**UNITED STATESSECURITIES AND EXCHANGE COMMISSION**

**Washington, D.C. 20549**

** **

**FORM 10-Q**

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

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**For Quarterly PeriodEnded March 31, 2007**

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**Or**

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

** **

**For the transition periodfrom                           to                           **

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**Commission file number33-90516**

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** **

**NEOPHARM, INC.**

(Exact name of Registrantas specified in its charter)
| **Delaware**                                                    | **51-0327886**                           |
|-----------------------------------------------------------------|------------------------------------------|
| (State or other  jurisdiction of incorporation or organization) | (I.R.S. Employer  Identification Number) |
|                                                            |                                     |
| **1850 Lakeside Drive  Waukegan, Illinois 60085**               |
| (Address of principal executive offices) (Zip Code)             |
|                                                            |
| **(847) 887-0800**                                              |
| (Registrant’s telephone number, including area code)       |

 

Indicate by checkmark whether the registrant (1) has filed all reports required to be filed bySection 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding12 months (or for such shorter period that the registrant was required to filesuch reports), and (2) has been subject to such filing requirements for thepast 90 days. Yes ý No o

Indicate by check markwhether Registrant is a large accelerated filer, an accelerated filer, or anon-accelerated filer. See definition of “accelerated filer and largeaccelerated filer” in Rule 12b-2 of the Exchange Act. (Check one):

Large acceleratedfiler o         Acceleratedfiler x         Non-accelerated filer o

Indicate by checkmark whether the registrant is a shell company (as defined in Rule 12b-2 of theExchange Act). Yes oNo ý

As of April 28,2007, the number of shares of the issuer’s common stock outstanding, was asfollows:

| **Title of each class**             |   | **Number  of shares outstanding** |
|-------------------------------------|--------|-----------------------------------|
| Common Stock  ($.0002145 par value) |   | 28,086,688                        |

 

 

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NEOPHARM, INC.

FORM 10-QINDEX
| PART I. FINANCIAL  INFORMATION |   |                                                                                                                      |   |
|--------------------------------|--------|---------------------------------------------------------------------------------------------------------------------------|--------|
| Item 1.                   |   | Financial Statements                                                                                                      |   |   |   |
|                           |   | Condensed Consolidated Balance Sheets as of March 31,  2007 (unaudited) and December 31, 2006                             |   |   |   |
|                           |   | Condensed Consolidated Statements of Operations for  the three months ended March 31, 2007 and March 31, 2006 (unaudited) |   |   |   |
|                           |   | Condensed Consolidated Statements of Cash Flows for  the three months ended March 31, 2007 and March 31, 2006 (unaudited) |   |   |   |
|                           |   | Notes to Condensed Consolidated Financial Statements  (unaudited)                                                         |   |   |   |
| Item 2.                   |   | Management’s Discussion and Analysis of Financial  Condition and Results of Operations                               |   |   |   |
| Item 3.                   |   | Quantitative and Qualitative Disclosures About Market  Risk                                                               |   |   |   |
| Item 4                    |   | Controls and Procedures                                                                                                   |   |   |   |
| PART  II. OTHER INFORMATION    |   |                                                                                                                      |   |
| Item 1.                   |   | Legal  Proceedings                                                                                                        |   |   |   |
| Item 1A.                  |   | Risk  Factors                                                                                                             |   |   |   |
| Item 2.                   |   | Unregistered Sales of Equity Securities and Use of  Proceeds                                                              |   |   |   |
| Item 3.                   |   | Defaults Upon Senior Securities                                                                                           |   |   |   |
| Item 4.                   |   | Submission of Matters to a Vote of Security Holders                                                                       |   |   |   |
| Item 5.                   |   | Other  Information                                                                                                        |   |   |   |
| Item 6.                   |   | Exhibits                                                                                                                  |   |   |   |
| SIGNATURE  PAGE                |   |                                                                                                                      |   |

 

2

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**PART I - FINANCIAL INFORMATION**

**Item 1 - Financial Statements**

**NEOPHARM, INC.Condensed Consolidated Balance Sheets**
| ** **                                                                                                                                | ** ** | **March 31,  2007** | ** ** | **December 31,  2006** | ** ** |
|-------------------------------------------------------------------------------------------------------------------------------------------|------------|--------------------------|------------|-----------------------------|------------|
| ** **                                                                                                                                | ** ** | **(unaudited)**          | ** ** | ** **                  | ** ** |
| **ASSETS**                                                                                                                                |       |                     |       |                        |       |
| Current assets:                                                                                                                           |       |                     |       |                        |       |
| Cash and cash  equivalents                                                                                                                |       | $                        | 1,922,000  |                        | $          | 1,852,000 |   |
| Short-term  investments                                                                                                                   |       | 26,932,000               |       | 36,735,000                  |       |
| Prepaid expenses  and other                                                                                                               |       | 656,000                  |       | 627,000                     |       |
| Total current  assets                                                                                                                     |       | 29,510,000               |       | 39,214,000                  |       |
| Fixed assets,  net                                                                                                                        |       | 1,033,000                |       | 1,266,000                   |       |
| Other assets                                                                                                                              |       | 211,000                  |       | 209,000                     |       |
| Total assets                                                                                                                              |       | $                        | 30,754,000 |                        | $          | 40,689,000 |   |
|                                                                                                                                      |       |                     |       |                        |       |
| **LIABILITIES AND STOCKHOLDERS’  EQUITY**                                                                                            |       |                     |       |                        |       |
| Current  liabilities:                                                                                                                     |       |                     |       |                        |       |
| Accounts payable                                                                                                                          |       | $                        | 827,000    |                        | $          | 5,085,000 |   |
| Accrued clinical  trial expenses                                                                                                          |       | 1,910,000                |       | 2,272,000                   |       |
| Accrued  compensation                                                                                                                     |       | 666,000                  |       | 811,000                     |       |
| Obligations  under capital lease                                                                                                          |       | 30,000                   |       | 30,000                      |       |
| Other accrued  expenses                                                                                                                   |       | 1,534,000                |       | 1,379,000                   |       |
| Total current  liabilities                                                                                                                |       | 4,967,000                |       | 9,577,000                   |       |
|                                                                                                                                      |       |                     |       |                        |       |
| Obligations  under capital lease                                                                                                          |       | 98,000                   |       | 105,000                     |       |
| Deferred revenue                                                                                                                          |       | 2,000,000                |       | 2,000,000                   |       |
| Deferred rent                                                                                                                             |       | 28,000                   |       | 35,000                      |       |
| Derivative  financial instruments                                                                                                         |       | 103,000                  |       | 101,000                     |       |
| Total  liabilities                                                                                                                        |       | 7,196,000                |       | 11,818,000                  |       |
|                                                                                                                                      |       |                     |       |                        |       |
| Stockholders’  equity:                                                                                                               |       |                     |       |                        |       |
| Common stock,  $0.0002145 par value; 50,000,000 shares authorized: 28,086,688 and 28,080,408  shares issued and outstanding, respectively |       | 6,000                    |       | 6,000                       |       |
| Additional  paid-in capital                                                                                                               |       | 290,238,000              |       | 290,098,000                 |       |
| Accumulated  deficit                                                                                                                      |       | (266,686,000             | )          | (261,233,000                | )          |
| Total  stockholders’ equity                                                                                                          |       | 23,558,000               |       | 28,871,000                  |       |
| Total liabilities and  stockholders’ equity                                                                                          |       | $                        | 30,754,000 |                        | $          | 40,689,000 |   |

 

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

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**NEOPHARM, INC.**

**Condensed Consolidated Statements of OperationsThree Months Ended March 31, 2007 and March 31, 2006**(Unaudited)
| ** **                                                | ** ** | **Three Months Ended** | ** ** |
|-----------------------------------------------------------|------------|----------------------------------|------------|
| ** **                                                | ** ** | **March 31, 2007**     | ** ** | **March 31, 2006** | ** ** |
| Product revenue                                           |       | $                                | —     |   | $ | 1,000 |   |
| Total revenue                                             |       | —                           |       | 1,000 |   |
|                                                      |       |                             |       |   |   |
| Expenses:                                                 |       |                             |       |   |   |
| Research and  development                                 |       | 3,007,000                        |       | 5,844,000 |   |
| Selling,  general, and administrative                     |       | 2,859,000                        |       | 3,045,000 |   |
| Change in fair  value of derivative financial instruments |       | 2,000                            |       | (543,000 | ) |
| Total expenses                                            |       | 5,868,000                        |       | 8,346,000 |   |
| Loss from operations                                      |       | (5,868,000                       | )          | (8,345,000 | ) |
|                                                      |       |                             |       |   |   |
| Interest income                                           |       | 415,000                          |       | 666,000 |   |
| Net loss                                                  |       | $                                | (5,453,000 | ) | $ | (7,679,000 | ) |
| Net loss per share —                                 |       |                             |       |   |   |
| Basic and  diluted                                        |       | $                                | (0.19      | ) | $ | (0.28 | ) |
| Weighted average shares  outstanding —               |       |                             |       |   |   |
| Basic and diluted                                         |       | 28,080,478                       |       | 27,317,829 |   |

 

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

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**NEOPHARM, INC.**

**Condensed Consolidated Statements of Cash FlowsThree Months Ended March 31, 2007 and March 31, 2006(**Unaudited)
| ** **                                                                   | ** ** | **Three Months Ended** | ** ** |
|------------------------------------------------------------------------------|------------|----------------------------------|------------|
| ** **                                                                   | ** ** | **March 31, 2007**     | ** ** | **March 31, 2006** | ** ** |
| Cash flows from  operating activities:                                       |       |                             |       |   |   |
| Net loss                                                                     |       | $                                | (5,453,000 | ) | $ | (7,679,000 | ) |
| Adjustments to  reconcile net loss to net cash used in operating activities: |       |                             |       |   |   |
| Depreciation and  amortization                                               |       | 233,000                          |       | 334,000 |   |
| Stock-based  compensation expense                                            |       | 131,000                          |       | 572,000 |   |
| Increase  (decrease) in fair value of derivative financial instruments       |       | 2,000                            |       | (543,000 | ) |
| Gain on  retirement of equipment and furniture                               |       | (2,000                           | )          | (1,000 | ) |
| Non-cash  reorganization charge                                              |       | 6,000                            |       | — |   |
| Changes in  assets and liabilities:                                          |       |                             |       |   |   |
| Increase in  interest receivable on short-term investments                   |       | (3,000                           | )          | (47,000 | ) |
| (Increase)  decrease in prepaid expenses and other                           |       | (29,000                          | )          | 107,000 |   |
| Increase in  other assets                                                    |       | (2,000                           | )          | (1,000 | ) |
| Decrease in  accounts payable                                                |       | (4,258,000                       | )          | (226,000 | ) |
| Decrease in  other current liabilities                                       |       | (352,000                         | )          | (1,782,000 | ) |
| Increase in deferred  and unearned revenue                                   |       | —                           |       | 1,000 |   |
| Increase  (decrease) in deferred rent                                        |       | (7,000                           | )          | 15,000 |   |
| Net cash and cash  equivalents used in operating activities                  |       | (9,734,000                       | )          | (9,250,000 | ) |
|                                                                         |       |                             |       |   |   |
| Cash flows from  investing activities:                                       |       |                             |       |   |   |
| Proceeds from  sales of marketable securities                                |       | 9,800,000                        |       | 16,150,000 |   |
| Purchase of  marketable securities                                           |       | —                           |       | (40,800,000 | ) |
| Proceeds from  sale (purchase) of equipment and furniture, net               |       | 2,000                            |       | (28,000 | ) |
| Net cash and cash  equivalents provided by (used in) investing activities    |       | 9,802,000                        |       | (24,678,000 | ) |
|                                                                         |       |                             |       |   |   |
| Cash flows from  financing activities:                                       |       |                             |       |   |   |
| Proceeds from  issuance of common stock                                      |       | —                           |       | 38,731,000 |   |
| Proceeds from  employee stock purchase plan                                  |       | 9,000                            |       | — |   |
| Repayment of  capital lease obligation                                       |       | (7,000                           | )          | (5,000 | ) |
| Net cash and cash  equivalents provided by financing activities              |       | 2,000                            |       | 38,726,000 |   |
|                                                                         |       |                             |       |   |   |
| Net increase in cash  and cash equivalents                                   |       | 70,000                           |       | 4,798,000 |   |
| Cash and cash  equivalents, beginning of period                              |       | 1,852,000                        |       | 1,486,000 |   |
| Cash and cash equivalents, end of period                                     |       | $                                | 1,922,000  |   | $ | 6,284,000 |   |

 

*Supplementaldisclosure of non-cash financing activities:*

During the three months endedMarch 31, 2006, the Company entered into a capital lease obligation for officeequipment totaling $161,000.

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

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

**Note 1 Basis of Presentation**

The financialinformation herein is unaudited. The balance sheet as of December 31, 2006 isderived from audited financial statements.

The accompanyingunaudited condensed consolidated financial statements of NEOPHARM, Inc. andsubsidiary (“we”, “us”, “our”, or the “Company”) have been prepared inaccordance with U.S. generally accepted accounting principles, or U.S. GAAP,for interim financial information and with the instructions to Form 10-Q andRule 10-01 of Regulation S-X. Accordingly, these financial statements do notcontain all of the information and notes required by U.S. GAAP for completefinancial statements. In the opinion of management, the accompanying unauditedcondensed consolidated interim financial statements contain all adjustments(consisting of normal recurring adjustments) necessary to a fair presentation.The results of operations for the three month period ended March 31, 2007 arenot necessarily indicative of our operating results for fiscal 2007 or futureinterim periods.

The unauditedcondensed consolidated financial statements include the accounts of NEOPHARM,Inc. and its wholly owned subsidiary, NEOPHARM EU Limited. NEOPHARM EU Limitedwas created in 2004 to comply with regulatory requirements enacted for clinicaltrials conducted in the European Union. NEOPHARM EU has nominal assets and hasnot conducted any business. All significant intercompany accounts andtransactions are eliminated in consolidation.

While we believethat the disclosures presented herein are adequate to make the information notmisleading, it is suggested that these financial statements be read inconjunction with the financial statements and notes included in the Company’s2006 Annual Report on Form 10-K filed with the United States Securities andExchange Commission, or SEC.

The preparation offinancial statements in conformity with U.S. GAAP requires management to makeestimates and assumptions that affect the reported amounts of assets andliabilities and disclosure of contingent assets and liabilities at the date ofthe consolidated financial statements and the reported amounts of revenue andexpense during the reporting periods. Actual results could differ from thoseestimates.

*RecentAccounting Pronouncements*

We adoptedFinancial Accounting Standards Board (FASB) Interpretation No. 48 (FIN No. 48),*Accounting for Uncertainty*in*Income Taxes,* effective January 1, 2007.The new standard defines the threshold for recognizing the benefits of taxreturn positions in the financial statements as “more-likely-than-not” to besustained by the taxing authorities based solely on the technical merits of theposition. If the recognition threshold is met, the tax benefit is measured andrecognized as the largest amount of tax benefit that in our judgment is greaterthan 50% likely to be realized. The adoption of FIN No. 48 did not have amaterial impact on the Company’s consolidated financial position or results ofoperations.

In September 2006,the FASB issued SFAS No. 157, *Fair Value Measurement*,or SFAS 157. SFAS 157 defines fair value, establishes a framework for measuringfair value under U.S. GAAP, and expands disclosures about fair valuemeasurements. SFAS 157 is effective for financial statements for fiscal yearsbeginning after November 15, 2007 and interim periods within those fiscalyears. We do not expect the adoption of SFAS 157 to have a material impact onour consolidated financial position or results of operations.

In February 2007,the FASB issued SFAS No. 159, The Fair Value Option for Financial Assets andFinancial Liabilities - Including an amendment of FASB No. 115 (“SFAS No. 159”).SFAS No. 159 permits companies to choose to measure many financial instrumentsand certain other items at fair value in order to mitigate volatility inreported earnings caused by measuring related assets and liabilitiesdifferently without having to apply complex hedge accounting provisions. SFASNo. 159 is effective for the Company’s fiscal year ending December 31, 2009,with early adoption permitted. We are currently assessing the impact, if any,of this statement on our consolidated financial statements.

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**Note 2Loss Per Share**

The followingtable sets forth the computation of basic and diluted net loss per share:
| ** **                           | ** ** | **Three Months Ended** | ** ** |
|--------------------------------------|------------|----------------------------------|------------|
| ** **                           | ** ** | **March 31, 2007**     | ** ** | **March 31, 2006** | ** ** |
| Numerator:                           |       |                             |       |   |   |
| Net loss                             |       | $                                | (5,453,000 | ) | $ | (7,679,000 | ) |
| Denominator:                         |       |                             |       |   |   |
| Weighted average  shares outstanding |       | 28,080,478                       |       | 27,317,829 |   |
|                                 |       |                             |       |   |   |
| Loss per share - basic  and diluted  |       | $                                | (0.19      | ) | $ | (0.28 | ) |
|                                 |       |                             |       |   |   |
| Potential common share  equivalents: |       |                             |       |   |   |
| Stock options                        |       | 2,252,277                        |       | 4,094,857 |   |

 

As we haveincurred net losses in each of the periods presented, basic and diluted lossper share amounts are the same, as the effect of common share equivalents isanti-dilutive.

**Note 3 Share-based Compensationand Non-Employee Stock Options**

We currentlysponsor the following share-based payment plans:

*2006Plan*

In June 2006, ourstockholders approved the NEOPHARM, Inc. 2006 Equity Incentive Plan, or the2006 Plan. The 2006 Plan provides for the issuance of stock options, non-vestedstock, restricted stock, performance units or performance share awards to employees,directors and consultants convertible to up to 1,000,000 shares of our commonstock. Awards under the 2006 Plan generally consist of stock options having anexercise price equal to the average of the lowest and highest reported saleprices 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 awardsgranted to our non-employee directors under the 2006 Plan typically vest oneyear from the date of grant. The 2006 Plan limits to 500,000 the shares ofcommon stock which may be issued pursuant to restricted stock or bonus stockawards. As of March 31, 2007, 302,417 shares were available for issuance underthe 2006 Plan.

*2006Employee Stock Purchase Plan*

In June 2006, ourshareholders also approved the 2006 Employee Stock Purchase Plan, or thePurchase Plan, under which eligible employees may purchase shares of commonstock quarterly through payroll deductions. An aggregate of 100,000 shares ofcommon stock may be issued under the Purchase Plan. The price per share underthe Purchase Plan is 85% of the lower of the closing price of the common stockon (i) the first business day of the plan period or (ii) the purchase date. ThePurchase Plan imposes a limitation upon a participant’s right to acquire commonstock if immediately after or prior to purchase, the employee owns 5% or moreof the total combined voting power or value of our common stock. During theperiod ending March 31, 2007, 6,280 shares were issued under the Purchase Planresulting in compensation expense of $8,000. At March 31, 2007, 54,396 sharesremained available for issuance.

*The1998 Plan*

Our 1998 EquityIncentive Plan, or the 1998 Plan, provided for the grant of awards, primarilystock options, to employees, directors, and consultants to acquire up to4,600,000 shares of our common stock. Following the June 2006 shareholderapproval of the 2006 Plan, no further awards have been or will be made underthe 1998 Plan.

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*Share-BasedCompensation Summary*

Amounts recognizedin the consolidated statements of operations with respect to our share-basedcompensation plans were as follows:
| ** **                                             | ** ** | **Three Months Ended** | ** ** |
|--------------------------------------------------------|------------|----------------------------------|------------|
| ** **                                             | ** ** | **March 31, 2007**     | ** ** | **March 31, 2006** | ** ** |
| Research and  development                              |       | $                                | 16,000     |   | $ | 167,000 |   |
| Selling, general  and administrative                   |       | 115,000                          |       | 405,000 |   |
| Total cost of  share-based payment plans during period |       | $                                | 131,000    |   | $ | 572,000 |   |

 

We have nevercapitalized, or recognized an income tax benefit from, share-basedcompensation.

*StockOption Award Summary*

The following is asummary of activity relating to option awards to employees and non-employeedirectors during the three months ended March 31, 2007:
| ** **                                                        | ** ** | **Number of  Options** | ** ** | **Weighted  Average  Exercise Price/  Grant Date  Fair Value** | ** **  | **Weighted  Average  Remaining  Contractual Life  in years** | ** ** | **Aggregate  Instrinsic  Value** | ** ** |
|-------------------------------------------------------------------|------------|-----------------------------|------------|-------------------------------------------------------------------------------|-------------|------------------------------------------------------------------------|------------|----------------------------------|------------|
| Outstanding at  December 31, 2006                                 |       | 2,531,783                   |       | $                                                                             | 11.28/$8.29 |                                                                   |       |                             |       |   |
| Granted                                                           |       | 300,000                     |       | 1.90/1.39                                                                     |        |                                                                   |       |                             |       |
| Exercised                                                         |       | —                      |       |                                                                          |        |                                                                   |       |                             |       |
| Forfeited/expired/cancelled                                       |       | (737,631                    | )          | 8.35/5.62                                                                     |        |                                                                   |       |                             |       |
| Outstanding at  March 31, 2007                                    |       | 2,094,152                   |       | 11.00/8.02                                                                    |        | 6.29                                                                   |       | $                                | —     |   |
|                                                              |       |                        |       |                                                                          |        |                                                                   |       |                             |       |
| Exercisable at  March 31, 2007                                    |       | 1,107,366                   |       | $                                                                             | 14.91/11.54 |                                                                   | 3.78       |                             | $          | — |   |
|                                                              |       |                        |       |                                                                          |        |                                                                   |       |                             |       |
| Weighted-average  fair value of options granted during the period |       |                        |       | $                                                                             | 1.39        |                                                                   |       |                             |       |   |

 

As of March 31,2007 the Company expects to recognize $2.5 million of unrecognized share-basedcompensation over a weighted average period of 2.1 years.

No stock optionswere granted to non-employee directors during the three months ended March 31,2007.

As of March 31,2007, there were 58,083 non-vested non-employee director shares outstanding,with $81,000 of unrecognized compensation expense to be recognized over aweighted average period of three months.

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*StockOption Valuation Information*

We have estimatedthe fair value of our share-based compensation using the Black-Scholesoption-pricing model. This model requires the use of subjective assumptionsthat have a significant impact on the fair value estimate. We are providing theweighted-average estimated fair value of employee stock options granted in thisperiod as calculated using the Black-Scholes model and the relatedweighted-average assumptions:
| ** **                | ** ** | **Three months ended  March 31, 2007** | ** ** |
|---------------------------|------------|------------------------------------------------------------|------------|
| Expected volatility       |       | 80.96                                                      | %          |
| Risk-free interest rate   |       | 4.53                                                       | %          |
| Expected term (in  years) |       | 6.25                                                       |       |
| Expected dividend yield   |       | 0.0                                                        | %          |

 

We have based ourassumptions regarding expected volatility on the historic volatility of ourcommon stock, the risk-free interest rate on the U.S. Treasury yield curve ineffect at the time of grant, and the expected term of options using the “SimplifiedMethod” in accordance with SAB No. 107,*Share-Based Payment*.

*DerivativeFinancial Instruments*

Prior to 2000, wegranted common stock options to certain non-employee consultants ascompensation related to research and development activities. As of January 1,2006, the effective date of SFAS123(R), options granted to certainnon-employees to purchase 234,025 shares of our common stock were vested andoutstanding. Upon adoption of SFAS 123(R), these non-employee common stockoptions were accounted for as derivative instruments in accordance with SFAS133,*Accounting for Derivative Instrumentsand Hedging Activities,* and recorded as a liability.

In August 2006, weentered into a separation agreement with Lawrence A. Kenyon, our former ChiefFinancial Officer, under which Mr. Kenyon’s employment status changed fromemployee to consultant reflecting his continued service to the Company. Underthe agreement*,* at that time40,300 options were forfeited and 17,025 unvested employee stock options werereclassified to non-employee option grants which will vest through May 31, 2007and are exercisable until August 29, 2007. We have recognized the expense forthese non-employee grants accordingly.

As of March 31,2007, there were 175,150 non-employee options outstanding and the Companyremeasured and calculated the estimated fair value of the *outstanding* non-employee options to be$103,000. The Company recorded the change in fair value of $2,000 as a changein fair value of derivative financial instruments on the Company’s unauditedcondensed consolidated statement of operations for the three months ended March31, 2007.

We use theBlack-Scholes option-pricing model to estimate the fair value of thenon-employee option grants outstanding over the remaining contractual terms ofthe outstanding options, which ranged from 5 months to 39 months at March 31,2007.

**Note 4Cash and Cash Equivalents and Short-term Investments**

We consider all highlyliquid investments purchased with an original maturity of three months or lessto be cash equivalents. Included with cash are cash equivalents of $299,000 and$593,000 as of March 31, 2007 and December 31, 2006, respectively. The carryingvalue of these investments approximates their fair market value due to theirshort maturity and liquidity.

Short-term investmentsconsist of auction rate certificates with scheduled maturities greater than 90days at the time of purchase. Webelieve the structural features of the auction rate certificates, including aninterest rate reset feature which adjusts the rate typically every 7 to 35days, provide us with liquidity characteristics similar to cash equivalents. Asprovided by Statement of Financial Accounting Standards, or SFAS, No. 115, *Accounting for Certain Investments in Debt and EquitySecurities,*we have elected to treat all of our investments inmarketable securities as “available-for-sale,” which requires that theseinvestments be recorded at fair market value. However, given the interest ratereset features of our auction rate certificates, the carrying value of ourshort-term investments represents their fair value.

As of March 31, 2007, our investments in auction rate certificates havematurities ranging from 18 to 38 years. Despite the long-term nature of theirstated contractual maturities,the Company has demonstrated the ability to liquidate these securities asneeded. Accordingly, as these securities represent the investment of cash,which is available for operations, they have been classified as a current asseton the accompanying Consolidated Balance Sheets.

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Included with the carrying value of the investments in marketablesecurities was accrued interest income receivable of $82,000 and $85,000 as ofMarch 31, 2007 and December 31, 2006, respectively.

Short-term investments, stated at cost, which approximates fair marketvalue, are as follows:
| ** **                    | ** ** | **March 31,  2007** | ** ** | **December 31,  2006** | ** ** |
|-------------------------------|------------|--------------------------|------------|-----------------------------|------------|
|                          | ** ** | ** **               | ** ** | ** **                  | ** ** |
| State government  agencies    |       | $                        | 26,850,000 |                        | $          | 36,650,000 |   |
| Total short-term  investments |       | $                        | 26,850,000 |                        | $          | 36,650,000 |   |

 

**Note 5Fixed Assets**

We record fixedassets at cost and record depreciation using the straight-line method over therelated asset’s estimated useful life. Expenditures that do not extend the lifeor improve the productivity of assets are charged to expense when incurred.When fixed assets are disposed of, the related costs and accumulateddepreciation are removed from the accounts and any gain or loss is recorded.Depreciation and amortization expense for the three months ended March 31, 2007and 2006, was $233,000 and $334,000, respectively.

Long-lived assetsare reviewed for impairment when changes in circumstances indicate the carryingamount of an asset may not be recoverable. Recoverability of assets to be heldand used is measured by a comparison of the carrying amount of the assets toestimated undiscounted cash flows expected to be generated by the assets. Ifthe 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 carryingamount of the asset exceeds the fair value of the asset.

**Note 6Employee Termination and Facility Consolidation Costs**

During 2006, ourworkforce was reduced from 96 to 53 employees through various organizationalrestructuring initiatives, separation agreements with certain officers andthrough attrition. Additionally, in March, 2007, the Company terminated theemployment of Mr. Guillermo Herrera, its President and Chief Executive Officer.In connection with his employment agreement, Mr. Herrera is scheduled toreceive a salary continuation of approximately $35,400 per month for twelvemonths, unless and until he obtains alternative full-time employment, in whichcase the monthly payments would terminate. Payments to Mr. Herrera would alsoterminate for breach of restrictive covenants. The entire potential obligationof twelve monthly payments to Mr. Herrera has been reflected in the operatingresults of the Company for the first quarter ended March 31, 2007.

Accrued but unpaid employee costs related to the reorganization,separation and employment agreements are included in other accrued expenses at March 31, 2007 and December 31,2006, and totaled $494,000 and $415,000, respectively. The remaining payoutsare expected to be completed by the first quarter 2008.

See also Note 11,Subsequent Events related to an additional restructuring initiated on April 18,2007, resulting in the reduction of 15 additional employees, or approximately42% of the workforce at that time.

Also in 2006, in connection with our facility consolidation, we vacated ouroffice space in Lake Forest, Illinois and have included $177,000 and $238,000in other accrued expenses as the remaining estimated lease exposure at March31, 2007 and December 31, 2006, respectively.

**Note7 Stockholders’ Equity**

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

We maintain aStockholder Rights Plan whereby rights to purchase shares of Series AParticipating Preferred Stock become exercisable by our stockholders in theevent a non-excluded party acquires, or attempts to acquire, 15% or more of ouroutstanding commonstock.

**Note8 Income Taxes**

In July 2006, theFinancial Accounting Standards Board (the “FASB”) issued FASB InterpretationNo. 48, “Accounting for Uncertainty in Income Taxes—an interpretation of FASBStatement No. 109,” (“FIN 48”) to clarify the accounting for uncertain taxpositions accounted for in accordance with FASB Statement No. 109, “Accountingfor Income Taxes.” The Company adopted FIN 48 as of January 1, 2007. We had nomaterial unrecognized tax benefits and no adjustments to liabilities oroperations were required.

The Company’saccounting policy is to recognize interest expense and penalties as income taxexpense. However, due to the Company’s lack of unrecognized tax benefits andthe history of significant net operating losses, the Company does not have anyamounts accrued for the payment of interest and penalties as of March 31, 2007.

At December 31,2006, the Company had net operating loss (“NOL”) carryforwards for tax purposesof approximately $242.1 million expiring at various dates through 2026, forwhich a full valuation allowance has been provided. We do not believe the totalamount of unrecognized tax benefits will change significantly within the nexttwelve months. In addition, future changes in the unrecognized tax benefit willhave no impact on the effective tax rate due to the existence of the valuationallowance.

The Company filesU.S. federal and state income tax returns. Principally due to the NOLs, allreturns filed since the Company’s conversion from an S-corporation in 1995remain subject to examination by U.S. and state tax jurisdictions.

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**Note 9Contingencies**

NEOPHARM, Inc. and certain of our former officers have been named in aconsolidated amended complaint, which alleges various violations of the federalsecurities laws in connection with our public statements regarding our LEP drugproduct candidate during the period from October 31, 2001 through April 19,2002. On November 4, 2002, we moved to have the complaint dismissed. Our motion to dismiss was granted inpart and denied in part in February 2003. In November 2004, the plaintiffsfiled a motion to amend and a motion for summary adjudication. The motion toamend seeks to include certain pre-class period statements in the complaint.The motion for summary adjudication asks the Court to rule that certainstatements made in an arbitration award regarding the LEP drug productcandidate be deemed facts established in this proceeding. On February 23, 2007,the Court entered an order denying both the plaintiffs’ motion to amend and theplaintiffs’ motion for summary adjudication. The Court has set a fact discoverycut-off date of August 24, 2007. No trial date has yet been set. We intend tovigorously defend each and every claim in the complaint. Management is unableto estimate the potential outcome or range of possibilities, if any. Inaddition, we maintain insurance coverage to mitigate the financial impact ofany potential loss.

We entered into variouscontractual arrangements, primarily during the fourth quarter of 2006, undertake or pay agreements, with Diosynth RTP, Inc. (“Diosynth”), to secure access to manufacturing capacity forthe potential manufacture and regulatory advancement of CINTREDEKIN BESUDOTOXthrough early 2008. As a result of the FDA’s decision to require additionalPhase 3 clinical testing of CINTREDEKIN BESUDOTOX, the Company advised Diosynththat the timing of further work to support a potential BLA submission must bedelayed. Diosynth has indicated that such a delay constitutes a default underour contract. In response, the Company invoked the dispute resolutionprovisions of the contract in an attempt to resolve these and other differencesbetween the two companies regarding Diosynth’s manufacture of this drugcompound. A dialogue between the senior executives of our Company and Diosynthis ongoing. In the event these discussions fail to resolve the parties’differences, the contract calls for mediation and eventually binding arbitration.Under the terms of the various contractual arrangements, if the Company cannotsettle its outstanding differences with Diosynth, and such dispute were toculminate in an arbitration judgment against the Company, we may be obligatedto pay half of the disputed processing costs, which we currently estimate to beapproximately $1.8 million as of March 31, 2007.

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

**Note 10Commitments**

On March 23, 2007, the Company entered into an employment agreement withMr. Laurence P. Birch (the “Agreement”) to serve as its President and ChiefExecutive Officer. Mr. Birch was subsequently elected to the Company’s Board of Directors on March 30, 2007. Under terms ofthe Agreement, Mr. Birch is provided an annual base salary of $275,000 and atarget bonus of 50% of his base salary based on performance criteria to beestablished by the Board in consultation with Mr. Birch, with the potential toearn up to 100% of his base salary for over achievement of performancecriteria. In the event the Company terminates Mr. Birch’s employment withoutcause, after six months employment, he would be entitled to receive acontinuation of his then current base salary for a period of twelve months. Inthe event of a termination after a change of control of the Company, Mr. Birchwould receive, in addition to twelve months salary continuation, a lump sumpayment equal to the prior year’s bonus, if any, plus accelerated vesting ofall options or restricted stock. Mr. Birch was granted stock options topurchase up to 300,000 shares of the Company’s common stock at an exerciseprice equal to $1.90 per share, which options vest in four equal annualinstallments on the anniversary of the date of hire. In addition, the Companycommitted to issue 180,665 shares of restricted stock to Mr. Birch upon sharesfor such an award becoming available under the Company’s equity incentive plan,either through the expiration or cancellation of share awards granted to othersor approval of an increase in the number of shares available under the plan.

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**Note 11Subsequent Events**

*Reorganizationand Workforce Reduction*

Following the Company’s announcement on March 29, 2007 that additionalPhase 3 clinical trials have been recommended for its drug product candidate,CINTREDEKIN BESUDOTOX, the Company initiated an organizational realignment onApril 18, 2007 which reduced the workforce from 36 to 21 employees. Thereorganization included the agreement of the Company’s Executive VP-ChiefMedical Officer and the Executive VP-Commercial Operations to step down at ayet to be determined date. Both of these individuals have agreed to remain withthe Company during a transition period. The Company intends to search for asuitable replacement for the Executive VP-Chief Medical Officer, but does notcurrently intend to replace the Executive VP-Commercial Operations.

The Company anticipates that the termination costs associated with thisworkforce reduction will result in a second quarter 2007 restructuring chargeof approximately $600,000.

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**Item 2 - Management’s Discussionand 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 tothe safe harbor provisions of the Private Securities Litigation Reform Act of1995. We caution readers that important factors may affect our actual resultsand could cause such results to differ materially from forward-lookingstatements made by or on our behalf. Such factors include, but are not limitedto, those risks and uncertainties relating to difficulties or delays indevelopment, testing, manufacturing, regulatory approval, recruitment ofpatients, production and marketing of the Company’s drug candidates, including,but not limited to: our drug product candidate IL13-PE38QQR, or CINTREDEKINBESUDOTOX, and our NeoLipid® product candidates LE-SN38, LEP-ETU and LE-DT; ourability to make, or the timing of, a filing of any Biologics LicenseApplication, or BLA, for approval ofCINTREDEKIN BESUDOTOX with the United States Food and Drug Administration, orFDA; our ability to conserve our cash resources, to implement reductions ingeneral and administrative expenditures and to obtain additional sources offinancing in the future; the performance of third-party contractors;uncertainty regarding the outcome of certain pending class action litigation;unexpected adverse side effects or inadequate therapeutic efficacy of our drugproduct candidates, including, but not limited to, CINTREDEKIN BESUDOTOX, thatcould slow or prevent our drug product candidates coming to market; theuncertainty of patent protection for our intellectual property and tradesecrets; our ability to raise additional funds at all or on terms acceptable tous; and other factors referenced under Item 1A, “Risk Factors” in Part II of this Quarterly Report on Form10-Q and in our annual report on Form 10-K for the calendar year endedDecember 31, 2006.

The followingshould be read in conjunction with our condensed consolidated financialstatements and related notes and with Management’s Discussion and Analysis ofFinancial Condition and Results of Operations and the Risk Factors section included as Item 1A herein and in theCompany’s 2006 Annual Report on Form 10-K. The results discussed below are notnecessarily indicative of the results to be expected in any future periods. Thefollowing discussion contains forward-looking statements that are subject torisks and uncertainties, which could cause actual results to differ fromstatements made.

**Overview**

We are a biopharmaceutical company engaged in the research, development,and commercialization of drugs for the treatment of cancer. Since we began our business in 1990, we have devoted our resourcesprimarily to funding research and product development programs. We have builtour drug development program around our two proprietary technology platforms: atumor-targeting toxin platform and NeoLipid® liposomal drug delivery system. Wehave advanced four drug product candidates in various stages of clinicaldevelopment for the treatment of cancer. The following table summarizes keyinformation about our current drug product candidate pipeline:
| **Drug product candidate**   | ** ** | **Clinical indication(s)**                                     | ** ** | **2007 Clinical  development status** | ** ** | **Commercialization  rights** | ** ** |
|----------------------------------------|------------|---------------------------------------------------------------------|------------|-------------------------------------------------|------------|-------------------------------|------------|
|                                   |       |                                                                |       |                                            |       |                          |       |
| CINTREDEKIN  BESUDOTOX  (IL13-PE38QQR) |       | Glioblastoma  multiforme (brain cancer)                             |       | Completed  Phase 3(1)                           |       | World  wide (2)               |       |
|                                   |       |                                                                |       |                                            |       |                          |       |
| LE-SN38*(Liposomal SN-38)*             |       | Colorectal  cancer and other solid tumors                           |       | Phase  2(3)                                     |       | World  wide                   |       |
| * *                               |       |                                                                |       |                                            |       |                          |       |
| LEP-ETU*(Liposomal Paclitaxel)*        |       | Breast  cancer, lung cancer, ovarian cancer and other solid tumors  |       | Planning  possible Phase 3(4)                   |       | World  wide                   |       |
| * *                               |       |                                                                |       |                                            |       |                          |       |
| LE-DT*(Liposomal Docetaxel)*           |       | Breast cancer, lung  cancer, prostate cancer and other solid tumors |       | Pre-IND(5)                                      |       | World wide                    |       |

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(1)             Representatives of the FDA’s Office ofOncology indicated during a review of the clinical data with the Company onMarch 28, 2007, that an additional Phase 3 clinical trial for CINTREDEKIN BESUDOTOXin the treatment of GBM would be required before the FDA could accept theCompany’s Biologics License Application (BLA). The Company continues toevaluate its options regarding CINTREDEKIN BESUDOTOX, which is furtherdiscussed below in the Drug Product Candidate Summary.

(2)             Development and commercialization rights for Japanhave been sublicensed to Nippon Kayaku Co., Ltd.

(3)             The Company announced on March 30, 2007 that theinterim analysis of data following the completion of treatment of the first 21patients demonstrated diseasestabilization, but the study did not achieve the primary tumor responseendpoint. The Company is reassessing project next steps including additionaldata analyses and the possibility of other studies related to lung and breastcancer.

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(4)             Following recent receipt of communication from theFDA on our Phase 3 Special Protocol Assessment filed with the FDA in December2006, we are continuing discussions with the FDA on clinical and regulatoryplans for LEP-ETU.

(5)             We anticipatefiling an LE-DT Investigational New Drug Application, or IND, with the U.S. FDAin late 2007.

To date, we havenot received FDA approval for any of our drug product candidates. We expect tocontinue to incur losses for the foreseeable future as we continue our researchand development activities, which include the sponsorship of human clinical trials for our drug product candidates.Until we are able to successfully commercialize one or more of our drug productcandidates, we anticipate that we will be required to fund our research anddevelopment activities primarily by other means, including, but not limited to,issuing equity or other securities, licensing drug product candidates to thirdparties and collaborating with third parties to develop formulations of theircompounds using our technology.

**Drug ProductCandidate Summary**

*CINTREDEKIN BESUDOTOX*

The drug product candidate which we have advanced the farthest isCINTREDEKIN BESUDOTOX, a tumor-targeting toxin being developed as a treatmentfor glioblastoma multiforme, or GBM, a deadly form of brain cancer.

We haveexclusively licensed CINTREDEKIN BESUDOTOX from the NIH and the FDA, and havebeen developing this drug product candidate under a Cooperative Research andDevelopment Agreement, or CRADA, with the FDA Center for Biologics Evaluationand Research, or CBER. CINTREDEKIN BESUDOTOX has received orphan drugdesignation in the US and Europe and holds fast track drug development programstatus from the FDA. In addition, CINTREDEKIN BESUDOTOX has been selected toparticipate in the FDA’s Continuous Marketing Application, CMA, Pilot 2program. We also hold a non-exclusive license to utilize a patented processowned by the U.S. government relating to convection enhanced delivery, or CED,for us to use with drugs, including CINTREDEKIN BESUDOTOX in the treatment ofgliomas.

Conventional,non-specific chemotherapeutic drugs attack cancer cells by stopping them fromdividing and reproducing, but can also damage normal healthy cells because theydo not discriminate between cancerous and healthy cells. Furthermore, standard chemotherapy drugs are usuallyadministered systemically, which leads to their distribution throughout thebody rather than to one area, such as a tumor in the brain. Common side effectsof chemotherapy that are caused by damage to bone marrow include the body’sinability 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, on the other hand, is being developed as ahighly specific tumor-targeting agent. CINTREDEKIN BESUDOTOX is a recombinantprotein consisting of a single molecule composed of two parts: atumor-targeting molecule and a cytotoxic agent. The targeting componentconsists of interleukin-13(IL-13), an immune regulatory cytokine.Malignant glioma cells, as compared to normal brain cells, express IL-13receptors at a higher density. The cytotoxic agent is a potent bacteriallyderived toxin called PE38. CINTREDEKIN BESUDOTOX is designed to detect and bindIL-13 receptors on the surface of malignant glioma cancer cells and selectivelydeliver PE38 to destroy tumor cells while sparing healthy surrounding cells.CINTREDEKIN BESUDOTOX is administered by a technique known asconvection-enhanced delivery, or CED, in which the drug is delivered throughcatheters inserted in brain tissue surrounding the tumor (peritumoraladministration) or into the tumor (intratumoral administration) followingsurgical resection of the tumor. CED is designed to infuse CINTREDEKINBESUDOTOX directly to the tumor site and adjacent brain tissue with the goal ofkilling resident tumor cells and preventing recurrence of tumor cell growth,and minimize systemic drug exposure and toxicity.

In December 2006, we reached the final efficacy endpoint at 215 deaths inour Phase 3 clinical trial, the PRECISE Trial, for the treatment of recurrentGBM. The PRECISE Trial did not meet the primary endpoint at 215 deaths, whichwas a statistically significant difference, or separation, in the overallsurvival curves versus the Gliadel Wafer®. Based upon review of the PRECISEtrial results with the Company on March 28, 2007, the FDA concluded that anadditional Phase 3 trial would be required prior to acceptance of a potentialBLA filing by the Company, which will substantially delay, or even prevent, thepotential commercialization of the product.

A second Phase 3 clinical trial, if pursued, is currently estimatedto require at least three additional years and $25,000,000 to complete. As theCompany does not have sufficient resources to undertake such a project, this would 

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require that substantialadditional financing be obtained or made available to the Company from sourcesoutside the Company in order to independently pursue the completion of thetrial.

Nevertheless, anddespite the FDAconclusions, the Company continues to believe that CINTREDEKIN BESUDOTOX has demonstrated sufficient efficacy topotentially attract a third party via a licensing arrangement, joint venture orother means, that may enable the completion of a second CINTREDEKIN BESUDOTOX Phase 3 trial. If such an arrangement were tobe entered into, and there can be no assurance given that such financing orother arrangement would become available, or, even if available, that it wouldbe on terms acceptable to the Company, it is hoped that data could be generatedfrom a second Phase 3 trial that could demonstrate statistically superiorefficacy and safety of CINTREDEKIN BESUDOTOXbased on, among other factors, enhanced catheter placement technology notavailable during the PRECISE study, a narrowed focus of testing centers and agenetic study that would help to identify patients that may be more receptiveto treatment.

The Company continues to evaluate its optionsrelated to CINTREDEKIN BESUDOTOX. Therecan be no assurance that the Company will be successful in attracting and thenconsummating any third party agreement or other financing that would enable thecompletion of a second Phase 3 trial, or if a second Phase 3 trial iscompleted, that data evidencing statistical superiority would be generated, or,even if such data were produced, that the FDA might require still more data orthat the FDA would accept or approve a BLA submissionby the Company.

*NeoLipid® Platform*

*LE-SN38*

LE-SN38 is ourNeoLipid**®** liposomal formulation ofSN-38, the active metabolite of Camptosar® (Pfizer Inc.), a chemotherapeuticpro-drug, which is used as a first-line and second-line colorectal cancertreatment. At the present time, without the NeoLipid® system, SN-38 isinsoluble and can only be used to treat cancer by administering the pro-drugCamptosar®. A pro-drug is a compound that is converted into the active drug inthe body. However, Camptosar® is converted into SN-38 in the liver at different rates bydifferent patients, and this variability in conversion rates can result insuboptimal dosing and adverse side effects, such as severe diarrhea. Byemploying our proprietary NeoLipid® technology to deliver SN-38, we hope todeliver the active drug to the tumor cells without the need for conversion,therefore minimizing variability and optimizing dose with minimal side effects.

During 2004, wecompleted a Phase 1 clinical trial for LE-SN38. Results from this Phase 1 studydemonstrated the safety and tolerabilityof LE-SN38 and established a maximum tolerated dose (MTD) for all but a smallsubset of patients who metabolize SN-38 slowly. Pharmacokinetic analysis ofblood samples from patients treated with LE-SN38 showed that blood levels andsystemic drug exposure to SN-38 were comparable to or greater than thatexpected from the marketed Camptosar® dose based on previously publishedstudies.

During the secondquarter of 2006, in conjunction with the Cancer and Leukemia Group B, CALGB, weinitiated enrollment in a Phase 2 clinical trial for LE-SN38 in metastaticcolorectal cancer patients and completed enrollment of the 21st patient inDecember, 2006.

On March 30, 2007,the Company announced that the interim analysis of data following thecompletion of treatment of the first 21 patients demonstrated disease stabilization, but thestudy did not achieve the primary tumor response endpoint. The Company isreassessing project next steps including additional data analyses and thepossibility of other studies related to lung cancer and breast cancer.

*LEP-ETU*

LEP-ETU is ourNeoLipid® liposomal formulation of the widely used cancer drug, paclitaxel.Paclitaxel, also known as Taxol® (Bristol-Myers Squibb Company), has beenapproved in the US for the treatment of ovarian, breast and lung cancers.Despite paclitaxel’s wide use and its tumor cytotoxic characteristics, itseffectiveness can be limited by its adverse side effects, which can includenausea, vomiting, hairloss and nerve and muscle pain. Because of the chemical characteristics ofpaclitaxel, it cannot be introduced into the body unless it is first formulatedin a mixture of castor oil (Cremophor®) and ethanol, which can lead tosignificant side effects such as hypersensitivity reactions. We believe that byusing our proprietary NeoLipid® technology, which eliminates the need forCremophor and ethanol, LEP-ETU may overcome many current limitations ofpaclitaxel treatment for cancer patients and may limit the adverse side effectsof current treatments.

During 2004, wecompleted a Phase 1 clinical trial for LEP-ETU. Results of the study indicatedthat LEP-ETU appeared to be well tolerated in terms of typical paclitaxel sideeffects by the majority of patients, including those receiving the higher dosesof drug, as well as those who were not premedicated with antihistamines andsteroids. 

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Antitumor activity wasobserved, with 16% of patients experiencing partial responses (shrinkage oftumor by 50% or more). Additionally, 44% of patients evidenced stable diseaseand were able to complete 4 or more 3-week cycles of LEP-ETU treatment.Patients previously treated with taxanes were among those who responded toLEP-ETU.

Following recent receipt of communication from theFDA on our Phase 3 Special Protocol Assessment filed with the FDA in December2006, we are continuing discussions with the FDA on clinical and regulatoryplans for LEP-ETU.

*LE-DT*

Pre-clinical workhas also advanced on our earlier stage liposomal formulation of the anti-canceragent docetaxel, LE-DT, which is the active ingredient in Sanofi Aventis’Taxotere® which is approved for use in certain breastcancer, non-small cell lung cancer,gastric adenocarcinoma and head and neck cancer indications. We anticipatefiling an LE-DT Investigational New Drug Application, or IND, with the U.S. FDAin late 2007.

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We intend to further develop the NeoLipid® drug product candidates by usingour internal resources and by continuing to collaborate with other companies and leading governmental andeducational institutions.

In addition, we intend to explore the use ofour proprietary NeoLipid® liposomal drug delivery technology to createnew products in two ways: life cycle management, therefore extending the patentlife and/or modifying the pharmacokinetic profile of existing cancer drugs, andby utilizing our platform to develop new drugs. We are aware of several widelyused cancer drugs that are nearing patent expiration, as well as other widelyused cancer drugs with patents that have expired. When a drug is combined withanother agent or delivery system in a novel way, its patent life may beextended. Secondly, while many chemotherapeutic drugs have been effective forthe treatment of cancer, these drugs have been limited in their use because ofadverse side effects and difficulties in administration. Using our NeoLipid®drug delivery technology, we believe opportunities exist for us to increase theusefulness of these compounds as improved anti-cancer treatments. Thirdly, webelieve that our liposomal drug delivery technology may provide us with aplatform for the development of novel therapeutic agents for cancer drugdevelopment.

It is difficult topredict with any certainty the timing of and total estimated costs to completedevelopment of drug product candidates in early stage, or Phase I, clinicaldevelopment, as well as the estimated date such drug product candidates wouldbe available for sale, if approved by the FDA. A number of factors contributeto this uncertainty, including: side effects encountered in early stageclinical trials, ability to scale up manufacturing for commercial supply, andthe fact that the size and scope of pivotal Phase 3 clinical trials are unknownuntil sufficient data is available to present a Phase 3 plan to the FDA forapproval. In addition, our drug product candidates are required to be approvedby the FDA after completing Phase 3 clinical trials before we can sell thedrugs to generate revenue and, potentially, realize net cash inflows.Additional clinical trial expenses are expected to be incurred for CINTREDEKINBESUDOTOX to meet our ongoing patient and potential manufacturing obligations.

The table belowincludes a summary of identified direct project costs incurred to date for ourclinical research and development projects. Generally, identified project costsinclude expenses incurred specifically for clinical trials and pre-clinicalstudies we conduct, and exclude expenses incurred for salaries paid to ourprofessional staff, our Waukegan facility and general laboratory supplies usedin our research, which are included with non-project specific costs.
| ** **                               | ** ** | **Total Direct Costs**                                 | ** ** |
|------------------------------------------|------------|------------------------------------------------------------------|------------|
| **Research Project**                | ** ** | **Three months ended   March 31, 2007** | ** ** | **Cummulative costs  through March 31, 2007** | ** ** |
| CINTREDIEKIN  BESUDOTOX                  |       | $                                                                | 1,179,000  |   | $ | 67,438,000 |   |
| LEP-ETU                                  |       | 47,000                                                           |       | 7,630,000 |   |
| LE-SN38                                  |       | 39,000                                                           |       | 5,267,000 |   |
| Non-project  specific                    |       | 1,742,000                                                        |       | N/A |   |
| Total research  and development expenses |       | $                                                                | 3,007,000  |   |   |   |
|                                          |            |                                                                  |            |  |  |  |  |

 

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**Results of Operations — ThreeMonths Ended March 31, 2007 vs. Three Months Ended March 31, 2006.**

There was no product revenue for the three months ended March 31, 2007, ascompared to $1,000 for the three months ended March 31, 2006. The sole sourceof the $1,000 in product revenue in the first quarter 2006 was from sales ofNeoPhectin and NeoPhectin-AT.

Research and development expense for the three months ended March 31, 2007 decreased by approximately $2.8million compared to the same period in 2006. The decrease is attributed to a$1.3 million reduction in payroll expenses, primarily attributed to the Company’svarious restructuring initiatives implemented during 2006 and a $1.4 milliondecrease in project costs. The decrease in project costs is primarilyattributed to decreases in the PRECISE trial and Initial Diagnosis GBM Phase 1trial expenditures related to sites costs, data management and third partycontract services as these clinical trials move towards completion.

Selling, general, and administrative expenses decreased approximately $0.2million for the three months ended March 31, 2007 compared to the same periodin 2006. The decrease is attributed to a $0.7 million decrease in personnelcosts, primarily attributed to the Company’s various restructuring initiativesimplemented during 2006, offset by $0.4 million in costs associated with thetermination of the Company’s former Chief Executive Officer in March, 2007.

The change in fair value of derivative financial instruments of $(0.5) million in the first quarter of2006 is attributed to a decrease in valuation of stock options granted tonon-employee consultants prior to 2000, resulting from a decrease in theCompany’s stock price from $10.79 at December 31, 2005 to $8.36 per share atMarch 31, 2006. There was minimal impact to the valuation of these options forthe quarter ended March 31, 2007 as the Company’s stock price remained flat,increasing $.03 per share since the beginning of the year to $1.70 per share atMarch 31, 2007.

The Company generatedinterest income on cash and short-term investments of approximately $0.4million and $0.7 million for the three months ended March 31, 2007 and 2006,respectively. The decrease in interest income during the period was primarilydue to a decrease in average short-term investment balances, which were used tofund operations.

**Liquidityand Capital Resources**

Net cash used byoperating activities was $9.7 and $9.3 million for the three months ended March31, 2007 and 2006, respectively. The increase in cash used by operations,despite the $2.2 million lower net loss for the quarter ended March 31, 2007compared to 2006, is primarily attributed to the significant reduction inaccounts payable balances.

In January 2006,we completed the sale of 4,025,000 shares of our common stock to the public.Proceeds to the Company were approximately $39.0 million net of underwritingfees but before expenses. The proceeds from this sale of stock are being usedto fund clinical trials of our drug product candidates; preclinical studies forother potential drug product candidates; and for working capital, capitalexpenditures, and other general corporate purposes.

Our primary source of cash has been proceeds from issuance of our commonshares and interest earned on the investment of the stock issuance proceeds. As of March 31, 2007, we had $1.9 millionin cash and cash equivalents and $26.9 million in short-term investments,consisting solely of state government auction rate certificates, which webelieve provide us liquidity characteristics very similar to cash equivalents.

Our primary use ofcash over the next 12 to 18 months is expected to fund, in addition to generaland administrative expenses, advancement of our NeoLipid® clinical andpre-clinical research and development efforts and our remaining CINTREDEKINBESUDOTOX Phase 3 clinical trial patient obligations.

As a result of theApril 18, 2007 restructuring initiative (see also Note 11 Subsequent Events),the Company expects to reduce general and administrative expenditures for 2007by approximately $2.0 million compared to 2006. The total cost reductionsimplemented and planned, before consideration of project costs, are expected toresult in annualized cash consumption rate of approximately $6.9 million.

Given the delay inthe Company’s commercialization efforts related to CINTREDEKIN BESUDOTOX, theApril 18, 2007 restructuring initiative and the reprioritization of the Company’svarious liposome based products, the Company currently projects it hassufficient funds to continue operations into 2009 before requiring additionalfinancing. The date as to which sufficient funds continue to be available foroperations, without additional financing, may vary depending upon the timingand implementation of various strategies under consideration by the Company.

We may seek tomeet future funding requirements through public or private offerings ofsecurities or with collaborative or other development or licensing arrangementswith corporate or private venture partners. Additional financing may not beavailable when needed or on terms acceptable to us, if at all. If adequatefinancing is not available, we may be required to further delay, scale back, oreliminate certain of our research and development programs, relinquish 

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rights to certain of ourtechnologies, drugs or products, or license our products or technologies tothird parties that we would otherwise seek to develop ourselves.

We have noexposure to off-balance sheet arrangements, no special purpose entities, or activitiesthat include non-exchange-traded contracts accounted for at fair value.

**Critical Accounting Policies**

In preparing ourfinancial statements in conformity with U.S. generally accepted accountingprinciples, or GAAP, we must make a variety of decisions and estimates thatimpact reported results and related disclosures. Such decisions include theselection of the appropriate accounting principles to be applied, theassumptions on which our accounting estimates are based, and the consistentapplication of those accounting principles. Due to the industry in which weoperate and the nature of our business, the following accounting policies arethose that we believe are most important to the portrayal of our financialcondition and results and that require the most difficult, subjective orcomplex judgments, often as a result of the need to make estimates about theeffect of matters that are inherently uncertain.

*IncomeTaxes*

Income taxes areaccounted for under SFAS No. 109, “Accounting for Income Taxes”, in whichdeferred tax assets and liabilities are recognized for the future taxconsequences attributable to differences between the financial statementcarrying amounts of existing assets and liabilities and their respective taxbases and operating loss andtax credit carryforwards. Deferred tax assets and liabilities aremeasured using enacted tax rates that are expected to be in effect in the yearsin which those temporary differences are expected to be recovered or settled.We recognize, at the largest amount that is more-likely-than-not to besustained upon audit by the relevant taxing authority, the impact of anuncertain income tax position on its income tax return. An uncertain income taxposition will not be recognized if management judges that it has less than a50% likelihood of being sustained. Interest expense and penalties are recordedas income tax expense. We provide valuationallowances against deferred tax assets for amounts which are not considered “morelikely than not” to be realized.

*Contingencies*

Liabilities forloss contingencies arising from claims, assessments, litigation, fines, andpenalties and other sources are recorded when it is probable that a liabilityhas been incurred and the amount of the assessment can be reasonably estimated.Recoveries from other parties are recorded when realized.

*Share-BasedCompensation*

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 compensationcost is estimated at the grant date based on the award’s fair value ascalculated by the Black-Scholes option-pricing model and is recognized asexpense over the requisite service period. We also use the Black-Scholes modelto estimate the fair value of non-employee options grants that are accountedfor as derivative instruments. The Black-Scholes model requires various highlyjudgmental assumptions including volatility and expected option life. If any ofthe assumptions used in the Black-Scholes model change significantly,share-based compensation expense may differ materially in the future from thatrecorded in the current period.

**Item 3 — Quantitative andQualitative Disclosures about Market Risk**

As of March 31,2007, we did not own any derivative instruments, but we were exposed to marketrisks, limited primarily to the impact of changes in U.S. interest rates on ourcash and short-term investments. As of March 31, 2007, we held total cash andcash equivalents of $1.9 million and short-term investments in auction rate certificatesof $26.9 million. All cash equivalents have a maturity of less than 90 days.Declines in future interest rates would reduce interest income from ourinvestments. Based upon our balance of cash, cash equivalents and short-terminvestments at March 31, 2007, a 1.0% decline in interest rates would decreaseour annual interest income by approximately $0.3 million.

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**Item 4 — Controls and Procedures**

*Evaluationof Disclosure Controls and Procedure*

Our disclosurecontrols and procedures are designed to ensure that information required to bedisclosed in the reports that we file or submit under the Securities ExchangeAct of 1934, as amended, is recorded, processed, summarized and reported withinthe time periods specified in the Securities and Exchange Commission’s rulesand forms, including ensuring that such information is accumulated andcommunicated to management as appropriate to allow timely decisions regardingrequired disclosure. We necessarily apply judgment in assessing the costs andbenefits of such controls and procedures that, by their nature, can onlyprovide reasonable assurance regarding management’s control objectives.

Our President andChief Executive Officer/Acting Chief Financial Officer, has carried out anevaluation, with the participation of our management, of the effectiveness ofthe 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 bythis report, based on the evaluation required by paragraph (b) of Rule 13a-15under the Securities Act of 1934.

Based on theevaluation of internal control over financial reporting, management identifiedthe following material weakness as of March 31, 2007:

The Company did not maintain sufficient staff with appropriate trainingin United States generally accepted accounting principles and Securities andExchange Commission rules and regulations with respect to financial reporting.This deficiency resulted in a more than remote likelihood that a materialmisstatement of the Company’s interim financial statements would not beprevented or detected.

As a result ofthis material weakness, management concluded that internal controls overfinancial reporting were not effective as of March 31, 2007, based on thecriteria identified above.

In light of thematerial weakness described above, in preparing our financial statements at andfor the quarter ended March 31, 2007, we performed additional procedures in anattempt to ensure that such financial statements were fairly presented in allmaterial respects in accordance with generally accepted accounting principles.Notwithstanding the material weakness described above, management believes thatthe condensed consolidated financial statements included in this Form 10-Qfairly present, in all material respects, the Company’s financial condition,results of operations and cash flows for the periods and dates presented.

*Changes in Internal Control Over Financial Reportingand Management’s Remediation Efforts*

Our management hasdiscussed the material weakness described above and other potentialdeficiencies with our Audit Committee. In an effort to improve our internalcontrols over financial reporting, we engaged a third party accounting firm toassist us in the proper accounting and disclosures related SFAS 123R *Share-Based Payment*and hired an independent consultant with previous SEC reporting experience on acontract basis to provide assistance until suitable replacement personnel arehired. We are continuing to evaluate the structure and needs of the finance andaccounting department to ensure we meet all of our financial reportingobligations.

In addition to theweaknesses discussed above, the following changes in our internal controls overfinancial reporting occurred during the quarter ended March 31, 2007: On March21, 2007, Ronald E. Pauli resigned as our Chief Financial Officer. On March 23,2007 the Company terminatedthe employment of Guillermo A. Herrera, its President and Chief Executive Officer. Effective March 23, 2007 theBoard of Directors appointed Laurence P. Birch as President and Chief ExecutiveOfficer and on March 30, 2007 Mr. Birch was appointed to the Board ofDirectors. Mr. Birch was then appointed as Acting Chief Financial Officereffective April 16, 2007, to serve in suchcapacity until a permanent Chief Financial Officer can be engaged.

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**PART II - OTHER INFORMATION**

**Item 1 - Legal Proceedings**

NEOPHARM, Inc. and certain of our former officers have been named in aconsolidated amended complaint, which alleges various violations of the federalsecurities laws in connection with our public statements regarding our LEP drugproduct candidate during the period from October 31, 2001 through April 19,2002. On November 4, 2002, we moved to have the complaint dismissed. Our motionto dismiss was granted in partand denied in part in February 2003.

In November 2004, the plaintiffs filed a motion to amend and a motion forsummary adjudication. The motion to amend seeks to include certain pre-classperiod statements in the complaint. The motion for summary adjudication asksthe Court to rule that certain statements made in an arbitration award regarding the LEP drug product candidate bedeemed facts established in this proceeding. On February 23, 2007, the Courtentered an order denying both the plaintiffs’ motion to amend and theplaintiffs’ motion for summary adjudication. The Court has set a fact discoverycut-off date of August 24, 2007. No trial date has yet been set. We intend tovigorously defend each and every claim in the complaint. Management is unableto estimate the potential outcome or range of possibilities, if any. Inaddition, we maintain insurance coverage to mitigate the financial impact ofany potential loss.

We are from timeto time subject to claims and litigation arising in the ordinary course ofbusiness. We intend to defend vigorously any such litigation that may ariseunder 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 ifadverse to us, will not have a material adverse effect on our consolidatedfinancial position or results of operations. While we maintain insurance tocover the use of our drug product candidates in clinical trials, we do notpresently maintain insurance covering the potential commercial use of our drugproduct candidates and there is no assurance that we will be able to obtain ormaintain such insurance on acceptable terms.

**Item 1A. - Risk Factors**

Below are the riskfactors that have been revised since the filing of our annual report on March16, 2007 on Form 10-K for the year ended December 31, 2006 (the “2006 Form 10-K”).We face significant additional risks, which are set forth in the Part 1, Item1A in our 2006 Form 10-K under the caption “Risk Factors.” You are urged toread these risk factors in the 2006 Form 10-K, in addition to the followingrevised risk factors set forth below. Each of the risk factors set forth hereand in our 2006 Form 10-K could materially adversely affect our business,operating results and financial condition, as well as the value of aninvestment in our common stock. Additional risks and uncertainties notpresently known to us, or those we currently deem immaterial, may alsomaterially harm our business, operating results and financial condition.

**Our drugproduct candidate, CINTREDEKIN BESUDOTOX, failed to meet the statisticalendpoint established in its Phase 3 PRECISE clinical trial and the FDA hasconcluded that additional Phase 3 clinical testing is required. As a result,CINTREDEKIN BESUDOTOX may never be approved for commercial use, or, even ifapproved, may not have the market potential for which we had hoped. Failure tosuccessfully commercialize CINTREDEKIN BESUDOTOX would impair our ability togenerate revenues and our business would be harmed.**

We have invested asignificant portion of our time and financial resources in the development ofCINTREDEKIN BESUDOTOX. In December 2006, we suffered a significant setback withthe results of our Phase 3 clinical trial of CINTREDEKIN BESUDOTOX, the PRECISE trial, despiteachieving potentially promising results in earlier clinical trials. Patients inthe PRECISE trial received treatment either with CINTREDEKIN BESUDOTOX or withGliadel® Wafers, a product currently approved to treat this disease. Theprimary endpoint of the study did not demonstrate a statistically significantoverall patient survival difference between patients treated with CINTREDEKINBESUDOTOX and patients treated with Gliadel® Wafers.

Since theannouncement of the PRECISE trial results in December, 2006 the Company and ourScientific Advisory Board have been working to develop a potential regulatory path forward based onthe totality of the clinical data. However, the FDA Office of Oncologyindicated during a review of the clinical data with the Company on March 28,2007, that an additional Phase 3 clinical trial for CINTREDEKIN BESUDOTOX inthe treatment of GBM would be required before the FDA could accept the Company’sBiologics License Application (BLA) for CINTREDEKIN BESUDOTOX.

Even if a secondPhase 3 trial were to be undertaken and completed, there can be no assurancethat the FDA will indicate at that time, or at any time, that there is aregulatory path for the use of CINTREDEKIN BESUDOTOX as a treatment forGlioblastoma Multiforme, that there is a current unmet medical need forCINTREDEKIN BESUDOTOX, 

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that the FDA wouldapprove a BLA, if one were eventually to be filed, or that the FDA will notrequire still more data or testing which would preclude advancement ofCINTREDEKIN BESUDOTOX. Additionally, any adverse safety findings in any futureclinical trials could delay or prevent regulatory approval.

Even if apotential second Phase 3 trial is completed, prior to commercialization ofCINTREDEKIN BESUDOTOX in the United States, we will have to submit, and the FDAwill have to approve, a BLA for CINTREDEKIN BESUDOTOX. A BLA is a lengthy,complex submission to the FDA, which must comply in format and content withelaborate and detailed FDA requirements. We have never submitted a BLA before.The FDA may refuse to accept a BLA for filing if it is incomplete. Even if webelieve that we have submitted all of the data and information necessary tosatisfy FDA requirements for approval of the BLA, there is a risk that the FDAwill require additional data and information that we are unable to provide. Thelength and outcome of the FDA’s review of the BLA is uncertain. The FDA’sapproval is contingent on many factors, including its evaluation of ourpreclinical and clinical trial results, its assessment of the manufacturingprocess we propose as well as the process controls, its review of our drugsubstance specifications and proposed analytical procedures, the data weprovide on the drug’s stability, and its inspection of the facilities whereCINTREDEKIN BESUDOTOX is manufactured. The FDA may ask an advisory committeefor its recommendations on the BLA, and we cannot predict the outcome of theadvisory committee process.

Additionally, asthe PRECISE trial did not show superiority to Gliadel, the medical communitymay be unwilling, or less willing, to accept CINTREDEKIN BESUDOTOX as analternative to Gliadel, or other treatment options, which could diminish itsmarket potential. Health care reimbursement may not be available to patientsfor a treatment which has not shown superiority if that treatment is moreexpensive than the alternative.

Even though theFDA has awarded orphan drug designation to CINTREDEKIN BESUDOTOX, a competitorcould obtain orphan drug designation for the same drug for the same indication.The FDA could approve that competitor’s product first and give it seven yearsof market exclusivity. In this case, we might not be allowed to market acompeting product in the United States for seven years. This would have amaterial adverse effect on our business. The law would permit the FDA toapprove our product during the seven years if certain conditions were met, butthere is no assurance we could satisfy these conditions. We might be able tomarket the product outside the United States, if certain conditions were met, butthere is no guarantee that we would be able to satisfy those conditions. Theexport process can be complex, and there are no assurances that export would bepermitted or that another country would accept the product. Even if the FDAwere to approve CINTREDEKIN BESUDOTOX as an orphan drug, and there is noassurance at this point that we will even be able to pursue such approval, andthen award us seven years of exclusivity in connection with its use, the lawpermits the FDA, in certain situations, to approve a competitor’s product. Thiscould have a material adverse effect on the commercial success of our product.

**Wedepend on third parties for a variety of functions, including the research anddevelopment, manufacturing, clinical testing, and regulatory compliance of ourdrug product candidates. No assurance can be given that these third partiesarrangements will allow us to successfully or timely develop, manufacture andmarket our drug product candidates.**

We do not have theinternal infrastructure to conduct clinical trial management or certain otheraspects of clinical testing ourselves. On March 31, 2007, we had 40 full-timeemployees and, as a result of our restructuring initiated on April 18, 2007, wefurther reduced our workforce by 15 employees. As of May 1, 2007, attritionfurther reduced our workforce to 21 employees. We therefore rely heavily onthird parties to perform a variety of functions with respect to the clinicaldevelopment of our drug product candidates, including clinical trial management,manufacturing and testing of our drug product candidates. If we developadditional drug product candidates with commercial potential, we will have toeither hire additional personnel skilled in clinical testing or engage thirdparties to perform such services.

We depend on thesethird parties to apply the appropriate expertise and resources to expeditiouslyand competently perform the services for which they have been retained. Thefailure of any of these third parties to fulfill their contractual obligationsor otherwise perform key tasks appropriately or in a timely manner, or theirfailure to comply with applicable government regulations, could require us toseek alternative third parties to fulfill these functions and could potentiallyinvalidate a clinical trial, significantly slow the filing of a potential BLA,preclude its timely approval or even preclude its approval altogether.

Although we arecurrently aware of alternative manufacturers and service providers who might beable to supply us with our requirements for our drug product candidates, havingto utilize alternative providers would result in significant additional delaysin the development, filing for approval, and potential approval by the FDA ofour drug product candidates, particularly for CINTREDEKIN BESUDOTOX.

As part of thework that is required to support a potential BLA for CINTREDEKIN BESUDOTOX, wehave contracted with Diosynth to assist in the development of manufacturingprocesses in connection with the scale-up of 

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manufacturing ofCINTREDEKIN BESUDOTOX from preclinical testing and clinical development tocommercial-scale operations, including the preparation and filing of documentsfor process development, method development, and process validation. Theseprograms must be developed in compliance with applicable governmentregulations, including the FDA’s current good manufacturing practice, or cGMP,requirements for biological products, which are extremely complex and requireconsiderable time, resources, and ongoing investment to comply with. We do notcurrently have ourselves or through Diosynth, commercial scale cGMP compliantmanufacturing ability with respect to CINTREDEKIN BESUDOTOX. However, given thedelay in making a possible BLA submission, the lack of commercial scale cGMPcompliant manufacturing ability is not considered critical to the presentadvancement of CINTREDEKIN BESUDOTOX and, if necessary, it is believed that,given time, alternative manufacturers could be retained as needed, though thiscould be expected to further slow development of this drug product candidateshould the Company elect to pursue such further development.

Manufacturingestablishments, including contract manufacturers such as Diosynth, are subjectto inspections by the FDA for compliance with cGMP. Any errors or omissions incompleting the process or method development or process validation, if notpromptly corrected by us and/or the manufacturer, could significantly delay, oreven prevent, a potential BLA filing. If FDA approval is delayed, or the FDArequires additional clinical testing or other information, or the FDA does notapprove the BLA, our ability to achieve revenues from product sales may beimpaired and our stock price would be materially and adversely affected.

We have engagedother companies on a per study basis for assistance in the management andtesting for our Phase I and Phase II clinical trials. To oversee datamanagement in our clinical trials we have contracted, on a per study basis,with Advanced Clinical Services. To conduct our large animal testing, we haveengaged, again on a per study basis, Southern Research Institute.

We do notcurrently have commercial scale cGMP compliant manufacturing capacity for anyof our liposome based drug product candidates we are developing. All of ourliposome compounds are produced at the Center for Advanced Drug Development (“theCenter”) which is affiliated with the University of Iowa Pharmacy School. TheCenter has indicated that it is currently able to meet our needs for researchand clinical trials, but we cannot be sure that it will be able to meet ourneeds in a timely manner or on a cost-effective basis in the future. If theCenter were unable to meet our needs in the future, it is believed that, giventime, alternative manufacturers could be retained as needed, though this couldbe expected to further slow development of these drug product candidates.

We also in-licensetechnology from governmental and academic institutions in order to minimize ourinvestment in basic research, and we enter into collaborative arrangements withcertain of these entities with respect to research and development of our drugproduct candidates. At this time we have a research agreement in place with theFDA. No assurance can be given that we will enter into more of theserelationships, that we will be able to maintain or renew the research agreementwith FDA, that this relationship will provide benefits to us, or that we willbe able to establish new relationships on beneficial terms, without unduedelays or expenditures.

**Ourstock price has been and is likely to continue to be volatile, and aninvestment in our common stock could decline in value. If our stock pricedeclines below $1.00 per share and remains there, or we fail to otherwisesatisfy NASDAQ listing requirements, our stock could be delisted by NASDAQ.**

The market priceof our common stock has been highly volatile and may continue to be so. Forexample, during 2006, the market price of our common stock fluctuated between$1.66 and $12.67 per share and during 2005 the market price of our common stockfluctuated between $15.47 and $7.16 per share. During the quarter ended March31, 2007 our stock price fluctuated between $1.40 and $2.37 per share.

In addition,failure to maintain NASDAQ listing requirements, including but not limited to,a minimum bid price of $1.00 per share for 30 consecutive days, would result innotification of a possible delisting if the deficiency were not corrected. Adelisting of our stock would be expected to have a negative impact on the valueof our shares.

The followingfactors, among others, could have a significant impact on the market price ofour stock:

·                                          thesuccess or failure of our clinical trials or those of our competitors;

·                                          ourability to conserve our cash resources or to obtain financing, when needed;

·                                          litigation,including, but not limited to, current class action lawsuits;

·                                          actualor anticipated fluctuations in our financial results;

·                                          economicconditions in the US and abroad;

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

·                                          adverseregulatory actions or decisions;

·                                          lossesof key management;

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·                                          changinggovernmental regulations;

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

·                                          developmentsor disputes concerning patents or other proprietary rights;

·                                          productor patent litigation; and

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

Additionally,volatility or a lack of positive performance in our stock price may adverselyaffect our ability to retain key employees, all of whom have been granted stockoptions.

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

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

We estimate thatas of March 31, 2007, our then existing cash reserves, should be sufficient tofinance our operations at current and projected levels of development andgeneral corporate activity into 2009. The date that sufficient funds continueto be available for operations, without additional financing, may vary dependingupon the timing and implementation of various strategies under consideration bythe Company.

Our projection asto the date that sufficient funds continue to be available for operationswithout additional financing does not contemplate the Company’s independentcompletion of a second Phase 3 clinical trial of CINTREDEKIN BESUDOTOX ascurrently required by the FDA in order for them to accept a BLA. We currentlyestimate that a second Phase 3 clinical trial, would if pursued, require atleast three additional years and $25,000,000 to complete. This would requiresubstantial additional financing be made available to the Company in order toindependently pursue the completion of the trial. We currently do not have suchfunds, nor have we received any offers from third parties to make suchfinancing available to us.

We do notanticipate being able to generate revenues from product sales in the near termat a rate sufficient to fund our operations. We will need additional futurefinancing depending on a number of factors, including, but not limited to, thefollowing:

·                                          adecision to pursue additional Phase 3 clinical testing for CINTREDEKINBESUDOTOX;

·                                          ourdegree of success in gaining approval for and thereafter successfullycommercializing our drug product candidates;

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

·                                          apossible obligation to pay damages arising from the ongoing consolidated classaction lawsuit, to the extent these possible damages exceed, or are not coveredby, our insurance;

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

·                                          emergenceof competing technologies and other adverse market developments;

·                                          changesin or terminations of our existing licensing arrangements;

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

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

·                                          thecost of manufacturing scale-up and development of marketing operations, if weundertake those activities, or are required to pay for terminating suchactivities under existing contracts.

Additionalfinancing may not be available when we need it or be on terms acceptable to us.If adequate financing is not available, we may be required to further delay, scale-back,or eliminate certain of our research and development programs, to relinquishrights to some of our technologies or products, or to grant licenses to thirdparties to commercialize products or technologies that we would otherwise seekto develop ourselves. We could also be required to cease operations. Ifadditional capital is raised through the sale of equity, our stockholders’ownership interest could be diluted and such securities may have rights,preferences, or privileges superior to those of our other stockholders. Theterms of any debt securities we may sell to raise additional capital may placerestrictions on our operating activities. Failure to secure additionalfinancing may cause us to delay or abandon some or all of our development programs.

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**We havelost key management personnel and may be unable to attract and retain thetalent required for our business, and therefore our business could be harmed.**

Since January 1,2006, we have had substantial turnover in our personnel at all levels, butparticularly among our senior management ranks, with all of the named executiveofficers serving as of that date having either resigned, been terminated orindicated that they will be leaving the Company in the near future. With theexception of the position of President and Chief Executive Officer, we have notyet filled several of these positions. At the present time, we are highlydependent on our President and Chief Executive Officer Mr. Laurence P. Birch,who is also serving as our Acting Chief Financial Officer. Additionally, ourChief Medical Officer Dr. Jeffrey W. Sherman, has announced that he will bestepping down from his position, though he has agreed to continue servingduring a transition period during which we will endeavor to find a suitablereplacement. Mr. Timothy Walbert’s position as Executive VP-CommercialOperations was no longer considered vital to current operations of the Companygiven the delay in the commercialization of CINTREDEKIN BESUDOTOX and as aresult, the position was eliminated as part of the April 18, 2007 restructuringinitiative. Mr. Walbert is continuing to serve in a transition capacity.

Dr. Sherman andMr. Walbert accepted employment on the basis of written offers which set forththe salary and benefits to be provided, including, but not limited to, salarycontinuation payments upon termination of employment. Mr. Birch has a writtenemployment contract with us, which also provides post termination benefits asdescribed therein. We do not have key man insurance on any of our management.If we were to lose the services of Mr. Birch, or are unable to replace otherkey members of our senior executive staff, our product development andachievement of our strategic objectives could be delayed. In addition, oursuccess will depend on our ability to attract and retain qualified commercial,scientific, technical, and managerial personnel. Given the large turnover inour employees, and the recent set backs in our various clinical trials, it isexpected that recruiting additional personnel and retaining our existingpersonnel will be more difficult. No assurance can be given that we will beable to retain existing personnel or attract and retain qualified staff in thefuture.

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

As of September30, 2006, management had concluded that a control deficiency with respect tothe review and verification of the accuracy of the calculation estimating thefair value of non-employee stock options constituted a material weakness ininternal control over financial reporting. A material weakness is a controldeficiency, or combination of control deficiencies that results in more than aremote likelihood that a material misstatement of the annual or interimfinancial statements will not be prevented or detected. This control deficiencyresulted in an adjustment to the unaudited interim condensed consolidatedfinancial statements for the quarter ended March 31, 2006 affecting derivativefinancial instruments and change in fair value of derivative financialinstruments.

During 2006,management revised its policies and procedures with respect to its controlsover the review and verification of the accuracy of the calculation estimatingthe fair value of non-employee stock options to ensure that all reasonablesteps will be taken to correct this material weakness. At December 31, 2006,the deficiency was considered to be remediated as the new internal controlswere operational for a period of time, were tested, and management concludedthat the controls are operating effectively at that time.

Our management also evaluated the effectiveness of the design and operationof our disclosure controls and procedures as of the three months ended March 31, 2007 andconcluded that our disclosure controls and procedures were not effective as ofthat date, because of the material weakness in our internal control overfinancial reporting. A description of the material weakness related to ourinadequate controls over financial reporting is set forth above in Part I, Item4 “Controls and Procedures”.

We have adopted, or are in the process of adopting, various remedialmeasures that are designed to improve our internal controls over financial reporting. We cannot assure you,however, that these remedial measures will be effective.

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

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**Item 2. - Unregistered Sales ofEquity Securities and Use of Proceeds**

None

**Item 3. - Defaults Upon SeniorSecurities**

None

**Item 4. - Submission of Mattersto a Vote of Security Holders**

None

**Item 5. - Other Information**

None

**Item 6. - Exhibits**

31.1                           Certificationpursuant to Section 302 of the Sarbanes-Oxley Act of 2002

32.1                           Certificationpursuant to section 906 of the Sarbanes-Oxley Act or 2002

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**SIGNATUREPAGE**

**Pursuantto the requirements of the Securities Exchange Act of 1934, the Registrant hasduly caused this report to be signed on its behalf by the undersigned,thereunto duly authorized.**
| Dated: May 10, 2007 | /s/ Laurence P. Birch                                                                                                                  |
|---------------------|----------------------------------------------------------------------------------------------------------------------------------------|
|                | Laurence P. Birch                                                                                                                      |
|                | President and Chief Executive  Officer (Principal Executive Officer) and Acting Chief Financial Officer  (Principal Financial Officer) |

 

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