukeganfacilities and general laboratory supplies used in our research, which areidentified as non-project specific.

 

 
| **Research Project**                    |   | **Costs  Incurred in  Current Quarter** |      | **Costs  Incurred  Year-to-Date** |   | **Total  Costs  Incurred Since  Beginning of Project** |   |
|-----------------------------------------|--------|-----------------------------------------|-----------|-----------------------------------|--------|--------------------------------------------------------|--------|
| IL13-PE38                               |   | $                                       | 4,434,703 |                              | $      | 9,248,601                                              |   | $ | 15,871,934 |   |
| LE-SN38                                 |   | 253,529                                 |      | 1,163,374                         |   | 2,046,711                                              |   |
| LEP-ETU                                 |   | 196,736                                 |      | 579,231                           |   | 661,959                                                |   |
| LErafAON                                |   | 150,614                                 |      | 522,920                           |   | 5,950,663                                              |   |
| LEM                                     |   | 167,044                                 |      | 696,516                           |   | 3,057,255                                              |   |
| Non-project specific                    |   | 3,961,636                               |      | 12,829,462                        |   | N/A                                                    |   |
| Total research and development expenses |   | 9,164,262                               |      | 25,040,104                        |   | N/A                                                    |   |
|                                         |        |                                         |           |                                   |        |                                                        |        |  |  |  |

 

Theincrease in general and administrative expenses in the third quarter and firstnine months of 2003 as compared with the same periods in 2002 was almostentirely related to expenses incurred in connection with prosecuting ourarbitration claim against Pharmacia (see Part II Item 1. Legal Proceedings). Wehave incurred approximately $10.2 million in arbitration related expensesduring 2003 and, at this time, anticipate at least $1.8 million in additionalarbitration related expenses for the remainder of 2003 due to the extension oftime granted by the Arbitral Panel to hear the remainder of the case.  We remain confident that the hearing willconclude before the end of 2003. Although we currently anticipate that the hearing phase of thearbitration will conclude in 2003, we do expect to incur some arbitrationrelated expenses in the first quarter of 2004. However, the size and scope ofthe 2004 arbitration expenses can only be determined upon conclusion of thehearing. As of the date of this report, the hearing phase of the arbitration isstill ongoing.

 

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As aresult of the additional arbitration expenses now expected to be incurred inthe fourth quarter of 2003 and updated estimates relating to the timing ofresearch and development expenses for the clinical development of ourcompounds, we currently estimate a net loss for 2003 in the range ofapproximately $2.75 - $2.77 per share as compared to our previous estimate of$2.66 - $2.70 per share.  We remaincommitted to the commercialization of our compounds and are considering variousoptions to fund the clinical development of the multiple compounds currently inclinical trials.

 

OnOctober 1, 2003, we filed a registration statement with the Securities and Exchange Commission forthe proposed offering from time to time of up to $125 million of NeoPharmcommon stock, preferred stock or a combination of these securities. Although aregistration statement has been filed with the SEC, the registration statementhas not yet become effective. As a result, these securities may not be sold,nor may offers to buy be accepted, prior to the time the registration statementbecomes effective.  Upon theregistration statement becoming effective, the securities will be available forsale to fund our operations as needed.  The Company has no immediate plans tosell any securities under this registration statement.  Wecontinue to closely monitor all of our development programs to ensure that onlyprojects that show activity in human clinical trials continue to receivefinancial support.

 

InNovember 2003, we announced plans to sell a product recently developedutilizing the latest advances in our NeoLipidTM technology.  We expect to commence selling NeoPhectinTMgene transfection kits to distributors in January 2004.  Our current laboratory facilities provide uswith the ability to produce commercial quantities of the material withoutreducing the level of our research and development activities.  Accordingly, we do not expect to incursignificant incremental costs to produce NeoPhectinTM gene transfection kits.

 

**Results of Operations – ThreeMonths Ended September 30, 2003 vs. Three Months Ended September 30,2002.**

 

The Company recorded norevenue for the three months ended September 30, 2003 or for the threemonths ended September 30, 2002.

 

Research and developmentexpense for the three months ended September 30, 2003 was $9,164,262compared to $8,978,572 for the same period in 2002. During the third quarter of2003, we continued to advance our lead compound, IL13-PE38 towards a pivotalPhase III clinical trial.  As a result,the overall increase in research and development costs was the result ofincreased expenses of approximately $3,129,000 related to the development of IL13-PE38,including costs associated with producing the Phase III drug supply.  As a result of our efforts to begin thePhase III clinical trial for IL13-PE38, we reduced our research and developmentexpenses for other research projects by approximately $2,943,000 during thethird quarter of 2003 as compared to the third quarter of 2002.

 

Generaland administrative expenses (including related party expenses) for the threemonths ended September 30, 2003 were $3,203,950 compared to $1,887,593 forthe same period in 2002. The overall increase in general and administrativeexpenses was the result of increased expenses of approximately $862,000 due towork done on the arbitration claim filed against Pharmacia (see Part II Item 1. Legal Proceedings), anincrease of approximately $207,000 in other legal and professional fees due tothe Company’s efforts to improve its intellectual property position and complywith new securities laws and regulations, increased insurance expense ofapproximately $103,000 for the Company’s directors and officers liability insuranceand commercial insurance premiums, increased general and administrative payrollexpenses, consulting fees and Director’s fees of approximately $177,000 and adecrease in depreciation expense of approximately $32,000 resulting from theCompany’s change from an accelerated depreciation method to the straight linemethod.

 

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The Company generatedinterest income on cash and investments of $148,615 and $602,200 for the threemonths ended September 30, 2003 and September 30, 2002,respectively.  The decrease in interestincome for the third quarter of 2003 was primarily due to the reduction in thetotal cash available for investing during the third quarter of 2003 as theCompany used its cash to fund the development of its compounds and to payexpenses associated with the ongoing arbitration case with Pharmacia during2003.

 

Net loss for the threemonths ended September 30, 2003 was $12,219,597, or $<0.65> pershare basic and diluted, compared to net loss of $10,263,965, or $<0.55>per share basic and diluted, for the three months ended September 30,2002.

 

**Results of Operations – Nine MonthsEnded September 30, 2003 vs. Nine Months Ended September 30, 2002.**

 

The Company recorded norevenue for the nine months ended September 30, 2003 or for the ninemonths ended September 30, 2002.

 

Research and developmentexpense for the nine months ended September 30, 2003 was $25,040,104compared to $21,620,967 for the same period in 2002. The overall increase inresearch and development costs was primarily the result of increased expensesof approximately $6,690,000 related to the development of our lead compound,IL13-PE38, as we prepare to enter pivotal Phase III clinical trials, as well asincreased expenses of approximately $714,000 for the Phase I development ofLE-SN38 and approximately $509,000 for the Phase I development of LEP-ETU.  These increased expenses were offset by areduction of approximately $6,176,000 in other research and developmentexpenses during the firstninemonths of 2003.  In addition, weexperienced an increase in payroll and consulting expense of approximately$1,414,000 related to increases in our research and development staff, and anincrease of approximately $268,000 in expenses incurred for the operation ofthe research and development facility in Waukegan, Illinois.

 

Generaland administrative expenses (including related party expenses) for the ninemonths ended September 30, 2003 were $15,563,622 compared to $5,355,013for the same period in 2002. The overall increase in general and administrativeexpenses was the result of increased expenses of approximately $9,457,000 dueto work done on the arbitration claim filed against Pharmacia (see Part II Item 1. Legal Proceedings), anincrease of approximately $496,000 in other legal and professional fees due tothe Company’s efforts to improve its intellectual property position and complywith new securities laws and regulations, increased insurance expense ofapproximately $306,000 for the Company’s directors and officers liabilityinsurance and commercial insurance premiums, increased general andadministrative payroll expenses, consulting fees and Director’s fees ofapproximately $251,000 and a decrease in general office expenses of approximately$302,000 resulting from the Company’s ongoing efforts to reduce expenses.

 

TheCompany generated interest income on cash and investments of $688,062 and$1,888,379 for the nine months ended September 30, 2003 andSeptember 30, 2002, respectively. The decrease in interest income for the first nine months of 2003 wasprimarily due to a reduction in the total cash available for investing duringthe first nine months of 2003 as the Company used its cash to fund thedevelopment of its compounds and to pay expenses associated with the ongoingarbitration case with Pharmacia.

 

Net loss for the nine monthsended September 30, 2003 was $39,915,664, or $<2.12> per share basicand diluted, compared to net loss of $25,087,601, or $<1.34> per sharebasic and diluted, for the nine months ended September 30, 2002.

 

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**Liquidity and Capital Resources**

 

AtSeptember 30, 2003, we had approximately $53,552,000 in cash and cashequivalents and short-term investments, and net working capital ofapproximately $48,499,000. All excess cash is currently invested in marketablesecurities with less than twelve months to maturity.  We believe that our cash and cash equivalents and short-terminvestments should be adequate to fund our operations for at least the next 12months. However, we can offer no assurances that additional funding will not berequired during that period. On October 1, 2003, we announced the filingof a registrationstatement with the Securities and Exchange Commission for the proposed offeringfrom time to time of up to $125 million of NeoPharm common stock, preferredstock or a combination of these securities. Although a registration statementhas been filed with the SEC, the registration statement has not yet becomeeffective. As a result, these securities may not be sold, nor may offers to buybe accepted, prior to the time the registration statement becomeseffective.  Upon the registrationstatement becoming effective, the securities will be available for sale to fundour operations as needed.  The Company has no immediate plans tosell any securities under this registration statement.  As a result of anticipated sales ofNeoPhectinTM, we expect to require working capital to provide customers withcustomary payment terms on sales made; however, we do not expect to requireworking capital to build inventory as our current business strategy includesproducing kits only upon receipt of firm purchase orders from customers.  We believe that our current capital resourcesare sufficient to provide the working capital needs for sales of NeoPhectinTM.

 

Ourassets at September 30, 2003 were approximately $59,049,000 compared to$95,937,000 at December 31, 2002. This decrease in assets was primarilydue to a decrease of cash and cash equivalents and investments in marketablesecurities of approximately $37,548,000 as a result of cash used in operatingactivities during the first nine months of 2003.

 

Ourliabilities at September 30, 2003 increased to approximately $6,435,000from approximately $4,028,000 at December 31, 2002. This increase wasprimarily attributable to increased accrued clinical trial expenses ofapproximately $1,638,000 and an increase in accrued compensation ofapproximately $845,000.  Other accruedexpenses, including accrued legal expenses and accounts payable, decreasedapproximately $76,000 since December 31, 2002.

 

We mayseek to satisfy our future funding requirements through public or privateofferings of securities, with collaborative or other arrangements withcorporate partners or from other sources including, but not limited to, salesof NeoPhectinTM. Additional financing may not be available when needed or onterms acceptable to us. If adequate financing is not available, we may berequired to delay, scale back or eliminate certain of our research anddevelopment programs, relinquish rights to certain of our technologies, cancerdrugs or products, or license third parties to commercialize products ortechnologies that we would otherwise seek to develop ourselves.

 

**Critical Accounting Policies**

 

Inpreparing the Company’s financial statements in conformity with accountingprinciples generally accepted in the United States of America, management mustmake a variety of decisions which impact the reported amounts and relateddisclosures. Such decisions include the selection of the appropriate accountingprinciples to be applied, the assumptions on which to base accountingestimates, and the consistent application of those accounting principles. Dueto the type of industry in which the Company operates and the nature of itsbusiness, the following accounting policies are those that management believesare most important to the portrayal of the Company’s financial condition andresults and that require management’s most difficult, subjective or complexjudgments, often as a result of the need to make estimates about the effect ofmatters that are inherently uncertain.

 

*Cash Equivalents and Investments*

 

TheCompany considers all highly liquid investments purchased with an originalmaturity of three months or less to be cash equivalents. The carrying value ofthese investments approximates the fair market value. Short-term investment inmarketable securities includes liquid investments purchased with an originalmaturity of between three months and one year. As provided by SFASNo. 115, the Company has elected to treat all of its investments inmarketable securities as “available-for-sale”, which requires these investmentsto

 

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be recorded at fairmarket value. Unrealized gains and losses, net of related tax effect, onavailable-for-sale securities are excluded from earnings and are reported as aseparate component of other comprehensive income until realized. Realized gainsand losses from the sale of available-for-sale securities are determined on aspecific identification basis. A decline in market value of available-for-salesecurities that is deemed to be other than temporary, results in the reductionof the carrying amount to fair value. The impairment is charged to earnings anda new cost basis for the security is established.

 

*Income Taxes*

 

Incometaxes are accounted for under the asset and liability method. Deferred taxassets and liabilities are recognized for the future tax consequencesattributable to differences between the financial statement carrying amounts ofexisting assets and liabilities and their respective tax bases and operatingloss and tax credit carryforwards. Deferred tax assets and liabilities aremeasured using enacted tax rates expected to apply to taxable income in theyears in which those temporary differences are expected to be recovered orsettled. The effect on deferred tax assets and liabilities of a change in taxrates is recognized in income in the period that includes the enactment date.Management provides valuation allowances against the deferred tax asset foramounts which are not considered “more likely than not” to be realized.

 

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.

 

*Stock-Based Compensation*

 

TheCompany applies the intrinsic-value-based method of accounting prescribed byAccounting Principles Board (APB) Opinion No. 25, *Accounting for Stock Issued to Employees*,and related interpretations including FASB Interpretation No. 44, *Accounting for Certain Transactions Involving StockCompensation, an Interpretation of APB Opinion No. 25*, issuedin March 2000, to account for its fixed-plan stock options. Under thismethod, compensation cost is recorded on the date of grant only if the currentmarket price of the underlying stock exceeded the exercise price. SFASNo. 123, *Accounting for Stock-BasedCompensation*, established accounting and disclosure requirementsusing a fair-value-based method of accounting for stock-based employeecompensation plans. As allowed by SFAS No. 123, the Company has elected tocontinue to apply the intrinsic-value-based method of accounting describedabove, and has adopted only the disclosure requirements of SFAS No. 123.

 

*Research and Development*

 

Researchand development costs are expensed when incurred. These costs include, amongother things, consulting fees and costs reimbursed to third parties underlicense and research agreements. Payments related to the acquisition oftechnology rights, for which development work is in process, are expensed andconsidered a component of research and development costs. The Company also allocatesindirect costs, consisting primarily of operational costs for administeringresearch and development activities, to research and development expenses.

 

**Forward Looking Statements**

 

Anystatements made by NeoPharm, Inc. (“we”, “us”, “our”, or the “Company”) in thisquarterly report that are forward looking are made pursuant to the safe harborprovisions of the Private Securities Litigation Reform Act of 1995.  The Company cautions readers that importantfactors may affect the Company’s actual results and could cause such results todiffer materially from forward-looking statements made by or on behalf of theCompany.  Such factors include, but arenot limited to, those risks and

 

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uncertaintiesrelating to difficulties or delays in development, testing, regulatoryapproval, production and marketing of the Company’s drug candidates, non-drugproducts such as NeoPhectinTM, uncertainty regarding the outcome of damageclaims made by or against the Company, unexpected adverse side effects orinadequate therapeutic efficacy of the Company’s drug candidates that couldslow or prevent products coming to market, the uncertainty of patent protectionfor the Company’s intellectual property or trade secrets, and other factorsreferenced under “Risk Factors” in the Company’s Annual Report on Form 10-K forthe fiscal year ended December 31, 2002.

 

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

 

As of September 30,2003, we did not own any derivative instruments, but we were exposed to marketrisks, primarily changes in U.S. interest rates.  As of September 30, 2003, we held total cash and investmentsof $53,552,208.  Maturities range fromless than one month to approximately 10 months.  Declines in interest rates over time will reduce our interestincome from our investments.  Based uponour balance of cash, cash equivalents and marketable securities as ofSeptember 30, 2003, a decrease in interest rates of 1.0% would cause acorresponding decrease in our annual interest income of approximately $536,000.

 

**Item 4****– Controlsand Procedures**

 

As ofSeptember 30, 2003, we carried out an evaluation, under the supervisionand with the participation of our management, including our Chief ExecutiveOfficer and Chief Financial Officer, of the effectiveness of the design andoperation of our disclosure controls and procedures. Based on that evaluation,our management, including the Chief Executive Officer and Chief FinancialOfficer, concluded that our disclosure controls and procedures are operatingeffectively as designed.

 

Duringthe three months ended September 30, 2003, there were no significantchanges in our internal controls or in other factors that could significantlyaffect internal controls.

 

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**PART II - OTHER INFORMATION**

 

Item1.                                                             Legal Proceedings

 

OnApril 19, 2002, the Company filed a Demand for Arbitration with theAmerican Arbitration Association in accordance with the terms of its LicenseAgreement dated February 19, 1999 (the “License Agreement”) with PharmaciaCorporation (now Pfizer), Pharmacia and Upjohn, Inc. and Pharmacia andUpjohn Company (collectively, “Pharmacia”), for the purpose of resolving adispute with Pharmacia concerning delays in the development programs for LEP(Liposome Encapsulated Paclitaxel) and LED (Liposome Encapsulated Doxorubicin)which were being conducted by Pharmacia. The Company contends that Pharmaciafailed in its duty under the License Agreement to use reasonable efforts todevelop LEP and LED and that such failure constitutes a breach of the LicenseAgreement. The Company further contends that Pharmacia breached its duty toconsult with NeoPharm on the progress of the drug development program andthereby impaired NeoPharm’s ability to monitor the development of thesecompounds. The Company is seeking all damages to which it is entitled. NeoPharmbelieves that these damages are substantial. On May 16, 2002, Pharmaciaresponded by denying the Company’s allegations, asserting various counterclaimsand seeking restitution of monies paid, reimbursement of out-of-pocket expensesand substantial punitive damages. Subsequently, Pharmacia stated in a letterdated November 19, 2002, that it did not intend to move forward with theclinical development of NeoPharm’s NeoLipidTM LEP (LEP-ETU) because of itscontention that NeoPharm had not provided Pharmacia with sufficient productdata and test samples, a claim which NeoPharm denies. Pharmacia also statedthat it would not continue to develop the earlier formulations of LEP and LED.Although Pharmacia indicated that it did not intend to continue with the clinicaldevelopment of LEP and LED, Pharmacia did not indicate that it had terminatedthe License Agreement. As a result, in November 2002, NeoPharm terminatedthe License Agreement in order to allow NeoPharm to continue with the furtherdevelopment of NeoLipidTM formulations of LEP, as well as LED. Pharmaciadisputes the propriety of the termination and has included the termination aspart of the arbitration hearing. In January 2003, NeoPharm reached anagreement with Pharmacia that allows NeoPharm to reference Pharmacia’s LEPInvestigational New Drug application (IND) and start human clinical trials withLEP-ETU. The arbitration proceeding is currently ongoing and no prediction canbe made as to the outcome of the claims that the Company and Pharmacia have assertedagainst each other, or the amounts, if any, which either party may be awardedagainst the other, which recoveries or liabilities could be substantial. Thearbitration hearing began on May 28, 2003, was adjourned on June 27,2003, and reconvened on August 25, 2003. The Arbitral Panel has indicatedthat the taking of evidence will conclude no later than the end of 2003.NeoPharm has completed presenting its case to the panel.

 

TheCompany was also 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. The original lawsuits also named as individualdefendants John N. Kapoor, Chairman of the Company, and James M. Hussey, theCompany’s President and CEO, and Dr. Aquilur Rahman, a former director andexecutive officer of the Company. The first of these Class Action Suits wasfiled on April 26, 2002 and all of the Class Action Suits have been filedin the United States District Court for the Northern District of Illinois,Eastern Division. On September 16, 2002, a consolidated amended complaintwas filed against NeoPharm in this matter. The amended complaint shortened theclass period to October 31, 2001 through April 19, 2002, removedDr. Rahman as a defendant, and added Dr. Imran

 

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Ahmad,the Company’s current Chief ScientificOfficer and Senior Vice President of Research and Development, as a defendant.The Company intends to vigorously defend each and every claim in the classaction suits and, on November 4, 2002, moved to have the complaintdismissed. The Company’s motion to dismiss was granted in part and denied inpart in February 2003. Dr. Kapoor was dismissed from the lawsuit at that time.  No trial date has been set.

 

Item2.                                                           Changes in Securities and Use of Proceeds

 

On July 1, 2003, the Company announced the adoption of a shareholderrights plan.  The plan is designed toprotect Company shareholders from coercive or unfair takeover techniques thatcould deny them the opportunity to realize the full value of theirinvestment.  The terms of the plan providefor a dividend of one right to purchase one 

one-thousandth (1/1000th) of a share of a newly createdclass of preferred stock (“Series A Participating Preferred Stock”) for eachshare of common stock outstanding as of the close of business on July 28, 2003.  The rights expire on July 28, 2013 and mayonly be exercised if certain conditions are met.  The Company also entered into a Preferred Stock Rights Agreementwith Computershare Investor Services LLC (“Computershare”) wherebyComputershare agreed to act as a rights agent. A copy of the Preferred Stock Rights Agreement was filed as an exhibitto the Company’s Registration Statement on Form 8-A filed on July 17, 2003(Commission File No. 

000-26898).

 

Item3.                                                           Defaults Upon Senior Securities

None

 

Item4.                                                           Submission of Matters to a Vote ofSecurity-Holders

None

 

Item5.                                                           Other Information

None

 

Item6.                                                           Exhibits and Reports on Form 8-K

 

(a)          Exhibits

 
| Exhibit  10.1 |   | First Amended and Restated Synthetic Cardiolipin Supply Agreement  dated November 1999 between Avanti Polar Lipids, Inc. and the Company |
|---------------|--------|------------------------------------------------------------------------------------------------------------------------------------------|
|          |   |                                                                                                                                     |
| Exhibit  10.2 |   | Conditional  Option Agreement dated January 26, 1999 between Avanti Polar Lipids, Inc. and  the Company                                  |
|          |   |                                                                                                                                     |
| Exhibit  31.1 |   | Certification  of the Chief Executive Officer pursuant to Section 302 of the  Sarbanes–Oxley Act of 2002.                      |
|          |   |                                                                                                                                     |
| Exhibit  31.2 |   | Certification  of the Chief Financial Officer pursuant to Section 302 of the  Sarbanes–Oxley Act of 2002.                      |
|          |   |                                                                                                                                     |
| Exhibit  32.1 |   | Certification  of the Chief Executive Officer pursuant to section 906 of the Sarbanes–Oxley  Act of 2002.                      |
|          |   |                                                                                                                                     |
| Exhibit  32.2 |   | Certification  of the Chief Financial Officer pursuant to Section 906 of the  Sarbanes–Oxley Act of 2002.                      |

 

(b)         Reportson Form 8-K

 

On July 1, 2003, the Company filed a report on Form8-K incorporating a press release announcing the adoption of a shareholderrights plan by the Company’s Board of Directors.

 

On July 7, 2003, the Company filed a report on Form8-K to disclose the Shareholder Rights Plan Agreement adopted by the Company’sBoard of Directors.

 

On August 13, 2003, the Company filed a report onForm 8-K incorporating a press release reporting the Company’s financialresults for the second quarter ended June 30, 2003.

 

18

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**SIGNATUREPAGE**

 

**Pursuant to the requirements of theSecurities Exchange Act of 1934, the Registrant has duly caused this report tobe signed on its behalf by the undersigned, thereunto duly authorized.**

 
|                          | NEOPHARM,  INC. |
|-------------------------------|-----------------|
| Date:  November 14, 2003 | By:             | /s/  Lawrence A. Kenyon |
|                          |            | Lawrence  A. Kenyon, |
|                          |            | *Chief Financial Officer  (Principal Accounting Officer and  Principal Financial Officer)* |

 

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