UNITED
STATES


SECURITIES
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
      1934For
      Quarterly Period Ended September 30, 2008Oro
            TRANSITION
      REPORT PURSUANT TO SECTION 13 OR 15 (d) OF THE SECURITIES EXCHANGE
      ACT OF 1934For
      the transition period
      from             toCommission
      file number 33-90516





NEOPHARM,
INC.


(Exact
name of Registrant as specified in its charter)





Delaware
            
            51-0327886(State
      or other jurisdiction of
              incorporation
      or organization)
            
            (I.R.S.
      Employer Identification Number)101
      Waukegan Road  Suite 970
              Lake
      Bluff, Illinois 60044(Address
      of principal executive offices) (Zip Code)(847)
      887-0800(Registrant’s
      telephone number, including area
code)





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





Indicate
by check mark whether Registrant is a large accelerated filer, an accelerated
filer, a non-accelerated filer or a smaller reporting company.  See
definitions of “accelerated filer,” “large accelerated filer,” and “smaller
reporting company” in Rule 12b-2 of the Exchange Act. (Check one):




Large
accelerated filer o                                                                Accelerated
filer o                                            Non-accelerated
filer o


Smaller
reporting company  ý




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


As of,
October 31, 2008 the number of shares outstanding of each of the issuer’s
classes of common stock was as follows:





Title
      of each class
            
            Number
      of shares outstandingCommon
      Stock ($.0002145 par value)
            
            28,497,049

















NEOPHARM,
INC.





FORM
10-Q


INDEX





PART I.
      FINANCIAL INFORMATIONItem
1.
            Financial
      StatementsCondensed
      Consolidated Balance Sheets as of September 30, 2008 (unaudited) and
      December 31, 2007Condensed
      ConsolidatedStatements of Operations
      for the three and nine months ended September 30, 2008
      and  September 30, 2007
(unaudited)Condensed Consolidated Statements of Cash Flows for the nine months ended
      September 30, 2008 and September 30, 2007
      (unaudited)Notes to Condensed
      Consolidated Financial Statements
(unaudited)Item
2.
            Management’s Discussion and
      Analysis of Financial Condition and Results of
      OperationsItem
3.
            Quantitative and Qualitative
      Disclosures About Market RiskItem
      4T
            Controls and
      ProceduresPART II. OTHER
      INFORMATIONItem
      1.
            Legal
      ProceedingsItem
      1A.
            Risk
      FactorsItem
      2.
            Unregistered Sales of Equity
      Securities and Use of ProceedsItem
      3.
            Defaults Upon Senior
      SecuritiesItem
      4.
            Submission of Matters to a
      Vote of Security HoldersItem
      5.
            Other
      InformationItem
      6.
            ExhibitsSIGNATURE
      PAGE








2




PART I - FINANCIAL INFORMATION
 ITEM
1.
 FINANCIAL
STATEMENTS
 
 NEOPHARM,
INC.
 Condensed Consolidated Balance
Sheets




September
      30,
                2008
              
              
              December 31,
                2007(unaudited)ASSETSCurrent
      assets:Cash
      and cash equivalents
              
              $
              5,364,000
              
              
              $
              1,022,000Available
      for sale securities
              
              
              -
              
              
              
              19,759,000Prepaid
      expenses and other current assets
              
              
              411,000
              
              
              
              417,000Total
      current assets
              
              
              5,775,000
              
              
              
              21,198,000Fixed
      assets, net of accumulated depreciation
              
              
              396,000
              
              
              
              395,000Available
      for sale securities
              
              
              13,476,000
              
              
              
              -Other
      assets
              
              
              649,000
              
              
              
              659,000Total
      assets
              
              $
              20,296,000
              
              
              $
              22,252,000LIABILITIES
      AND STOCKHOLDERS’ EQUITYCurrent
      liabilities:Accounts
      payable
              
              $
              1,349,000
              
              
              $
              1,340,000Accrued
      clinical trial expenses
              
              
              478,000
              
              
              
              278,000Accrued
      compensation
              
              
              946,000
              
              
              
              1,042,000Accrued
      manufacturing expenses
              
              
              739,000
              
              
              
              739,000Short-term
      debt
              
              
              5,042,000
              
              
              
              -Obligations
      under capital lease
              
              
              34,000
              
              
              
              32,000Other
      accrued expenses
              
              
              203,000
              
              
              
              494,000Total
      current liabilities
              
              
              8,791,000
              
              
              
              3,925,000Deferred
      rent
              
              
              12,000
              
              
              
              -Obligations
      under capital lease
              
              
              48,000
              
              
              
              74,000Total
      liabilities
              
              
              8,851,000
              
              
              
              3,999,000Stockholders’
      equity:Preferred
      stock, $0.01 par value; 15,000,000 shares authorized:none
      issued and outstanding
              
              
              -
              
              
              
              -Common
      stock, $0.0002145 par value; 50,000,000shares
      authorized: 28,497,049 and 28,488,550shares
      issued and outstanding, respectively
              
              
              6,000
              
              
              
              6,000Additional
      paid-in capital
              
              
              290,893,000
              
              
              
              290,481,000Accumulated
      other comprehensive loss
              
              
              (1,224,000
              )
              
              
              -Accumulated
      deficit
              
              
              (278,230,000
              )
              
              
              (272,234,000
              )Total
      stockholders’ equity
              
              
              11,445,000
              
              
              
              18,253,000Total
      liabilities and stockholders’ equity
              
              $
              20,296,000
              
              
              $
              22,252,000




The
accompanying notes to the condensed consolidated financial
statements
 are an
integral part of these financial statements.
   3




NEOPHARM,
INC.
 
 Condensed Consolidated Statements of
Operations
 Three
and Nine Months Ended September 30, 2008 and September 30, 2007
 (Unaudited)




Three
      Months Ended
              
              
              Nine
      Months EndedSeptember
      30, 2008
              
              
              September
      30, 2007
              
              
              September
      30, 2008
              
              
              September
      30, 2007Total
      revenue
              
              $
              -
              
              
              $
              -
              
              
              $
              -
              
              
              $
              -Expenses:Research
      and development
              
              
              1,454,000
              
              
              
              1,668,000
              
              
              
              3,291,000
              
              
              
              6,175,000Selling,
      general, and administrative
              
              
              1,056,000
              
              
              
              1,254,000
              
              
              
              3,572,000
              
              
              
              6,033,000Employee
      termination costs
              
              
              -
              
              
              
              -
              
              
              
              -
              
              
              
              555,000Facility
      consolidation costs
              
              
              -
              
              
              
              296,000
              
              
              
              (64,000
              )
              
              
              296,000Gain
      on sale of equipment and furniture
              
              
              (41,000
              )
              
              
              -
              
              
              
              (350,000
              )
              
              
              -Total
      expenses
              
              
              2,469,000
              
              
              
              3,218,000
              
              
              
              6,449,000
              
              
              
              13,059,000Loss
      from operations
              
              
              (2,469,000
              )
              
              
              (3,218,000
              )
              
              
              (6,449,000
              )
              
              
              (13,059,000
              )Other
      Income
              
              
              -
              
              
              
              2,000,000
              
              
              
              -
              
              
              
              2,000,000Net
      interest income
              
              
              58,000
              
              
              
              337,000
              
              
              
              453,000
              
              
              
              1,110,000Net
      loss
              
              $
              (2,411,000
              )
              
              $
              (881,000
              )
              
              $
              (5,996,000
              )
              
              $
              (9,949,000
              )Net
      loss per share —Basic
      and diluted
              
              $
              (0.08
              )
              
              $
              (0.03
              )
              
              $
              (0.21
              )
              
              $
              (0.35
              )Weighted
      average shares outstanding —Basic
      and diluted
              
              
              28,492,954
              
              
              
              28,377,120
              
              
              
              28,490,910
              
              
              
              28,189,815






The
accompanying notes to the condensed consolidated financial
statements
 are an
integral part of these financial statements.
 
 4




NEOPHARM,
INC.
 
 Condensed Consolidated Statements of Cash
Flows
 Nine
Months Ended September 30, 2008 and September 30, 2007
 (Unaudited)




Nine
      Months EndedSeptember
      30, 2008
              
              
              September
      30, 2007Cash
      flows from operating activities:Net
      loss
              
              $
              (5,996,000
              )
              
              $
              (9,949,000
              )Adjustments
      to reconcile net loss to net cash used in operating
      activities:Depreciation
      and amortization
              
              
              141,000
              
              
              
              587,000Stock-based
      compensation expense
              
              
              408,000
              
              
              
              238,000Gain
      on sale of equipment and furniture
              
              
              (18,000
              )
              
              
              -Writedown
      of fixed assets
              
              
              -
              
              
              
              296,000Changes
      in assets and liabilities:Interest
      receivable on short-term investments
              
              
              28,000
              
              
              
              52,000Prepaid
      expenses and other assets
              
              
              44,000
              
              
              
              124,000Accounts
      payable
              
              
              9,000
              
              
              
              (4,243,000
              )Other
      current liabilities
              
              
              (130,000
              )
              
              
              (129,000
              )Deferred
      and unearned revenue
              
              
              -
              
              
              
              (2,000,000
              )Net
      cash and cash equivalents used in operating activities
              
              
              (5,514,000
              )
              
              
              (15,024,000
              )Cash
      flows from investing activities:Proceeds
      from sales of marketable securities
              
              
              5,004,000
              
              
              
              13,248,000Purchase
      of equipment and furniture
              
              
              (143,000
              )
              
              
              (7,000
              )Proceeds
      from sale of equipment and furniture
              
              
              19,000
              
              
              
              -Net
      cash and cash equivalents provided by investing activities
              
              
              4,880,000
              
              
              
              13,241,000Cash
      flows from financing activities:Proceeds
      from employee stock purchase plan
              
              
              2,000
              
              
              
              14,000Proceeds
      from short-term debt
              
              
              5,000,000
              
              
              
              -Repayment
      of capital lease obligation
              
              
              (26,000
              )
              
              
              (22,000
              )Net
      cash and cash equivalents provided by (used in) financing
      activities
              
              
              4,976,000
              
              
              
              (8,000
              )Net
      increase in cash and cash equivalents
              
              
              4,342,000
              
              
              
              (1,791,000
              )Cash
      and cash equivalents, beginning of period
              
              
              1,022,000
              
              
              
              1,852,000Cash
      and cash equivalents, end of period
              
              $
              5,364,000
              
              
              $
              61,000






The
accompanying notes to the condensed consolidated financial
statements
 are an
integral part of these financial statements.
 
 5




NEOPHARM,
INC.
 NOTES TO CONDENSED CONSOLIDATED FINANCIAL
STATEMENTS
 (unaudited)
 
 1.
              BASIS
      OF PRESENTATION
 
 The
financial information herein is unaudited.  The balance sheet as of
December 31, 2007 is derived from audited financial
statements.
  The
accompanying unaudited condensed consolidated financial statements of NeoPharm,
Inc. and subsidiary (“we”, “us”, “our”, or the “Company”) have been prepared in
accordance with U.S. generally accepted accounting principles, or U.S. GAAP, for
interim financial information and with the instructions to Form 10-Q and Article
8-03 of Regulation S-X. Accordingly, these financial statements do not contain
all of the information and notes required by U.S. GAAP for complete financial
statements.  In the opinion of management, the accompanying unaudited
condensed consolidated interim financial statements contain all adjustments
(consisting of normal recurring adjustments) necessary to a fair
presentation.  The results of operations for the three and nine month
period ended and as of September 30, 2008 are not necessarily indicative of our
operating results for fiscal 2008 or future interim periods.
  The
unaudited condensed consolidated financial statements include the accounts of
NeoPharm, Inc. and its wholly owned subsidiary, NeoPharm EU Limited. As of and
through September 30, 2008, the subsidiary had nominal assets and had not
conducted any business.  All significant intercompany accounts and
transactions are eliminated in consolidation.
  While we
believe that the disclosures presented herein are adequate to make the
information not misleading, it is suggested that these financial statements be
read in conjunction with the financial statements and notes included in the
Company’s 2007 Annual Report on Form 10-K filed with the United States
Securities and Exchange Commission, or  SEC.
  The
preparation of financial statements in conformity with U.S. GAAP requires
management to make estimates and assumptions that affect the reported amounts of
assets and liabilities and disclosure of contingent assets and liabilities at
the date of the consolidated financial statements and the reported amounts of
revenue and expense during the reporting periods.  Actual results
could differ from those estimates.
  Amounts
presented have been rounded to the nearest thousand.
 
 Recent
Accounting Pronouncements
 
 In
September 2006, the FASB issued SFAS No. 157, “Fair Value Measurements.”
SFAS No. 157 defines fair value, establishes a framework for measuring fair
value, and expands disclosures about fair value measurements.  SFAS
No. 157 is effective for financial statements issued for fiscal years
beginning after November 15, 2007.  In February of 2008, the FASB
issued FASB Staff position 157-2 which delays the effective date of SFAS 157 for
non-financial assets and liabilities which are not measured at fair value on a
recurring basis (at least annually) until fiscal years beginning after November
15, 2008.  The Company adopted SFAS No. 157 on January 1, 2008,
but the adoption did not have a material  impact on its consolidated
financial statements.   See note 5 below.
 
 In
February 2007, the FASB issued SFAS No. 159, “The Fair Value Option for Financial
Assets and Financial Liabilities.”  SFAS No. 159 allows
entities the option to measure eligible financial instruments at fair value as
of specified dates.  Such election, which may be applied on an
instrument by instrument basis, is typically irrevocable once
elected.  SFAS No. 159 is effective for financial statements
issued for fiscal years beginning after November 15, 2007.  The
Company adopted SFAS No. 159 on January 1, 2008, but the adoption did not
have a material impact on its consolidated financial statements.
 
 Reclassifications
 
 Certain
reclassifications have been made to conform prior period consolidated financial
statements and notes to current period presentation.
 
 6
 2.
              NET
      LOSS PER SHARE
 
 The
following table sets forth the computation of basic and diluted net loss per
share:
  Three
      Months Ended
                
                
                Nine
      Months EndedSeptember
      30, 2008
                
                
                September
      30, 2007
                
                
                September
      30, 2008
                
                
                September
      30, 2007Numerator:Net
      loss
                
                $
                (2,411,000
                )
                
                $
                (881,000
                )
                
                $
                (5,996,000
                )
                
                $
                (9,949,000
                )Denominator:Weighted
      average shares outstanding
                
                
                28,492,954
                
                
                
                28,377,120
                
                
                
                28,490,910
                
                
                
                28,189,815Loss
      per share - basic and diluted
                
                $
                (0.08
                )
                
                $
                (0.03
                )
                
                $
                (0.21
                )
                
                $
                (0.35
                )
  As we have
incurred net losses in each of the periods presented, basic and diluted loss per
share amounts are the same.  Common share equivalents of 1,629,325 and
1,339,387 at September 30, 2008 and 2007, respectively, have been excluded from
the computation since the effect of their assumed conversion would be
anti-dilutive.
  3.
              SHARE-BASED
      COMPENSATION
 
 We
currently sponsor the following share-based payment plans:
 
 2006
Plan
  In
June 2006, our stockholders approved the NeoPharm, Inc. 2006 Equity
Incentive Plan, or the 2006 Plan.  The 2006 Plan originally provided
for the issuance of stock options, non-vested stock, restricted stock,
performance units or performance share awards to employees, directors and
consultants convertible to up to 1,000,000 shares of our common stock. During
the second quarter of 2007, the Board of Directors approved resolutions
increasing the total shares available for issuance under the 2006 Plan to
3,400,000 shares and increasing the number of shares of Common Stock that may be
granted to any Grantee during any calendar year, or earned by any Grantee under
any performance based award during any calendar year, from 500,000 to
750,000 shares.  Each of these Board resolutions were approved by the
shareholders at the Annual Meeting of Stockholders held in August
2007.  In 2008, the Board approved an increase in the number of shares
of the Company’s common stock that may be awarded under the 2006 Plan as
restricted stock or bonus stock from 500,000 to 1,500,000 and this Board
resolution was approved by the shareholders at the Annual Meeting of
Stockholders held in August 2008. Awards under the 2006 Plan generally consist
of stock options having an exercise price equal to the average of the lowest and
highest reported sale prices of our common stock on the date of grant; vest
ratably over four years; have a 10 year term; and are subject to continuous
employment.  Stock awards granted to our non-employee directors under
the 2006 Plan typically vest one year from the date of grant.  Awards
under the 2006 Plan vest immediately upon a change in control, as defined in the
2006 Plan.  Although the 2006 Plan provides for the issuance of
performance units and performance shares, we have not made grants of these types
of awards.  As of September 30, 2008 and December 31, 2007, 1,981,139
and 2,260,139 shares, respectively, were available for issuance under the 2006
Plan.
 
 2006
Employee Stock Purchase Plan
  In
June 2006, our shareholders approved the 2006 Employee Stock Purchase Plan,
or the Purchase Plan, under which eligible employees may purchase shares of
common stock quarterly through payroll deductions.  An aggregate of
100,000 shares of common stock may be issued under the Purchase
Plan.  The price per share under the Purchase Plan is 85% of the lower
of the closing price of the common stock on (i) the first business day of
the plan period or (ii) the purchase date.  The Purchase Plan
imposes a limitation upon a participant’s right to acquire common stock if
immediately after or prior to purchase, the employee owns 5% or more of the
total combined voting power or value of our common stock.  During the
three and nine month periods ending September 30, 2008, 4,140 and 8,499 shares,
respectively, were issued under the Purchase plan resulting in compensation
expense of $775 and $2,790, respectively.  During the three and nine
month periods ending September 30, 2007, 978 and 12,734 shares, respectively,
were issued under the Purchase plan, respectively.  As of September
30, 2008 and December 31, 2007, 37,896 and 46,395 shares remained available for
issuance, respectively.
  7
  The
1998 Plan
  Our 1998
Equity Incentive Plan, or the 1998 Plan, provided for the grant of awards,
primarily stock options, to employees, directors, and consultants to acquire up
to 4,600,000 shares of our common stock.  Following the June 2006
shareholder approval of the 2006 Plan, no further awards have been or will be
made under the 1998 Plan.  Option awards under the 1998 Plan were
generally granted with an exercise price equal to the closing price of our
common stock on the date of grant, but may have been granted with an exercise
price of not less than 85% of the fair market value of our common
stock.  Option awards under the 1998 Plan typically had a 10-year life
and vested ratably on the first four anniversaries of the grant, subject to
continuous employment.  Stock awards granted to our non-employee
directors under the 1998 Plan typically vest one year from the date of
grant.  Outstanding awards issued under the 1998 Plan vested
immediately upon a change in control, as defined in the 1998 Plan.
 
  Amounts
recognized in the consolidated statements of operations with respect to our
share-based compensation plans were as follows:
   Three
      Months Ended
                
                
                Nine
      Months EndedSeptember
      30, 2008
                
                
                September
      30, 2007
                
                
                September
      30, 2008
                
                
                September
      30, 2007Research
      and development
                
                $
                40,000
                
                
                $
                34,000
                
                
                $
                120,000
                
                
                $
                (7,000
                )Selling,
      general and administrative
                
                
                86,000
                
                
                
                79,000
                
                
                
                288,000
                
                
                
                235,000Total
      cost of share-based payment plans during period
                
                $
                126,000
                
                
                $
                113,000
                
                
                $
                408,000
                
                
                $
                228,000
  We have
never capitalized, or recognized an income tax benefit from, share-based
compensation.
 
 The following is a summary of activity
relating to option awards to employees and non-employee directors during the
nine months ended September 30, 2008:
   Number
      of Options
                
                
                Weighted
      Average Exercise Price/
                  Grant
      Date Fair Value
                
                
                Weighted
      Average Remaining Contractual Life in years
                
                
                Aggregate
      Instrinsic ValueOutstanding
      at December 31, 2007
                
                
                1,252,326
                
                
                $
                5.79/4.20Granted
                
                
                279,000
                
                
                $
                0.42/0.29Exercised
                
                
                -Forfeited/expired/cancelled
                
                
                (37,500
                )
                
                $
                3.72/2.34Outstanding
      at September 30, 2008
                
                
                1,493,826
                
                
                
                4.84/3.52
                
                
                
                8.76
                
                
                $
                -Exercisable
      at September 30, 2008
                
                
                657,901
                
                
                $
                4.30/2.94
                
                
                
                7.82
                
                
                $
                -Weighted-average
      fair value of options granted during the period
                
                
                -
                
                
                $
                -Nonvested
      at December 31, 2007
                
                
                755,051
                
                
                $
                1.92/1.37Granted
                
                
                279,000
                
                
                
                0.42/0.31Vested
                
                
                (170,626
                )
                
                
                1.96/1.41Forfeited
                
                
                (27,500
                )
                
                
                2.66/1.81Nonvested
      at September 30, 2008
                
                
                835,925
                
                
                $
                1.39/1.00
  As of
September 30, 2008 we expect to recognize $725,000 of unrecognized share-based
compensation for our outstanding options over a weighted average period of 1.6
years.
  Restricted
Stock Awards
  In June
2007, we granted 180,665 restricted shares of common stock to our chief
executive officer with a weighted average fair value of $1.36 per share and a
four year vesting period.  In August 2007, we granted 213,196
restricted shares of common stock to non-employee directors with a weighted
average fair value of $0.99 and a one year vesting period.  As of
September 30, 2008, there were a total of 135,499 restricted shares of common
stock outstanding for the chief executive officer with unearned compensation of
$167,000 which is expected to be earned within 33 months.  No
restricted shares of common stock were granted during the nine months ended
September 30, 2008.
   8
 Stock
      Option Valuation Information
 
 In August
2008, we granted 225,000 stock options to non-employee directors with a weighted
average fair value of $0.29 and a one year vesting period.  In August
2008 we also granted 50,000 stock options to our chief executive officer and
4,000 stock options to other employees, with a weighted average fair value of
$0.31 and a four year vesting period.  .
  We have
estimated the fair value of our share-based compensation using the Black-Scholes
option-pricing model. This model requires the use of subjective assumptions that
have a significant impact on the fair value estimate.  We have based
our assumptions regarding expected volatility on the historic volatility of our
common stock, the risk-free interest rate on the U.S. Treasury yield curve in
effect at the time of grant, and the expected term of options using the
“Simplified Method” in accordance with SAB No. 107,Share-Based
Payment.  The weighted-average estimated fair value of employee
stock options granted during the third quarter of 2008 were calculated using the
Black-Scholes model and the related weighted-average assumptions:
  Three months
      endedSeptember 30, 2008Expected
      volatility
              
              
              80.74
              %Risk-free
      interest rate
              
              
              3.45
              %Expected
      term (in years)
              
              
              7.0Expected
      dividend yield
              
              
              0.0
              %
 
  4.
              CASH
      AND CASH EQUIVALENTS AND INVESTMENTS IN AUCTION RATE
      SECURITIES
 
 We
consider all highly liquid investments purchased with an original maturity of
three months or less to be cash equivalents.  Included with cash are
cash equivalents of $5.0 million and $0.7 million as of September 30, 2008 and
December 31, 2007, respectively. The carrying value of these investments
approximates their fair market value due to their short maturity and
liquidity.
  Investments
in auction rate securities have scheduled maturities greater than 90 days at the
time of purchase, and are classified as available-for-sale securities and
recorded at fair value.  Auction rate securities are used by many
student-loan providers, municipalities and other governmental authorities to
raise cash to fund projects or operations, and money market funds. These auction
rate securities all have AAA/aaa credit ratings, consistent with our investment
policy guidelines, and have long-term nominal maturities with provisions calling
for the interest rates to be reset through periodic auctions every 7 to 28
days.  Beginning in February 2008, all of the auction rate securities
held by the Company as of September 30, 2008 have experienced failed
auctions.  An auction failure is not a default.  An auction
failure means that the parties wishing to sell securities could not because the
number of sellers was greater than the number of buyers at the reset
dates.  The auction rate securities typically have provisions such
that the interest rates initially reset at higher percentages upon failure in
the auction market, and then adjust so that interest rates average to prevailing
market-based percentages for these types of securities.  Interest
continues to accrue and be paid currently on all of the auction rate
securities.
  The
investment bank which holds NeoPharm’s auction rate securities has estimated the
fair value of all of its auction rate securities as of September 30, 2008,
including those held in the Company’s account.  The fair value of
NeoPharm’s auction rate securities was estimated to be $13.5 million, which is
$1.2 million less than their $14.7 million cost.  Since the timing of
the repurchase of the Company’s auction rate securities at par value has been
uncertain and dependent on the rate of improvement of market conditions, we have
arranged for and fully drawn on a $5.0 million credit facility collateralized by
all of the Company’s investments, including its auction rate securities (see
note 6 below).
  Subsequent
to September 30, 2008, we entered into an agreement with the investment bank
that holds our auction rate securities, which gives the Company Auction Rate
Securities Rights (Rights”) to sell all of our auction rate securities at par
value back to the investment bank at any time during the period between June 30,
2010 and July 2, 2012 under the terms of a nontransferable rights
offering.  This agreement also gives the Company the right to borrow
money from the investment bank in the form of a no net cost loan of up to 75% of
the fair value of the auction rate securities.  The Company is also
exploring other alternatives under which it would liquidate its auction rate
securities at par value, although it is not known when or to what extent such
alternatives will be available.  Accordingly, we have reclassified our
investments in auction rate securities from a Current Asset to a Non-Current
Asset on our Consolidated Balance Sheet as of September 30, 2008.
  9
 Based on
the Rights, we now have the ability, at a future date, to sell our auction rate
securities at par value to the investment bank that holds our auction rate
securities.  Additionally, we intend to hold these securities until we
can sell them at par value, either when the Rights are exercisable, or at an
earlier opportunity to do so.  Accordingly, the Company considers the
decline in the estimated fair value of its investments in auction rate
securities to be temporary.  As such, we are reporting the decline in
estimated fair value, which is considered to be temporary, of $0.4 million and
$1.2 million for the three and nine month periods ended September 30, 2008,
respectively, as Accumulated Other Comprehensive Income (Loss), a separate
component of Shareholders’ Equity, as provided by Statement of Financial
Accounting Standards, or SFAS, No. 115, Accounting for Certain Investments
in Debt and Equity Securities.
  An accrued
interest income receivable of $28,000 and $59,000 was included with prepaid
expenses and other current assets, and the carrying value of the investments in
auction rate securities, as of September 30, 2008 and December 31, 2007,
respectively.
  Investments
in auction rate securities, stated at estimated fair market value, are as
follows (in thousands):
  September
      30,
                  2008
                
                
                December
      31,
                  2007State
      government agencies, at par value
                
                $
                14,700
                
                
                $
                19,700Less:
      temporary decline in estimated fair value (Accumulated Other Comprehensive
      Loss)
                
                
                (1,224
                )
                
                
                -Net
      estimated fair value of investments in auction rate
    securities
                
                $
                13,476
                
                
                $
                19,700
  5.
              FAIR
      VALUE MEASUREMENT
 
 As
discussed in Note 1, SFAS 157 became effective for measuring and reporting
financial assets and liabilities in our financial statements as of January 1,
2008.  SFAS 157 defines fair value as the price that would be received
to sell an asset or paid to transfer a liability (an exit price) in the
principal or most advantageous market for the asset or liability in an orderly
transaction between market participants on the measurement date.
 
 SFAS 157
establishes a three-level hierarchy for disclosure to show the extent and level
of judgment used to estimate fair value measurements:
  Level 1 –
Uses unadjusted quoted prices that are available in active markets for identical
assets or liabilities as of the reporting date.
  Level 2 –
Uses inputs other than Level 1 that are either directly or indirectly observable
as of the reporting date through correlation with market data, including quoted
prices for similar assets and liabilities in active markets and quoted prices in
markets that are not active. Level 2 also includes assets and liabilities that
are valued using models or other pricing methodologies that do not require
significant judgment since the input assumptions used in the models, such as
interest rates and volatility factors, are corroborated by readily observable
data.
  Level 3 –
Uses inputs that are unobservable and are supported by little or no market
activity and reflect the use of significant management judgment. These values
are generally determined using pricing models for which the assumptions utilize
management’s estimates of market participant assumptions.
  We have
applied the provisions of SFAS 157 to financial assets and liabilities measured
at fair value on our consolidated financial statements.
 
 Investments
in student loan backed auction-rate securities are our only Level 3 assets and
these investments are classified as available-for-sale and recorded at fair
value. Because of the recent deterioration in the credit markets, auctions for
these securities have failed since the first quarter of 2008. Consequently, fair
value measurements have been estimated by the investment bank which holds
NeoPharm’s auction rate securities using an income-approach model (discounted
cash-flow analysis). The model considers factors that reflect assumptions
that  market participants would use in pricing similar securities,
including, the collateral underlying the investments, the creditworthiness of
the counterparty, expected future cash-flows, including the next time the
security is expected to have a successful auction, and risks associated with the
uncertainties of the current market, the formula applicable to each security
which defines the interest rate paid to investors in the event of a failed
auction, forward projections of the interest rate benchmarks specified in such
formulas, the likely timing of principal repayments; the probability of full
repayment considering the guarantees by the U.S. Department of Education of the
underlying student loans, guarantees by other third parties, and additional
credit enhancements provided through other means, and publicly available pricing
data for recently issued student loan asset-backed securities which are not
subject to auctions.
 
  10
 Based on
the Rights, we now have the ability, at a future date, to sell our auction rate
securities at par value to the investment bank that holds our auction rate
securities.  Additionally, we intend to hold these securities until we
can sell them at par value, either when the Rights are exercisable, or at an
earlier opportunity to do so.  Accordingly, the Company considers the
decline in the estimated fair value of its investments in auction rate
securities to be temporary.  As such, we are reporting the decline in
estimated fair value, which is considered to be temporary, of $0.4 million and
$1.2 million for the three and nine month periods ended September 30, 2008,
respectively, as Accumulated Other Comprehensive Income (Loss), a separate
component of Shareholders’ Equity, as provided by Statement of Financial
Accounting Standards, or SFAS, No. 115, Accounting for Certain Investments
in Debt and Equity Securities.
  Any
future fluctuations in fair value, including recoveries of previously unrealized
losses relating to these investments, would be recorded as Accumulated Other
Comprehensive Income (Loss).  Any adjustments in fair value that we
determine to be other-than-temporary would require us to recognize associated
adjustments to earnings.  We evaluate financial assets and liabilities
subject to fair value measurements on a recurring basis to determine the
appropriate level at which to classify them for each reporting
period.
 
 6.
              SHORT-TERM
      DEBT
 
 During the
second quarter of 2008, we entered into a credit agreement with the investment
bank that holds our auction rate securities that will enable the Company to
borrow up to a maximum of $5.0 million in the form of a demand margin
loan.  Under the terms of the agreement, borrowings are collateralized
by the Company’s auction rate securities and other investments and interest is
based on an annual rate equal to the sum of the prevailing daily 30-day LIBOR
rate plus 25 basis points.  This weighted average for this rate was
2.65% for the three months ended September 30, 2008, and as of September 30,
2008, this rate was 3.93%.  In June 2008, we borrowed $5.0 million
under this credit agreement and invested the proceeds in a short-term money
market fund.  This $5.0 million loan, along with accrued interest
expense, is shown as of September 30, 2008 on our Consolidated Balance Sheet as
short-term debt.  The $5.0 million proceeds invested in U.S.
government treasury bills and short-term money market funds are included in cash
and cash equivalents as of September 30, 2008 on our Consolidated Balance
Sheet.  Interest expense of approximately $30,000 and $42,000 for the
three and nine month periods ended September 30, 2008, is included in net
interest income in our Condensed Consolidated Statement of
Operations.
  Subsequent
to September 30, 2008, we entered into an agreement with the investment bank
that holds our auction rate securities, which gives the Company Auction Rate
Securities Rights (Rights”) to sell all of our auction rate securities at par
value back to the investment bank at any time during the period between June 30,
2010 and July 2, 2012 under the terms of a nontransferable rights
offering.  This agreement also gives the Company the right to borrow
money from the investment bank in the form of a no net cost loan of up to 75% of
the fair value of the auction rate securities, including the $5 million already
borrowed (see note 4 above).
  7.
              FIXED
      ASSETS
 
 We record
fixed assets at cost and record depreciation using the straight-line method over
the related asset’s estimated useful life.  Expenditures that do not
extend the life or improve the productivity of assets are charged to expense
when incurred.  When fixed assets are disposed of, the related costs
and accumulated depreciation are removed from the accounts and any gain or loss
is recorded.  Depreciation and amortization expense for the nine
months ended September 30, 2008 and September 30, 2007, was $141,000 and
$587,000, respectively.  During the nine months ended September 30,
2008, the Company capitalized the cost of leasehold improvements made in
connection with its move to a smaller corporate headquarters facility, and
laboratory equipment totaling $143,000.
  Long-lived
assets are reviewed for impairment when changes in circumstances indicate the
carrying amount of an asset may not be recoverable. Recoverability of assets to
be held and used is measured by a comparison of the carrying amount of the
assets to estimated undiscounted cash flows expected to be generated by the
assets.  If the carrying amount of an asset were to exceed its
estimated future cash flows, an impairment charge would be recognized by the
amount by which the carrying amount of the asset exceeds the fair value of the
asset.
  
 11
  8.
              FACILITY
      CONSOLIDATION COSTS
 
 The lease
on our former Waukegan facility, from which we moved to our new facility in Lake
Bluff, expired on March 31, 2008.  In this lease there was an
obligation when we vacated the premises for us to restore the facility to its
original condition when we moved into the facility.  As a result, for
the year ended December 31, 2007, we accrued an estimated cost of our
restoration obligation of $200,000.  In April 2008 we entered into an
agreement to pay $125,000 to the owner of our former Waukegan facility in lieu
of incurring the actual costs for the restoration of that
facility.  As a result, we recorded a reduction in facility
consolidation costs of $75,000 in the first quarter of 2008 to adjust the
accrual to the amount that was actually paid in April 2008.  During
the second quarter of 2008, other immaterial facility consolidation expenses of
$11,000 were also incurred.
  As a
result of Company’s restructuring in 2007 and the planned move into a
significantly smaller facility as described above, we recorded a charge during
the third quarter of 2007 totaling $296,000 to reduce the carrying value of
fixed assets, primarily furniture and fixtures and computers and office
equipment, to their estimated net realizable value.
  9.
              STOCKHOLDERS’
      EQUITY
 
 We
maintain a Stockholder Rights Plan whereby rights to purchase shares of Series A
Participating Preferred Stock become exercisable by our stockholders in the
event a non-excluded party acquires, or attempts to acquire, 15% or more of our
outstanding common stock.
  10.
              COMMITMENTS
  Manufacturing
Commitment--To secure access to manufacturing capacity for the potential
manufacture, scale-up of manufacturing and regulatory advancement of Cintredekin
Besudotox, we entered into agreements with a contract manufacturing
organization.  Under the terms of the agreements, we may be obligated
to pay half of the committed processing costs, or approximately $2.1 million,
should we elect not to utilize such capacity.   However, at
September 30, 2008, management does not believe that there is a current
obligation to pay this amount.  Refer to Note 11 for further
discussion.
  License
and Research Agreements—From time to time we enter into license and
research agreements with third parties. As of September 30, 2008, we had
significant agreements with three parties, as described below.
  Georgetown
University—We have entered into two license agreements with Georgetown
whereby we obtained an exclusive worldwide license to use certain technologies.
In exchange for the grant of one of these exclusive licenses that is related to
taxane derivatives, we agreed to pay Georgetown a royalty, ranging from 1.25% to
2.50% of any net sales from our products incorporating such technologies as
covered by the licensed patents. The royalty will be payable for the life of the
related patents. Additionally, we may be obligated to pay $400,000 upon entering
into any sublicense agreement and $250,000 upon approval of a New Drug
Application, or NDA.
  In July
2007, we entered into an exclusive license to use certain antisense technologies
covered by certain US patents.  In exchange for the grant of this
license, we paid Georgetown a non-refundable license issue fee of $10,000 and
are liable for yearly maintenance fees of $20,000.  In addition, we
agreed to pay Georgetown a royalty of 2.75% of net sales from our products
incorporating these technologies and 50% of any royalties received from sub
licensees.  We may also be obligated to make milestone payments
totaling $900,000 upon achievement of certain objectives.
  National
Institutes of Health—We entered into an exclusive worldwide licensing
agreement with the NIH in 1997 to develop and commercialize IL13-PE38QQR
(Cintredekin Besudotox). The agreement required us to pay NIH a $75,000
non-refundable license issue payment and minimum annual royalty payments of
$10,000, which increase to $25,000 after the first commercial sale. The
agreement further provides for us to make milestone payments to NIH of up to
$585,000 and royalties of up to 3.50% based on any future product
sales.  We made the first milestone payment of $25,000 to NIH in
November 1999 after the filing of the U.S. Investigational New Drug IND
application for IL13-PE38QQR.  We are required to pay the costs of
filing and maintaining product patents on the licensed patents. The agreement
extends to the expiration of the last to expire of the patents on the licensed
patents, if not terminated earlier. The agreement may be terminated by mutual
consent of NIH and us. Either party may terminate if the other party breaches a
material term or condition and such breach is not cured within a certain period
of time. Also, either party may unilaterally terminate by giving advanced
notice.
  On May 30,
2006 we entered into a non-exclusive Patent License Agreement with the NIH
providing us with a non-exclusive license to utilize a patented process owned by
the U.S. government relating to convection enhanced delivery, or CED, for us to
use with drugs, including Cintredekin Besudotox in the treatment of gliomas, in
the U.S., its territories and possessions.  Under the terms of this
Patent License Agreement, we have paid NIH a noncredit able, nonrefundable
license issue royalty of $5,000 and have agreed to pay a nonrefundable, minimum
annual royalty of $2,000, which will be credited against earned royalties, which
are fixed at one-half of one percent (0.5%) on aggregate future product sales
over $100 million.  An additional benchmark royalty of $20,00 is
payable within thirty (30) days of receiving approval from the U.S. FDA of
approval to use the licensed CED process in administrating a drug for the
treatment of gliomas.  Pursuant to an amendment to this Patent License
Agreement entered into in August 2006, we expanded the field of use to cover the
treatment of cancer, were given the right to sublicense our rights and extended
the time for us to reach certain benchmarks.  In return for these
additional rights, we agreed to pay additional sublicensing royalties one and
one-half percent (1.5%), to a maximum of $200,000, on the fair market value of
any upfront consideration received for granting a sublicense.
  12
 In June
2007, we entered into an exclusive worldwide license agreement with the NIH to
develop and commercialize IL13-PE38QQR (Cintredekin Besudotox) for use in the
treatment of asthma and pulmonary fibrosis.  Upon entering the
contract, we paid NIH a non-refundable license issue royalty of $125,000 and
have agreed to pay an annual royalty of $20,000, which will be credited against
earned royalties, which are fixed at four percent (4%) of net sales, including
those of sub licensees.  In addition, we may be obligated to make
milestone payments totaling $1,410,000 upon achievement of certain
objectives.  We are required to pay the costs of filing and
maintaining product patents on the licensed patents. The agreement extends to
the expiration of the last to expire of the patents on the licensed patents, if
not terminated earlier. The agreement may be terminated by mutual consent of NIH
and us. Either party may terminate if the other party breaches a material term
or condition and such breach is not cured within a certain period of time. Also,
either party may unilaterally terminate by giving advanced notice.
  U.S. Food and
Drug Administration—In 1997 the Company entered into a Cooperative
Research and Development Agreement, or CRADA, with the FDA. Pursuant to the
CRADA, we committed to work to commercialize the IL13-PE38QQR chimeric protein
which we licensed from NIH. The FDA agreed to collaborate on the clinical
development and commercialization of IL13-PE38QQR.   In September
2005, we and the FDA agreed to extend the term and funding of the CRADA through
July 2009 for $165,000 per year.
  Lovelace
Respiratory Research Institute—In the third quarter of 2008, the Company
entered into an agreement to pay $1.1 million for the performance of a
preclinical inhalation toxicology study in non-human primates for our
Cintredekin Besudotox IL13-PE38 therapeutic agent for the treatment of pulmonary
fibrosis.  Under the terms of this agreement, we paid $200,000 upon
execution of the agreement, and will pay an additional $500,000 in the fourth
quarter of 2008 and the remaining balance upon completion of the final study
report in the first quarter of 2009.  The payment of $200,000 made
during the third quarter of 2008 is included in research and development expense
in our Condensed Consolidated Statement of Operations for the three and nine
months ended September 30, 2008.
  Clinical
Trial Commitments—As of September 30, 2008, we had clinical trial
agreements with various parties, as described below.
  Excel Life
Science— In August 2007, the Company entered into an agreement with Excel
Life Science for the completion of Phase II clinical trials with the use of
LEP-ETU for the treatment of metastatic breast cancer.  The agreement
contains milestone payments which are based upon stages of completion of the
phase II clinical trials.  Upon entering the contract, we paid Excel
Life Sciences $70,000.  In March 2008, we began enrolling patients in
this phase II clinical trial and we recorded $70,000 in accrued clinical trial
expenses at March 31, 2008 for the patient enrollment milestone payment
obligation.  This patient enrollment milestone obligation was paid in
April 2008.  Included in accrued clinical trial expenses at September
30, 2008 is $70,000 for patient enrollment expense accrued toward the next
milestone payment obligation, for the 12 patients enrolled to-date in this study
as of September 30, 2008.  The total remaining obligation is
potentially $139,000 for the completion of this phase II clinical
trial.
  TGen Clinical
Research Services— In March 2008, we entered into an agreement with TGen
Clinical Research Services for the completion of Phase I clinical trials with
the use of LE-DT for the treatment of advanced solid tumors.  The
agreement contains milestone payments which are based upon stages of completion
of the phase II clinical trials.  Upon entering the contract, we paid
$13,000 to TGen Clinical Research Services.  Included in accrued
clinical trial expenses at September 30, 2008 is $40,000 for patient enrollment
expense accrued toward the next milestone payment obligation for the 3 patient
enrolled to-date in this study, net of payments made as of September 30,
2008.  The total remaining obligation is dependent on the number of
patients that are enrolled, and their progression in the phase I study at TGen,
but could potentially be $180,000 for the completion of the phase I clinical
trial at this site.
  Georgetown
University— In April 2008, we entered into an agreement with Georgetown
University Medical Center for the completion of Phase I clinical trials with the
use of LE-DT for the treatment of advanced solid tumors.  The
agreement contains milestone payments which are based upon stages of completion
of the phase II clinical trials.  Upon entering the contract, we
accrued a start up fee of $9,000 payable to Georgetown University Medical
Center.  Included in accrued clinical trial expenses at September 30,
2008 is $78,000 for patient enrollment expense accrued toward the next milestone
payment obligation, for the 6 patients enrolled to-date in this study as of
September 30, 2008.  The total remaining obligation is dependent on
the number of patients that are enrolled, and their progression in the phase I
study at Georgetown, but could potentially be $148,000 for the completion of the
phase I clinical trial at this site.
  13
 SIRO ClinPharm,
USA— In August 2008, we entered into an agreement with SIRO ClinPharm USA
(“SIRO”) for the completion of a planned confirmatory Phase III trial with the
use of the our drug product candidate Cintredekin Besudotox (IL13-PE38QQR)
(“IL-13”), for the treatment of patients suffering from Recurrent Glioblastoma
Multiforme (GBM).  The agreement provides for the enrollment and
management of patients in an initial Part I study of the trial at a total cost
to the Company of $828,000, with an option for us to enroll more patients in a
Part II study at an additional cost of $755,000.  If we do not opt to
enroll more patients in the Part II study of the trial, an additional payment of
$165,000 will be due for the Part I study of the trial.
  Termination
and Employment Agreements— On March 23, 2007, the Company terminated the
employment of Mr. Guillermo Herrera, its President and Chief Executive
Officer.  In accordance with his employment agreement,
Mr. Herrera was scheduled to receive a salary continuation of approximately
$35,400 per month for twelve months.  However, subsequent to his
termination, the Company determined that, based on the terms of the employment
agreement, no salary continuance was due Mr. Herrera and further payments
were stopped.  Refer to Note 11 for further discussion.
  On March
23, 2007, the Company entered into an employment agreement with Mr. Laurence P.
Birch (the “Agreement”) to serve as its President and Chief Executive
Officer.  Mr. Birch was subsequently elected to the Company’s Board of
Directors on March 30, 2007.   Under terms of the Agreement, Mr.
Birch is provided an annual base salary of $275,000 and a target bonus of 50% of
his base salary based on performance criteria to be established by the Board in
consultation with Mr. Birch, with the potential to earn up to 100% of his base
salary for over achievement of performance criteria.  In the event the
Company terminates Mr. Birch’s employment without cause he would be entitled to
receive a continuation of his then current base salary for a period of twelve
months.   In the event of a termination after a change of control
of the Company, Mr. Birch would receive, in addition to twelve months salary
continuation, a lump sum payment equal to the prior year’s bonus, if any, plus
accelerated vesting of all options or restricted stock.
  11.
              CONTINGENCIES
 
 NeoPharm,
Inc. and certain of our former officers have been named in a consolidated
amended complaint, which alleges various violations of the federal securities
laws in connection with our public statements regarding our LEP drug product
candidate during the period from October 31, 2001 through April 19,
2002.  On November 4, 2002, we moved to have the complaint
dismissed. Our motion to dismiss was granted in part and denied in part in
February 2003.  In November 2004, the plaintiffs filed a
motion to amend and a motion for summary adjudication. The motion to amend
sought to include certain pre-class period statements in the complaint. The
motion for summary adjudication asked the Court to rule that certain statements
made in an arbitration award regarding the LEP drug product candidate be deemed
facts established in this proceeding. On February 23, 2007, the Court entered an
order denying both the plaintiffs’ motion to amend and the plaintiffs’ motion
for summary adjudication.  Fact and expert discovery is
closed.  On March 21, 2008, the dispositive motion filing deadline,
NeoPharm filed a motion for summary judgment, on which we are awaiting the
court’s decision.  No trial date has yet been set.  We
intend to vigorously defend each and every claim in the
complaint.  Management is unable to estimate the potential outcome or
range of possibilities, if any.  In addition, we maintain insurance
coverage to mitigate the financial impact of any potential loss.
  The
employment of Mr. Guillermo Herrera, the former CEO of the Company, was
terminated effective March 23, 2007.  Since that date, he has
retained counsel and on May 7, 2007, Mr. Herrera’s attorney filed a suit
entitled Guillermo Herrera vs.
NeoPharm, Inc., Case No. 2007 L 004711 in the Circuit Court of Cook
County, Illinois, seeking payment of $212,500 for his 2006 bonus and $25,000 for
a salary increase for 2007.  Subsequent to this filing, the Company
determined that under the terms of his employment agreement the Company should
not be responsible for the payment of severance and terminated further
payments.  Mr. Herrera filed an Amended Complaint on February 21, 2008
alleging breach of his employment agreement with the Company, defamation, and
tortious presentation of the plaintiff in a false
light.  Mr. Herrera seeks an additional $363,612 representing the
remaining severance payments, plus attorneys’ fees and costs.  Mr.
Herrera also seeks unspecified compensatory and punitive damages.  The
Company is vigorously defending this matter. We are unable at this time to make
any prediction as to the outcome of this litigation.
  We entered
into various contractual arrangements, primarily during the fourth quarter of
2006, under take or pay agreements, with Diosynth Biotechnology, Inc.
(“Diosynth”), to secure access to manufacturing capacity for the potential
manufacture and regulatory advancement of Cintredekin Besudotox through early
2008.  As a result of the FDA’s decision to require additional Phase
III clinical testing of Cintredekin Besudotox, the Company advised Diosynth that
the timing of further work to support a potential BLA submission must be
delayed.  Diosynth has indicated that such a delay constitutes a
default under our contract.  In response, the Company invoked the
dispute resolution provisions of the contract in an attempt to resolve these and
other differences between the two companies.  A dialogue between the
senior executives of our Company and Diosynth while initiated, has not been
pursued by the parties.  In the event the parties fail to resolve
their differences, the contract provides for mediation and eventually binding
arbitration.  Under the terms of the various contractual arrangements,
if the Company can not settle its outstanding differences with Diosynth, and
Diosynth should refuse to delay the related disputed manufacturing activity, and
such dispute were to culminate in an arbitration judgment against the Company,
we may be obligated to pay half of the disputed processing costs.  The
Company estimates the potential exposure to be approximately $2.1 million at
September 30, 2008.
  14
 We are
from time to time subject to claims and litigation arising in the ordinary
course of business. We intend to defend vigorously any such litigation that may
arise under all defenses that would be available to us. In the opinion of
management, the ultimate outcome of those proceedings of which management is
aware, even if adverse to us, will not have a material adverse effect on our
consolidated financial position or results of operations.  While we
maintain insurance to cover the use of our drug product candidates in clinical
trials, we do not presently maintain insurance covering the potential commercial
use of our drug product candidates and there is no assurance that we will be
able to obtain or maintain such insurance on acceptable terms.
  12.
              SUBSEQUENT
      EVENTS
 
 Subsequent
to September 30, 2008, we entered into an agreement to sell all of our auction
rate securities at par value, to the investment bank that holds our auction rate
securities, at any time during the period between June 30, 2010 and July 2,
2012  under the terms of a nontransferable rights offering
..  This agreement also gives the Company the right to borrow money
from the investment bank in the form of a no net cost loan of up to 75% of the
market value of the auction rate securities (see note 4 above).
  
  ITEM 2.
              MANAGEMENT’S
      DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF
      OPERATIONS
  Any
statements made by NeoPharm, Inc. (“we”, “us”, “our”, or the “Company”) in this
quarterly report that are forward-looking are made pursuant to the safe harbor
provisions of the Private Securities Litigation Reform Act of
1995.  We caution readers that important factors may affect our actual
results and could cause such results to differ materially from forward-looking
statements made by or on our behalf.  Such factors include, but are
not limited to, those risks and uncertainties relating to difficulties or delays
in development, testing, manufacturing, regulatory approval, recruitment of
patients, production and marketing of the Company’s drug candidates, including,
but not limited to: our drug product candidate IL13-PE38QQR, or Cintredekin
Besudotox, and our NeoLipid® product candidates LE-SN38, LEP-ETU, LE-DT and
LE-rafAON; our ability to make, or the timing of, a filing of any Biologics
License Application, or BLA, for approval of Cintredekin Besudotox with the
United States Food and Drug Administration, or FDA; our ability to conserve our
cash resources, to implement reductions in general and administrative
expenditures and to obtain additional sources of financing in the future; the
performance of third-party contractors; uncertainty regarding the outcome of
certain pending class action and other outstanding
litigation;  unexpected adverse side effects or inadequate therapeutic
efficacy of our drug product candidates, including, but not limited to,
Cintredekin Besudotox, that could slow or prevent our drug product candidates
coming to market; the uncertainty of patent protection for our intellectual
property and trade secrets, including freedom to operate with any of our drug
product candidates and the uncertainty of maintenance of our trade secrets; our
ability to raise additional funds at all or on terms acceptable to us; and other
factors referenced under Item 1A, “Risk Factors” in Part II of this Quarterly
Report on Form 10-Q.
  The
following should be read in conjunction with our condensed consolidated
financial statements and related notes and with Management’s Discussion and
Analysis of Financial Condition and Results of Operations and the Risk Factors
section included as Item 1A herein and in the Company’s 2007 Annual Report
on Form 10-K.  The results discussed below are not necessarily
indicative of the results to be expected in any future periods.  The
following discussion contains forward-looking statements that are subject to
risks and uncertainties, which could cause actual results to differ from
statements made.
 
 15
 Overview
 
 We are a
biopharmaceutical company engaged in the research, development, and
commercialization of drugs for the treatment of various cancers and other
diseases. Our corporate office and research and development facility is located
in Lake Bluff, Illinois and we had 20 active employees as of September 30,
2008.  We have built our drug development program around our two
proprietary technology platforms: a tumor-targeting toxin platform and NeoLipid®
liposomal drug delivery system. We have advanced five drug product candidates in
various stages of clinical and pre-clinical development for the treatment of
cancer and one drug product candidate in pre-clinical development for treatment
of interstitial pulmonary fibrosis, or IPF, and asthma. The following table
summarizes key information about our current drug product candidate
pipeline:
  Drug
      product candidate
                
                Clinical
      indication(s)
                
                2008
      Clinical
                  development
      status
                
                
                Commercialization
                  rightsCintredekin
      Besudotox
                  (IL13-PE38QQR)
                Glioblastoma
      multiforme
                  (brain
      cancer)
                Completed Phase
      III(1)
                World
      wideLEP-ETU
                  (Liposomal
      Paclitaxel)
                Breast
      cancer, ovarian cancer and
                  other
      solid tumors
                Phase
      II(2)
                
                
                World
      wideLE-SN38
                  (Liposomal
      SN-38)
                Colorectal
      cancer and other
                  solid
      tumors
                Phase
      II(3)
                
                
                World
      wideLE-DT
                  (Liposomal
      Docetaxel)
                Breast
      cancer, ovarian cancer,
                  prostate
      cancer and othersolid
      tumors
                Phase
      I(4)
                
                
                World
      wideLE-rafAON
                  (Liposomal-raf-Antisense
                  Oligonucleotide)
                Pancreatic
      and prostate cancer
                Re-activate
      IND, Planning
                  Phase
      I/Phase II in
                  Pancreatic
      Cancer
                United
      StatesCintredekin
      Besudotox
                  (IL13-PE38QQR)
                Interstitial
      pulmonary fibrosis and asthma
                Pre-IND(5)
                
                
                World
      wide
 _________________________
 (1)
              Representatives
      of the United States Food and Drug Administration’s, or FDA, Office of
      Oncology indicated during a review of the clinical data with the Company
      in March 2007, that an additional Phase III confirmatory clinical trial
      for Cintredekin Besudotox in the treatment of glioblastoma multiforme, or
      GBM, would be required before the FDA could accept the Company's Biologics
      License Application, or BLA.   The Company has signed an
      agreement with a clinical research organization to oversee an initial
      Phase III confirmatory trial regarding Cintredekin
      Besudotox, which is further discussed below under the heading “Drug
      Product Candidate Summary - Cintredekin
  Besudotox.”
  (2)
              The
      Company announced on March 31, 2008 that it had enrolled its first
      patients in its multi-center open-label, Phase II clinical trial of
      Liposomal Paclitaxel (LEP-ETU) for efficacy and safety in patients with
      Metastatic Breast Cancer.
  (3)
              The
      Company announced in March  2007 that the interim analysis of
      data following the completion of treatment of the first 21 patients
      demonstrated disease stabilization, but the study for LE-SN38 did not
      achieve the primary tumor response endpoint.  The Company is
      reassessing project next steps including additional data analyses and the
      possibility of other studies related to lung and breast
      cancer.
  (4)
              The
      Company entered into agreements with TGen Clinical Research Services and
      Georgetown University in March 2008 and April 2008, respectively, for the
      completion of Phase I clinical trials with the use of LE-DT for the
      treatment of advanced solid tumors.  Patient enrollment in this
      Phase I clinical trial with LE-DT to define the toxicities,
      pharmacokinetics and maximum tolerated dose with this new modality of
      treatment began in the second quarter of
2008.
  (5)
              The
      Company entered into an agreement with Lovelace Respiratory Research
      Institute in the third quarter of 2008 for the completion of a two week
      inhalation toxicology study designed to provide a detailed preclinical
      evaluation of this product through nebulization to fully characterize the
      physio-chemical behavior of the nebulized
  product.
   To date,
we have not received FDA approval for any of our drug product
candidates.  We expect to continue to incur losses for the foreseeable
future as we continue our research and development activities, which include the
sponsorship of human clinical trials for our drug product
candidates.  Until we are able to successfully commercialize one or
more of our drug product candidates, we anticipate that we will be required to
fund our research and development activities primarily by other means,
including, but not limited to, issuing equity or other securities, licensing
drug product candidates to third parties and collaborating with third parties to
develop formulations of their compounds using our technology.
 
 16
 
 Drug
Product Candidate Summary
 
 Cintredekin
Besudotox
 Cintredekin Besudotox
(GBM)
  The drug
product candidate which we have advanced the farthest is Cintredekin Besudotox,
a tumor-targeting toxin being developed as a treatment for glioblastoma
multiforme, or GBM, a deadly form of brain cancer.
  We have
exclusively licensed Cintredekin Besudotox from the NIH and the FDA, and have
been developing this drug product candidate under a Cooperative Research and
Development Agreement, or CRADA, with the FDA Center for Biologics Evaluation
and Research, or CBER.  Cintredekin Besudotox has received orphan drug
designation in the US and Europe and FDA has designated it for the fast track
drug development program.  In addition, Cintredekin Besudotox has been
selected to participate in the FDA’s Continuous Marketing Application, CMA,
Pilot 2 program.  We also hold a non-exclusive license to utilize a
patented process owned by the U.S. government relating to convection enhanced
delivery, or CED, for use with drugs, including Cintredekin Besudotox in the
treatment of gliomas.
 
 We have
also signed a Cooperative Research and Development Agreement (the “NINDS CRADA”)
with the National Institute of Neurological Diseases and Stroke (“NINDS”) for
research on a therapeutic agent for untreatable brain diseases in
humans.  Under the terms of the NINDA CRADA, NINDS, which is part of
the NIH, will deliver NeoPharm’s proprietary drug, Cintredekin Besudotox in
conjunction with a surrogate marker via NINDS’ patented methodology of
Convection Enhanced Delivery (CED), which was previously licensed to NeoPharm.
The Company will provide both the drug and technical resources to study its
effects in various brain cancers in humans.
  Conventional,
non-specific chemotherapeutic drugs attack cancer cells by stopping them from
dividing and reproducing, but can also damage normal healthy cells because they
do not discriminate between cancerous and healthy cells.  Furthermore,
standard chemotherapy drugs are usually administered systemically, which leads
to their distribution throughout the body rather than to one area, such as a
tumor in the brain.  Common side effects of chemotherapy that are
caused by damage to bone marrow include the body’s inability to produce enough
red blood cells, causing weakness and fatigue; white blood cells, lowering the
body’s resistance to infections; or platelets, preventing blood from clotting
properly, which can lead to excessive bleeding.
  Cintredekin
Besudotox is being developed as a highly specific tumor-targeting
agent.  Cintredekin Besudotox is a recombinant protein consisting of a
single molecule composed of two parts: a tumor-targeting molecule and a
cytotoxic agent.  The targeting component consists of
interleukin-13(IL-13), an immune regulatory cytokine.  Malignant
glioma cells, as compared to normal brain cells, express IL-13 receptors at a
higher density.  The cytotoxic agent is a potent bacterially derived
toxin called PE38.  Cintredekin Besudotox is designed to detect and
bind IL-13 receptors on the surface of malignant glioma cells and selectively
deliver PE38 to destroy tumor cells.  Cintredekin Besudotox is
administered by a technique known as convection-enhanced delivery, or CED, in
which the drug is delivered through catheters inserted in brain tissue
surrounding the tumor (peritumoral administration) or into the tumor
(intratumoral administration) following surgical resection of the
tumor.  CED is designed to infuse Cintredekin Besudotox directly to
the tumor site and adjacent brain tissue with the goal of killing resident tumor
cells and preventing recurrence of tumor cell growth.  We hope to show
that this method of delivery minimizes both damage to the surrounding cells and
toxicity from systemic drug exposure.
  During
2006 and the first quarter of 2007, the Company primarily focused on completing
its Phase III trial and  commercialization strategy for Cintredekin
Besudotox, including the preparation of the corresponding BLA submission to the
FDA.  However, upon review of the results from the Company’s Phase III
PRECISE trial in March 2007, the FDA concluded that an additional Phase III
confirmatory trial would be required prior to acceptance of a potential BLA
filing by the Company.  This will substantially delay, and may even
prevent, the potential commercialization of the product.
  The
Company has entered into an agreement with a clinical research organization to
oversee an initial Phase III confirmatory trial with the primary objective of
overall survival, with a secondary objective of progression free survival for
patients with recurrent GBM against the standard of care.  The Company
is expecting to start enrolling patients in the fourth quarter of
2008.  If the results of such an initial confirmatory trial were to be
encouraging, the Company could elect to expand the trial into a larger Phase III
trial in order to support a possible BLA filing for Cintredekin Besudotox with
the FDA.  While the Company has sufficient resources to fund the
initial Phase III confirmatory trial, and evaluate possible drug activity,
additional funding from sources outside the Company would be necessary to expand
and then complete the necessary Phase III trial, make the BLA filing and advance
this drug product candidate.  The Company does not currently have the
financial reserves to fully fund the testing and obtain approval for any of its
drug product candidates, including, but not limited to, Cintredekin
Besudotox.  Even if third party financing were to become available,
and at this time no assurance can be given that it would be, there can be no
assurance given that the terms of any proposed third party financing arrangement
would be acceptable to the Company.  The Company continues to explore
drug delivery improvements as well as the possibility of genetic testing to
identify patients that might be more responsive to treatment.  There
can be no assurance that these modifications will result in a positive outcome
in a second Phase III trial.  Further, there can be no assurances the
data from a second Phase III trial, whether or not these modifications were
made, would be deemed acceptable by the FDA or that the FDA would approve a BLA
for Cintredekin Besudotox based on such data.
  17
 The
Company continues to evaluate the potential of  Cintredekin Besudotox
for the treatment of recurrent GBM.  There can be no assurance that,
if a second Phase III trial were completed, data evidencing statistical
superiority would be generated and, even if such data were generated and
produced to the FDA, there can be no assurance that the FDA would accept or
approve a BLA submission by the Company.
  Cintredekin Besudotox( IPF
and Asthma)
  The
Company has licensed IL13-PE38 from NIH, FDA, and University of Michigan as a
potential therapeutic agent for the treatment of pulmonary fibrosis and asthma.
The Company’s collaborators have completed extensive preclinical studies in
animal models for the control and reversal of pulmonary fibrosis with this
agent. Preclinical studies relating to asthma have also been
performed.  Other preclinical toxicology studies are also
underway.  The Company is moving forward with its plan to undertake
additional detailed preclinical evaluation of this.  In the third
quarter of 2008, the Company entered into an agreement for the performance of a
two week inhalation toxicology study with a two week recovery period in
non-human primates.   This study is designed to provide a
detailed preclinical evaluation of this product through nebulization to fully
characterize the physio-chemical and biological behavior of the nebulized
product.The
Company plans to submit an IND to the FDA in the first quarter of 2009 if those
studies show that it is reasonably safe to conduct clinical investigations in
humans.  The preclinical testing plan has been discussed with the FDA,
and the agency has made it clear that significant studies must be performed in
animals to explore potential side effects in humans, before the agency will
permit testing in humans.
  NeoLipid®
Platform
  LE-SN38
  LE-SN38 is
our NeoLipid® liposomal
formulation of SN-38, the active metabolite of Camptosar® (Pfizer Inc.), a
chemotherapeutic pro-drug, which is used as a first-line and second-line
colorectal cancer treatment. At the present time, without the NeoLipid® system,
SN-38 is insoluble and can only be used to treat cancer by administering the
pro-drug Camptosar®.  A pro-drug is a compound that is converted into
the active drug in the body. However, Camptosar® is converted into SN-38 in the
liver at different rates by different patients, and this variability in
conversion rates can result in suboptimal dosing and adverse side effects, such
as severe diarrhea.  We hope to show that our proprietary NeoLipid®
technology permits delivery of SN-38 to the tumor cells without the need for
conversion, therefore minimizing variability and optimizing dose with minimal
side effects.
  Results
from our 2004 Phase I clinical trial provided evidence of the safety and
tolerability of LE-SN38 and established a maximum tolerated dose (MTD) of 35
mg/m2  for
all but a small subset of patients who metabolize SN-38
slowly.  Pharmacokinetic analysis of blood samples from patients
treated with LE-SN38 showed that blood levels and systemic drug exposure to
SN-38 were comparable to or greater than that expected from the marketed
Camptosar® dose based on previously published studies.
  During the
second quarter of 2006, in conjunction with the Cancer and Leukemia Group B,
CALGB, we initiated enrollment in a Phase II clinical trial with LE-SN38 in
metastatic colorectal cancer patients, and completed enrollment of the 21st
patient in December, 2006.
  In March
2007, the Company announced that the interim analysis of data following the
completion of treatment of the first 21 patients demonstrated disease
stabilization, but the study did not achieve the primary tumor response
endpoint.  The Company is reviewing the data and, in particular,
examining the patients’ demography, prior chemotherapy exposure, advanced stage
of the disease, and other related factors. It is possible that patients who were
enrolled in this trial were exposed to other chemotherapy regimens prior to
enrolling and that this prior exposure may be the reason the study did not
achieve its primary endpoint.  The Company is also assessing the
potential  next steps for this project which may include additional
data analyses and the possibility of other studies related to lung cancer and
breast cancer with LE-SN38.
  18
  LEP-ETU
  LEP-ETU is
our NeoLipid® liposomal formulation of the widely used cancer drug,
paclitaxel.  Paclitaxel, also known as Taxol® (Bristol-Myers Squibb
Company), has been approved in the US for the treatment of ovarian, breast and
lung cancers.  Despite paclitaxel’s wide use and its tumor cytotoxic
characteristics, its effectiveness can be limited by its adverse side effects,
which can include nausea, vomiting, hair loss and nerve and muscle
pain.  Because of the chemical characteristics of paclitaxel, it
cannot be introduced into the body unless it is first formulated in a mixture of
castor oil (Cremophor®) and ethanol, which can lead to significant side effects
such as hypersensitivity reactions and cardiac toxicities.  We hope to
show that our proprietary NeoLipid® technology, which eliminates the need for
Cremophor and ethanol, permits delivery of paclitaxel treatment with fewer side
effects.
  During
2004, we completed a Phase I clinical trial for LEP-ETU.  In this
study, LEP-ETU appeared to be well tolerated in the majority of the patients.
Antitumor activity was observed, with 16% of patients experiencing partial
responses (shrinkage of tumor by 50% or more).  Additionally, 44% of
patients evidenced stable disease and were able to complete 4 or more, 3-week
cycles of LEP-ETU treatment.  Patients previously treated with taxanes
were among those who partially responded to LEP-ETU.
  Based
on the results obtained in its Phase I trial, the Company began patient
enrollment in the first quarter of 2008 in  five centers in a Phase II
trial designed to assess the efficacy and safety of LEP-ETU in recurrent breast
cancer patients.  Twelve patients have been enrolled as of end of the
third quarter of 2008.  This study is expected to be completed by the
end of 2008 or early 2009.  Depending on the outcome of this clinical
trial, we may decide to undertake multicenter and multinational Phase III trials
in this indication after thorough discussions with FDA.
  LE-DT
  Pre-clinical
work has also advanced on our earlier stage liposomal formulation of the
anti-cancer agent docetaxel, LE-DT, which is the active ingredient in Sanofi
Aventis’ Taxotere® which is approved for use in certain breast cancer, non-small
cell lung cancer, gastric adenocarcinoma, head and neck cancer indications and
prostate cancer.  We filed the Investigational New Drug Application,
IND, to the FDA in December 2007 and the IND became effective in January
2008.  Following   the activation of its IND, the
Company started enrolling patients in two cancer centers, Georgetown University,
Lombardi Cancer Center and at TGen, Scottsdale Health Care
system.  These two Centers have thus far enrolled nine patients in
this trial, which is designed to define the maximum tolerated dose (MTD) of
LE-DT in patients with metastatic solid cancer who have failed conventional
therapy, as of the third quarter of 2008.  This study is expected to
be completed by the end of 2008 or early 2009.
  LE-rafAON
  Preclinical
work with the new formulation of LE-rafAON, which is expected to have minimal
infusion related toxicities, is ongoing and we expect to submit a revised IND to
FDA in the fourth quarter of 2008.  The antisense oligonucleotide
agent c-raf has shown significant down regulation of the gene in Preclinical
studies. Also, LE-rafAON has exhibited significant radiation sensitization and
chemo sensitization with other anticancer agents such as gemcitabine and
paclitaxel in human xenograft models in mice in pancreatic and prostate
tumors.  We plan to perform the bridging Phase I trial with this newly
formulated LE-rafAON and thereafter start Phase II trials in pancreatic and
prostate cancer models where this gene seems to be potentially over
expressed.
  We intend
to further develop the NeoLipid® drug product candidates by using our internal
resources and by continuing to collaborate with other companies and leading
governmental and educational institutions.
  In
addition, we intend to explore the use of our proprietary NeoLipid®
liposomal drug delivery technology to create new products in two ways: life
cycle management, therefore extending the patent life and/or modifying the
pharmacokinetic profile of existing cancer drugs, and by utilizing our platform
to develop new drugs.  We are aware of several widely used cancer
drugs that are nearing patent expiration, as well as other widely used cancer
drugs with patents that have expired.  When a drug is combined with
another agent or delivery system in a novel way, its patent life may be
extended.  Additionally, while many chemotherapeutic drugs have been
effective for the treatment of cancer, these drugs have been limited in their
use because of adverse side effects and difficulties in
administration.  Our NeoLipid® drug delivery technology may increase
the usefulness of these compounds as improved anti-cancer
treatments.  Finally, we believe that our liposomal drug delivery
technology may provide us with a platform for the development of novel
therapeutic agents for cancer drug development.
  It is
difficult to predict with any certainty the timing of and total estimated costs
to complete development of drug product candidates in early stage, or Phase I,
clinical development, as well as the estimated date such drug product candidates
would be available for sale, if approved by the FDA.  A number of
factors contribute to this uncertainty, including: side effects encountered in
early stage clinical trials, ability to scale up manufacturing for commercial
supply, and the fact that the size and scope of pivotal Phase III clinical
trials are unknown until sufficient data is available to present a Phase III
plan to the FDA for approval.   In addition, our drug product
candidates require approval by the FDA after completing Phase III clinical
trials before we can sell the drugs to generate revenue and, potentially,
realize net cash inflows.  Substantial additional clinical trial
expenses are expected to be incurred for Cintredekin Besudotox before approval
can be sought again.
  19
 The table
below includes a summary of identified direct project costs incurred to date for
our clinical research and development projects.  Generally, identified
project costs include expenses incurred specifically for clinical trials and
pre-clinical studies we conduct, and exclude expenses incurred for salaries paid
to our professional staff, our Lake Bluff facility and the related depreciation
of equipment as well as general laboratory supplies used in our research, which
are included with non-project specific costs.
  Total
      Direct Costs IncurredResearch
      Project
                
                Three
      Months Ended September 30, 2008
                
                
                Nine
      Months Ended September 30, 2008
                
                
                Since
      Beginning of ProjectCintredekin
      Besudotox
                
                $
                293,000
                
                
                $
                437,000
                
                
                $
                67,945,000LEP-ETU
                
                
                43,000
                
                
                
                214,000
                
                
                
                8,004,000LE-SN38
                
                
                1,000
                
                
                
                10,000
                
                
                
                5,325,000LE-DT
                
                
                90,000
                
                
                
                206,000
                
                
                
                751,000LE-rafAON
                
                
                137,000
                
                
                
                345,000
                
                
                
                416,000Non-project
      specific and other
                
                
                890,000
                
                
                
                2,079,000
                
                
                
                N/ATotal
      research and development expenses
                
                $
                1,454,000
                
                
                $
                3,291,000
                
                
                
                N/A
  Results
of Operations
  Three
Months Ended September 30, 2008 as compared to Three Months Ended September 30,
2007
  Research
and development, or R&D, expense for the three months ended September 30,
2008 decreased by $0.2 million, to $1.5 million, compared to $1.7 million for
the same period in 2007.  The decrease is attributed to a $0.3 million
decrease in overall project costs, partially offset by a $0.1 increase in
payroll and benefits expenses.  The overall increase in payroll and
benefits expenses is primarily attributed to increases in payroll and benefits
expenses in 2008 for personnel who support the Company’s advancement of its
current clinical trials.  The decrease in overall project costs is
primarily attributed to a decrease in the PRECISE trial expenditures in
connection with the decision to bring that phase III trial to an early
conclusion, which was partially offset by the advancement of certain of our
NeoLipid® products into clinical trials from a pre-clinical status.
  Selling,
general, and administrative, or SG&A, expenses decreased $0.2 million, to
$1.1 million for the three months ended September 30, 2008, compared to $1.3
million for the same period in 2007.  The overall decrease in SG&A
is primarily attributed to the Company’s various cost reduction initiatives
implemented during 2007.  With the move into a smaller, more
cost-effective facility and other various cost containment measures that were
put into effect, the Company has been able to realize reductions in spending in
accounting, legal, consulting, travel expenses, equipment lease costs, board of
director compensation, and office supplies totaling $0.3 million.
  In the
three months ended September 30, 2007, we recorded facility consolidation costs
of $0.3 million to reduce the carrying value of fixed assets, primarily
furniture and laboratory equipment, to their estimated net realizable
value.
  In the
three months ended September 30, 2007, we recorded  other income of
$2.0 million dollars in recognition of an amount that had been recorded in
deferred income.  The Company received notification in September 2007,
that Nippon Kayaku Co, Ltd had elected to terminate the licensing agreement they
had entered into with the Company in 2004 for which they had paid to the Company
a non-refundable license fee of $2.0 million.  This amount had been
recorded as deferred income at that time.
 
 The
Company generated interest income on cash equivalents and short-term investments
net of interest expense on short term borrowings of approximately $0.1 million
and $0.3 million for the three months ended September 30, 2008 and September 30,
2007, respectively.  The decrease in net interest income during the
period was primarily due to a decrease in average short-term investment balances
which were used to fund operations, and a temporary decrease in the yields on
the Company’s short-term investment balances, in connection with the failed
auctions of the Company’s auction rate securities.
 
 20
  Nine
Months Ended September 30, 2008 as compared to Nine Months Ended September 30,
2007
  Research
and development, or R&D, expense for the nine months ended September 30,
2008 decreased by $2.9 million, to $3.3 million, compared to $6.2 million for
the same period in 2007.  The decrease is attributed to a $.5 million
reduction in payroll and benefits expenses, primarily attributed to the
Company’s various cost reduction initiatives implemented during 2007 and a $2.4
million decrease in overall project costs.  The decrease in overall
project costs is primarily attributed to decreases in the PRECISE trial and
Initial Diagnosis GBM Phase I trial expenditures and product manufacturing and
testing related costs in connection with decision to bring the PRECISE trial to
an early conclusion, which was partially offset by the advancement of our
NeoLipid® products into clinical trials from a pre-clinical
status.  Product manufacturing and testing related costs, research
supplies and lab facility expenses decreased by a combined $1.3 million as a
result of these changes in our drug development activities and the Company’s
move into a smaller, more cost-effective lab facility.
  Selling,
general, and administrative, or SG&A, expenses decreased $2.5 million, to
$3.6 million for the nine months ended September 30, 2008, compared to $6.1
million for the same period in 2007.  Included in this $2.5 million of
total SG&A for the nine months ended September 30, 2008 are one-time,
non-recurring expenses of $0.2 million related to the Company’s move into
smaller, more cost-effective facility.  The overall decrease in
SG&A is attributed to a $1.0 million decrease in personnel costs, primarily
attributed to the Company’s various cost reduction initiatives implemented
during 2007, and includes $0.4 million in costs associated with the termination
of the Company’s former Chief Executive Officer in March, 2007.  With
the reduction in people and cost containment measures put into effect, the
Company has been able to realize reductions in spending in accounting, legal,
patent, consulting, travel expenses, equipment lease costs, board of director
compensation, and office supplies totaling $1.5 million.
  Following
the Company’s announcement in March 2007 that additional Phase III clinical
trials have been recommended for its drug product candidate, Cintredekin
Besudotox, the Company initiated an organizational realignment in April 2007
which reduced the workforce by 25 employees resulting in a charge to earnings
totaling approximately $555,000.
  The lease
on our Waukegan facility, from which we are moved to our new facility in Lake
Bluff, expired on March 31, 2008.  The Waukegan lease imposed an
obligation on us to restore the facility to its original condition when we
vacated the facility.  As a result, for the year ended December 31,
2007, we accrued an estimated cost of our restoration obligation of
$200,000.  In April 2008 we entered into an agreement to pay $125,000
to the owner of our former Waukegan facility in lieu of the actual restoration
of that facility.  As a result, we recorded a reduction in facility
consolidation costs of $75,000 in the first quarter of 2008 to adjust the
accrual to the amount that was actually paid in April 2008, which was then
partially offset by other immaterial facility consolidation costs incurred in
the second quarter of 2008.
  In
connection with the Company’s restructuring in 2007, we recorded facility
consolidation costs of $0.3 million for the nine months ended September 30,
2007, to reduce the carrying value of fixed assets, primarily furniture and
laboratory equipment, to their estimated net realizable value.
 
 The
Company recorded  other income of $2.0 million dollars for the nine
months ended September 30, 2007, in recognition of an amount that had been
recorded in deferred income.  The Company received notification in
September 2007, that Nippon Kayaku Co, Ltd had elected to terminate the
licensing agreement they had entered into with the Company in 2004 for which
they had paid to the Company a non-refundable license fee of $2.0
million.  This amount had been recorded as deferred income at that
time.
  The
Company sold clinical equipment returned from the PRECISE trial that has been
expensed in a prior year, and realized a $0.3 million gain for the nine months
ended September 30, 2008.
  The
Company generated interest income on cash equivalents and short-term investments
net of interest expense on short term borrowings of approximately $0.5 million
and $1.1 million for the nine months ended September 30, 2008 and September 30,
2007, respectively.  The decrease in interest income during the period
was primarily due to a decrease in average short-term investment balances which
were used to fund operations, and a temporary decrease in the yields on the
Company’s short-term investment balances, in connection with the failed auctions
of the Company’s auction rate securities (see Note 4).
 
 21
  Liquidity
and Capital Resources
 
 Net cash
used in operating activities decreased $9.5 million from $15.0 million to $5.5
million for the Nine months ended September 30, 2008 and September 30, 2007,
respectively.  The decrease in cash used by operations was primarily a
result of the lower net loss for the quarter ended September 30, 2008 compared
to September 30, 2007, and a significant reduction in accounts payable balances
due to a reduction in overall operations.
  Our
primary source of cash has been proceeds from sales of marketable securities and
in the second quarter of 2008, borrowings under our credit agreement
..  As of September 30, 2008, we had available for sale securities with
an estimated fair value of $13.5 million, consisting solely of state government
auction rate securities.  All of the auction rate securities held by
the Company as of September 30, 2008 have experienced failed
auctions.  An auction failure is not a default.  An auction
failure means that the parties wishing to sell securities could not because the
number of sellers was greater than the number of buyers at the reset
dates.  The auction rate securities typically have provisions such
that the interest rates initially reset at higher percentages upon failure in
the auction market, and then adjust so that interest rates average to prevailing
market-based percentages for these types of securities.  Interest
continues to accrue and be paid currently on all of the auction rate
securities.
  The
investment bank which holds NeoPharm’s auction rate securities has estimated the
fair value of all of its auction rate securities as of September 30, 2008,
including those held in the Company’s account.  The fair value of
NeoPharm’s auction rate securities was estimated to be $13.5 million, which is
$1.2 million less than their $14.7 million cost.  Since the timing of
the repurchase of the Company’s auction rate securities at par value has been
uncertain and dependent on the improvement of market conditions, we have
arranged for and fully drawn on a $5.0 million credit facility collateralized by
all of the Company’s investments, including its auction rate
securities.
  Subsequent
to September 30, 2008, we entered into an agreement that gives us the right to
sell all of our auction rate securities at par value, to the investment bank
that holds our auction rate securities, at any time during the period between
June 30, 2010 and July 2, 2012, under the terms of a nontransferable rights
offering.  This agreement also gives the Company the right to borrow
money from the investment bank in the form of a no net cost loan of up to 75% of
the market value of the auction rate securities, which we believe will provide
us the liquidity to fund our operations through most of 2009, based on our
current forecasted cash consumption during that period of time.
  Based on
the Rights, we now have the ability, at a future date, to sell our auction rate
securities at par value to the investment bank that holds our auction rate
securities.  Additionally, we intend to hold these securities until we
can sell them at par value, either when the Rights are exercisable, or at an
earlier opportunity to do so.  Accordingly, the Company considers the
decline in the estimated fair value of its investments in auction rate
securities to be temporary.  As such, we are reporting the decline in
estimated fair value, which is considered to be temporary, of $0.4 million and
$1.2 million for the three and nine month periods ended September 30, 2008,
respectively, as Accumulated Other Comprehensive Income (Loss), a separate
component of Shareholders’ Equity, as provided by Statement of Financial
Accounting Standards, or SFAS, No. 115, Accounting for Certain Investments
in Debt and Equity Securities.
  We expect
that our primary use of cash over the next 12 to 18 months will be to fund, in
addition to general and administrative expenses, our initial Phase III
confirmatory trial for Cintredekin Besudotox for glioblastoma multiforme,
advancement of our Cintredekin Besudotox for pulmonary fibrosis and our
NeoLipid® clinical and pre-clinical research and development efforts, and our
remaining PRECISE Phase III clinical trial patient obligations.
  As a
result of the April 2007 cost reduction initiative coupled with other ongoing
cost-saving initiatives, the Company was able to reduce budgeted selling,
general and administrative expenditures by $2.5 million for the nine months
ended September 30, 2008 as compared to September 30, 2007.  The
Company currently projects it has sufficient cash available to fund operations
for 2008 and well into 2009 before requiring additional
financing.  The date as to which sufficient funds continue to be
available for operations, without additional financing, may vary depending upon
the timing and implementation of various strategies under consideration by the
Company.
  We may
seek to meet future funding requirements through public or private offerings of
securities or with collaborative or other development or licensing arrangements
with corporate or private venture partners. Additional financing may not be
available when needed or on terms acceptable to us, if at all.  If
adequate financing is not available, we may be required to further delay, scale
back, or eliminate certain of our research and development programs, relinquish
rights to certain of our technologies, drugs or products, or license our
products or technologies to third parties that we would otherwise seek to
develop ourselves.
  We have no
exposure to off-balance sheet arrangements, no special purpose entities, or
activities that include non-exchange-traded contracts accounted for at fair
value.
  22
 
 Critical
Accounting Policies
 
 In
preparing the Company’s financial statements in conformity with U.S. generally
accepted accounting principles, management must make a variety of decisions
which impact the reported amounts and related disclosures. Such decisions
include the selection of the appropriate accounting principles to be applied,
the assumptions on which to base accounting estimates and the consistent
application of those principles. Due to the type of industry in which we operate
and the nature of our business, the following policies are those that management
believes are the most important to the portrayal of our financial condition and
results and that require management’s most difficult, subjective or complex
judgments, often as a result of the need to make estimates about the effect of
matters that are inherently uncertain.
  Income
      Taxes
  In
assessing the realizability of deferred tax assets, management considers whether
it is more likely than not that some portion or all of the deferred tax assets
will not be realized. The ultimate realization of deferred tax assets is
dependent upon the generation of future taxable income during the periods in
which those temporary differences become deductible. Management considers the
scheduled reversal of deferred tax liabilities, projected future taxable income,
and tax planning strategies in making this assessment. Significant judgments are
required to estimate the generation of future taxable income and the timing of
the reversal of deferred tax liabilities.
  Contingencies
  To
properly account for and provide disclosure of loss contingencies, management
must apply judgment in determining whether a loss contingency is: probable,
reasonably possible, or remote. In instances where management has determined
that a loss contingency is probable, it must make use of estimates to determine
the amount of probable loss. Management must apply judgment in determining
whether or not it can make a reasonable estimate. Management must also apply
judgment in determining whether or not disclosure of loss contingencies that
have been accrued should be made for the consolidated financial statements not
to be misleading.
  Share-based
      Compensation
  We account
for share-based compensation in accordance with SFAS No. 123 (revised 2004),
Share-Based Payment, or
SFAS 123(R).  Under the provisions of SFAS 123(R), share-based
compensation cost is estimated at the grant date based on the award’s fair value
as calculated by the Black-Scholes option-pricing model and is recognized as
expense over the requisite service period.  We also use the
Black-Scholes model to estimate the fair value of non-employee options grants
that are revalued each quarter.  The Black-Scholes model requires
various highly judgmental assumptions including volatility and expected option
life.  If any of the assumptions used in the Black-Scholes model
change significantly, share-based compensation expense may differ materially in
the future from that recorded in the current period.
  Available
for Sale Securities
  Investments
in auction rate securities have scheduled maturities greater than 90 days at the
time of purchase, and are classified as available-for-sale securities and
recorded at fair value.  Auction rate securities are used by many
student-loan providers, municipalities and other governmental authorities to
raise cash to fund projects or operations, and money market funds. These auction
rate securities all have AAA/aaa credit ratings, consistent with our investment
policy guidelines, and have long-term nominal maturities with provisions calling
for the interest rates to be reset through periodic auctions every 7 to 28
days.  Beginning in February 2008, all of the auction rate securities
held by the Company as of September 30, 2008 have experienced failed
auctions.  An auction failure is not a default.  An auction
failure means that the parties wishing to sell securities could not because the
number of sellers was greater than the number of buyers at the reset
dates.  The auction rate securities typically have provisions such
that the interest rates initially reset at higher percentages upon failure in
the auction market, and then adjust so that interest rates average to prevailing
market-based percentages for these types of securities.  Interest
continues to accrue and be paid currently on all of the auction rate
securities.
  The
investment bank which holds NeoPharm’s auction rate securities has estimated the
fair value of all of its auction rate securities as of September 30, 2008,
including those held in the Company’s account.  The fair value of
NeoPharm’s auction rate securities was estimated to be $13.5 million, which is
$1.2 million less than their $14.7 million cost.  Since the timing of
the repurchase of the Company’s auction rate securities at par value has been
uncertain and dependent on the rate of improvement of market conditions, we have
arranged for and fully drawn on a $5.0 million credit facility collateralized by
all of the Company’s investments, including its auction rate securities (see
note 6 below).
  23
 Subsequent
to September 30, 2008, we entered into an agreement with the investment bank
that holds our auction rate securities, which gives the Company Auction Rate
Securities Rights (Rights”) to sell all of our auction rate securities at par
value back to the investment bank at any time during the period between June 30,
2010 and July 2, 2012 under the terms of a nontransferable rights
offering.  This agreement also gives the Company the right to borrow
money from the investment bank in the form of a no net cost loan of up to 75% of
the fair value of the auction rate securities.  The Company is also
exploring other alternatives under which it would liquidate its auction rate
securities at par value, although it is not known when or to what extent such
alternatives will be successful.  Therefore we have reclassified our
investments in auction rate securities from a Current Asset to a Non-Current
Asset on our Consolidated Balance Sheet as of September 30, 2008.
  Based on
the Rights, we now have the ability, at a future date, to sell our auction rate
securities at par value to the investment bank that holds our auction rate
securities.  Additionally, we intend to hold these securities until we
can sell them at par value, either when the Rights are exercisable, or at an
earlier opportunity to do so.  Accordingly, the Company considers the
decline in the estimated fair value of its investments in auction rate
securities to be temporary.  As such, we are reporting the decline in
estimated fair value, which is considered to be temporary, of $0.4 million and
$1.2 million for the three and nine month periods ended September 30, 2008,
respectively, as Accumulated Other Comprehensive Income (Loss), a separate
component of Shareholders’ Equity, as provided by Statement of Financial
Accounting Standards, or SFAS, No. 115, Accounting for Certain Investments
in Debt and Equity Securities.
 
 ITEM
3.         QUANTITATIVE
AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
 
 As of
September 30, 2008, we did not own any derivative instruments, but we were
exposed to market risks, primarily the impact of changes in United States
interest rates on our short-term investments and on our short-term debt. As of
September 30, 2008, we held total cash and cash equivalents of $5.4 million,
available for sale securities of auction rate securities of $13.5 million and
short-term debt of $5.0 million.  All cash equivalents have a maturity
less than 90 days. Declines in interest rates on our short-term investments over
time would reduce our interest income from our investments.  An
increase in the interest rate on our short-term debt over time would increase
our interest expense on our short-term debt. Based upon our cash and cash
equivalents as of September 30, 2008, a decrease in interest rates of 1.0% would
cause a corresponding decrease in our annual interest income on cash and cash
equivalents of approximately $55,000.  An increase in the interest
rate of 1.0% on our short-term debt as of September 30, 2008 would cause a
corresponding increase in our annual interest income of $50,000.
  The market
values of the available for sale securities may fluctuate due to market
conditions and other conditions over which we have no
control.  Fluctuations in the market price and valuations of these
securities may require us to record losses due to impairment in the value of the
securities underlying the investment.  This could result in future
charges to our earnings.  All of the auction rate securities held by
the Company as of September 30, 2008 have experienced failed
auctions.  An auction failure is not a default.  An auction
failure means that the parties wishing to sell securities could not because the
number of sellers was greater than the number of buyers of the reset
dates.  Refer to Note 4 of our financial statements for further
discussion regarding the failed auctions of our available for sale securities in
the auction markets as of September 30, 2008.
  ITEM
4T.        CONTROLS AND
PROCEDURES
 
 Disclosure
Controls and Procedures
  Ourdisclosure
controls and procedures are designed to ensure that information required to be
disclosed in the reports that we file or submit under the Securities Exchange
Act of 1934, as amended, is recorded, processed, summarized and reported within
the time periods specified in the Securities and Exchange Commission’s rules and
forms, including ensuring that such information is accumulated and communicated
to management as appropriate to allow timely decisions regarding required
disclosure.  We necessarily apply judgment in assessing the costs and
benefits of such controls and procedures that, by their nature, can only provide
reasonable assurance regarding management’s control objectives.
  Our
President and Chief Executive Officer/Acting Chief Financial Officer, has
carried out an evaluation, with the participation of our management, of the
effectiveness of the Company’s disclosure controls and procedures (as defined in
Rule 13a-15(e) of the Securities Exchange Act of 1934), as of the end of
the period covered by this report, based on the evaluation required by paragraph
(b) of Rule 13a-15 under the Securities Act of 1934.  Based upon
such evaluation, our President and Chief Executive Officer/Acting Chief
Financial Officer has concluded that, as of the end of such period, the
Company’s disclosure controls and procedures were effective.
 
 24
  Changes
in Internal Control Over Financial Reporting
  There have
been no significant changes in our internal control over financial reporting
that occurred during the quarter ended September 30, 2008, that have materially
affected, or are reasonably likely to materially affect our internal control
over financial reporting.
  25
  PART II - OTHER INFORMATION
 
  ITEM
      1.
              LEGAL
      PROCEEDINGS
  NeoPharm,
Inc. and certain of our former officers have been named in a consolidated
amended complaint, which alleges various violations of the federal securities
laws in connection with our public statements regarding our LEP drug product
candidate during the period from October 31, 2001 through April 19,
2002.  On November 4, 2002, we moved to have the complaint
dismissed. Our motion to dismiss was granted in part and denied in part in
February 2003.  In November 2004, the plaintiffs filed a
motion to amend and a motion for summary adjudication. The motion to amend
sought to include certain pre-class period statements in the complaint. The
motion for summary adjudication asked the Court to rule that certain statements
made in an arbitration award regarding the LEP drug product candidate be deemed
facts established in this proceeding. On February 23, 2007, the Court entered an
order denying both the plaintiffs’ motion to amend and the plaintiffs’ motion
for summary adjudication.  Fact and expert discovery is
closed.  On March 21, 2008, the dispositive motion filing deadline,
NeoPharm filed a motion for summary judgment, on which we are awaiting the
court’s decision.  No trial date has yet been set.  We
intend to vigorously defend each and every claim in the
complaint.  Management is unable to estimate the potential outcome or
range of possibilities, if any.  In addition, we maintain insurance
coverage to mitigate the financial impact of any potential loss.
  The
employment of Mr. Guillermo Herrera, the former CEO of the Company, was
terminated effective March 23, 2007.  Since that date, he has
retained counsel and on May 7, 2007, Mr. Herrera’s attorney filed a suit
entitled Guillermo Herrera vs.
NeoPharm, Inc., Case No. 2007 L 004711 in the Circuit Court of Cook
County, Illinois, seeking payment of $212,500 for his 2006 bonus and $25,000 for
a salary increase for 2007.  Subsequent to the initiation of this
action, the Company determined that under the terms of his employment agreement
the Company should not be responsible for the payment of severance and
terminated further payments.  Mr. Herrera filed an Amended Complaint
on February 21, 2008 alleging breach of his employment agreement with the
Company, defamation, and tortuously presenting him in a false
light.  Mr. Herrera seeks an additional $363,612 representing the
remaining severance payments, plus attorneys’ fees and costs.  Mr.
Herrera also seeks unspecified compensatory and punitive damages.  The
Company is vigorously defending this matter. We are unable at this time to make
any prediction as to the outcome of this litigation.
  
 ITEM 1A.
              RISK
      FACTORS
 
 Below are
the risk factors that have been revised since the filing of our annual report on
March, 28, 2008 on Form 10-K for the year ended December 31, 2007 (the
“2007 Form 10-K”) and our Quarterly Reports on Form 10-Q for the Quarters ended
March 31, 2008 and June 30, 2008 (“Prior 10-Qs”).  We face significant
additional risks, which are set forth in the Part I, Item 1A in our 2007 Form
10-K under the caption “Risk Factors.”  You are urged to read these
risk factors in the 2007 Form 10-K and Prior 10-Qs , in addition to the
following revised risk factors set forth below.  Each of the risk
factors set forth here and in our 2007 Form 10-K and Prior 10-Qs could
materially adversely affect our business, operating results and financial
condition, as well as the value of an investment in our common
stock.   Additional risks and uncertainties not presently known
to us, or those we currently deem immaterial, may also materially harm our
business, operating results and financial condition.
 
 Our
investments could lose market value and consequently harm our ability to fund
continuing operations.
  Investments
in both fixed-rate and floating-rate interest earning instruments carry varying
degrees of interest rate risk. Fixed-rate securities may have their fair market
value adversely impacted due to a rise in interest rates. In general, securities
with longer maturities are subject to greater interest rate risk than those with
shorter maturities. While floating-rate securities generally are subject to less
interest rate risk than fixed-rate securities, floating-rate securities may
produce less income than expected if interest rates decrease. Due in part to
these factors, our investment income may fall short of expectations or we may
suffer losses in principal if securities are sold that have declined in market
value due to changes in interest rates.
  26
 We
have invested a significant portion of our cash in auction rate securities,
which subjects us to liquidity risk and could require us to record impairment
charges if the fair value of these investments decline permanently or are
other-than temporarily impaired.  Furthermore, when we require
additional cash resources, an absence of liquidity from these investments could
require us to seek funds elsewhere, which may be more unattractive or
unavailable, especially in light of the current instability of credit
markets.
 
 Investments
in auction rate securities have scheduled maturities greater than 90 days at the
time of purchase, and are classified as available-for-sale securities and
recorded at fair value.  Auction rate securities are used by many
student-loan providers, municipalities and other governmental authorities to
raise cash to fund projects or operations, and money market funds. These auction
rate securities all have AAA/aaa credit ratings, consistent with our investment
policy guidelines, and have long-term nominal maturities with provisions calling
for the interest rates to be reset through periodic auctions every 7 to 28 days.
This auction process has historically provided a liquid market for auction rate
securities. In February 2008, all of the auction rate securities held by the
Company as of September 30, 2008 have experienced failed auctions.  An
auction failure is not a default.  An auction failure means that the
parties wishing to sell securities could not because the number of sellers was
greater than the number of buyers at the reset dates.  The funds
associated with failed auctions will not be accessible until a successful
auction occurs, a buyer is found outside of the auction process, or the
underlying securities have matured or are recalled by the issuer. We have
entered into an agreement with the investment bank that holds our auction rate
securities, which gives the Company Auction Rate Securities Rights (Rights”) to
sell all of our auction rate securities at par value back to the investment bank
at any time during the period between June 30, 2010 and July 2, 2012 under the
terms of a nontransferable rights offering.  This agreement also gives
the Company the right to borrow money from the investment bank in the form of a
no net cost loan of up to 75% of the fair value of the auction rate
securities.  The Company is also exploring other alternatives under
which it would liquidate its auction rate securities at par value, although it
is not known when or to what extent such alternatives will be
successful.  Accordingly, as of September 30, 2008, we are reporting
our investments in auction rate securities as a long-term asset in our
Consolidated Balance Sheet at their estimated fair value.  Based on
the Rights, we now have the ability, at a future date, to sell our auction rate
securities at par value to the investment bank that holds our auction rate
securities.  Additionally, we intend to hold these securities
until  we can sell them at par value, either when the Rights are
exercisable, or at an earlier opportunity to do so.  Accordingly, the
Company considers the decline in the estimated fair value of its investments in
auction rate securities to be temporary.  As such, we are reporting
the decline in estimated fair value, which is considered to be temporary, of
$0.4 million and $1.2 million for the three and nine month periods ended
September 30, 2008, respectively, as Accumulated Other Comprehensive Income
(Loss), a separate component of Shareholders’ Equity, as provided by Statement
of Financial Accounting Standards, or SFAS, No. 115, Accounting for Certain Investments
in Debt and Equity Securities.  If the fair value of these
investments declines permanently or is other-than temporarily impaired, we would
be required to take an impairment charge which would flow through our Condensed
Consolidated Statement of Operations as an expense.  Given the
substantial dislocation in the financial markets and among financial services
companies, we cannot be assured that the investment bank ultimately will have
the ability to repurchase our auction rate securities at par, or at any other
price, as these rights will be an unsecured contractual obligation of the
investment bank or that if the investment bank determines to purchase our
auction rate securities at any time, we will be able to reinvest the cash
proceeds of any such sale at the same interest rate or dividend yield currently
being paid to us. Also, as a condition of accepting the auction rate securities
rights, we were required to sign a release of claims against the investment
bank, which will prevent us from making claims against the investment bank
related to our investment in auction rate securities, other than claims for
consequential damages.
  The
      Nasdaq Capital Market may cease to list our common stock, which may cause
      our stock price to suffer and adversely affect the market liquidity of our
      common stock.
 
 On
December 26, 2007, we received notice from the Nasdaq Stock Market (“Nasdaq”)
advising us that for 30 consecutive trading days, the bid price of our common
stock had closed below the minimum $1.00 per share requirement for continued
listing under Nasdaq Marketplace Rule 4450(a)(5) (the “Rule”).  The
Company had until June 23, 2008 to regain compliance with the
Rule.  On June 24, 2008, Nasdaq notified the Company that as a result
of the Company’s failure to comply with the Rule as of June 23, 2008, the
Company’s common stock would be delisted unless the Company requested a hearing
before a Nasdaq Listing Qualifications Panel, which the Company did on July 1,
2008.  On August 14, 2008, the Company presented its plan to regain
compliance with the Rule to the Panel.  On September 4, 2008, the
Company issued a press release announcing that it had received notification from
the Panel granting the Company’s request to remain listed on The NASDAQ Stock
Market, subject to the condition that, on or before December 22, 2008, the
Company must evidence a closing bid price of $1.00 or more for a minimum of ten
consecutive business days.
  On
October 21, 2008, the Company received notification from the Panel informing the
Company that the Panel has extended the deadline for NeoPharm to regain
compliance with NASDAQ’s minimum bid price requirement to March 27, 2009 from
December 22, 2008.   This extension was granted in accordance
with NASDAQ’s decision to temporarily suspend for all companies currently listed
on any NASDAQ market, the bid price and market value requirements for continued
listing on such NASDAQ markets, given the recent extraordinary market
conditions. As a result, the Company’s common stock will continue to be listed
on The NASDAQ Capital Market, subject to the condition that, on or before March
27, 2009, the Company’s common stock must evidence a closing bid price of $1.00
or more for a minimum of ten consecutive business days.
 
 27
 Should the
Company be unable to meet the conditions established by the Panel, its
securities would be subject to delisting from The NASDAQ Stock
Market.  If our common stock were to be delisted, the delisting
could adversely affect the market liquidity of our common stock and the market
price of our common stock could decrease.  Such a delisting could also
adversely affect our ability to obtain financing for the continuation of our
operations and could result in a loss of confidence by investors, suppliers and
employees.  In addition, our stockholders ability to trade or obtain
quotations on our shares could be severely limited because of lower trading
volumes and transaction delays.  These factors could contribute to
lower prices and larger spreads in the bid and ask price for our common
stock.
 
 ITEM 2.
              UNREGISTERED
      SALES OF EQUITY SECURITIES AND USE OF
PROCEEDS
 
 None
 
 ITEM  3.
              DEFAULTS
      UPON SENIOR SECURITIES
 
 None
   ITEM 4.
              SUBMISSION
      OF MATTERS TO A VOTE OF THE SECURITY
HOLDERS
  On
      August 22, 2008, the Company held its Annual Meeting of Stockholders to
      vote on the matters listedlisted
      below.  All of the matters voted on at the Annual Meeting were
      approved by the Company’s stockholdersat
      the Annual Meeting.1.    
      To elect five directors to serve until the 2009 Annual Meeting of
      Stockholders.With
      respect to the election for directors, the votes were as
      follows:Votes For
                
                Votes Against
                
                Votes WithheldFrank
      C. Becker
                21,184,248
                
                —
                
                3,318,315Laurence
      P. Birch
                21,293,566
                
                —
                
                3,209,007Bernard
      A. Fox
                
                21,319,886
                
                —
                
                3,182,677Paul
      E. Freiman
                17,158,806
                
                —
                
                7,343,757John
      N. Kapoor
                21,328,998
                
                —
                
                3,173,5652.To approve an amendment to the NeoPharm, Inc. 2006 Equity Incentive
      Plan to increase the maximumnumber
      of shares of common stock that may be awarded under the Plan as restricted
      stock or asbonus
      stock from 500,000 to 1,500,000.Votes For
                
                Votes Against
                
                Abstain
                
                Non Votes11,564,502
                
                2,870,176
                
                25,457
                
                10,042,4283.To ratify the appointment of BDO Seidman, LLP as the Company's
      independent registered publicaccountants
      for 2008.Votes For
                
                Votes Against
                
                Abstain
                
                Non Votes23,884,890
                
                573,216
                
                44,457
                
                0
 
 ITEM 5.
              OTHER
      INFORMATION
 
 Subsequent
to September 30, 2008, we entered into an agreement with the investment bank
that holds our auction rate securities, which gives the Company Auction Rate
Securities Rights (Rights”) to sell all of our auction rate securities at par
value back to the investment bank at any time during the period between June 30,
2010 and July 2, 2012 under the terms of a nontransferable rights
offering.  This agreement also gives the Company the right to borrow
money from the investment bank in the form of a no net cost loan of up to 75% of
the fair value of the auction rate securities.  The Company is also
exploring other alternatives under which it would liquidate its auction rate
securities at par value, although it is not known when or to what extent such
alternatives will be available.  Accordingly, we have reclassified our
investments in auction rate securities from a Current Asset to a Non-Current
Asset on our Consolidated Balance Sheet as of September 30, 2008.
  28
  ITEM 6.
              EXHIBITS
 
 31.1
              Certification
      pursuant to Section 302 of the Sarbanes-Oxley Act of
  200232.1
              Certification
      pursuant to section 906 of the Sarbanes-Oxley Act or
  2002
 
 
 29
 
 
 SIGNATURE PAGE
 
 Pursuant
to the requirements of the Securities Exchange Act of 1934, the Registrant has
duly caused this report to be signed on its behalf by the undersigned, thereunto
duly authorized.
  Dated:  November
      13, 2008
                
                /s/  Laurence
      P. BirchLaurence
      P. BirchPresident
      and Chief Executive Officer (Principal Executive Officer) and Acting Chief
      Financial Officer (Principal Financial Officer)






30