UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
ý | | QUARTERLY REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 |
For Quarterly Period Ended September 30, 2005
Or
o | | TRANSITION REPORT PURSUANT TO SECTION 13 OR 15 (d) OF THE SECURITIES EXCHANGE ACT OF 1934 |
For the transition period from to
Commission file number 33-90516
NEOPHARM, INC.
(Exact name of Registrant as specified in 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 check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes ý No o
Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Exchange Act). Yes ý No o
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes o No ý
As of October 31, 2005, the number of shares outstanding of each of the issuer’s classes of common stock was as follows:
Title of each class | | Number of shares outstanding | |
Common Stock ($.0002145 par value) | | 23,739,889 | |
NEOPHARM, INC.
FORM 10-Q
INDEX
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PART I - FINANCIAL INFORMATION
Item 1 - Financial Statements
NEOPHARM, INC.
Condensed Consolidated Balance Sheets
| | September 30 2005 | | December 31, 2004 | |
| | (Unaudited) | | | |
ASSETS | | | | | |
Current assets: | | | | | |
Cash and cash equivalents | | $ | 40,105,417 | | $ | 63,106,655 | |
Trade accounts receivable | | 2,870 | | 10,888 | |
Inventories | | 4,368 | | 5,736 | |
Prepaid expenses | | 1,222,991 | | 1,108,282 | |
Other receivables | | 109,641 | | 308,087 | |
Total current assets | | 41,445,287 | | 64,539,648 | |
Fixed assets, net of accumulated depreciation | | 2,148,131 | | 2,894,723 | |
Total assets | | $ | 43,593,418 | | $ | 67,434,371 | |
| | | | | |
LIABILITIES AND STOCKHOLDERS’ EQUITY | | | | | |
Current liabilities: | | | | | |
Accounts payable | | $ | 562,877 | | $ | 398,505 | |
Accrued clinical trial expense | | 6,037,731 | | 4,634,618 | |
Accrued compensation | | 1,790,081 | | 3,227,230 | |
Other accrued expenses | | 1,872,872 | | 940,343 | |
Deferred and unearned revenue | | — | | 3,400 | |
Total current liabilities | | 10,263,561 | | 9,204,096 | |
| | | | | |
Deferred revenue | | 2,000,000 | | — | |
Deferred rent | | 41,978 | | — | |
| | | | | |
Stockholders’ equity: | | | | | |
Preferred stock, $0.01 par value; 15,000,000 shares authorized: none issued and outstanding | | — | | — | |
Common stock, $0.0002145 par value; 50,000,000 shares authorized: 23,704,322 and 23,372,755 shares issued and outstanding, respectively | | 5,085 | | 5,013 | |
Additional paid-in capital | | 249,637,337 | | 247,525,290 | |
Accumulated deficit | | (218,354,543 | ) | (189,300,028 | ) |
Total stockholders’ equity | | 31,287,879 | | 58,230,275 | |
Total liabilities and stockholders’ equity | | $ | 43,593,418 | | $ | 67,434,371 | |
| | | | | | | | | | |
The accompanying notes to condensed consolidated financial statements are an integral part of these financial statements.
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NEOPHARM, INC.
Condensed Consolidated Statements of Operations
Three and Nine Months Ended September 30, 2005 and 2004
(Unaudited)
| | Three-Month Periods Ended | | Nine Month Periods Ended | |
| | September 30, 2005 | | September 30, 2004 | | September 30, 2005 | | September 30, 2004 | |
Collaboration revenue | | $ | — | | $ | — | | $ | 500,000 | | $ | — | |
Product revenue | | 9,480 | | 84,740 | | 35,380 | | 116,020 | |
Total revenue | | 9,480 | | 84,740 | | 535,380 | | 116,020 | |
| | | | | | | | | |
Expenses: | | | | | | | | | |
Cost of product revenue | | 387 | | 3,466 | | 1,736 | | 4,008 | |
Research and development | | 8,538,368 | | 10,621,195 | | 24,573,044 | | 33,878,801 | |
Selling, general, and administrative | | 2,388,388 | | 3,712,207 | | 8,672,986 | | 9,896,836 | |
Recovery of note receivable | | — | | — | | (2,500,000 | ) | — | |
Related party expenses | | — | | — | | — | | 69,370 | |
Total expenses | | 10,927,143 | | 14,336,868 | | 30,747,766 | | 43,849,015 | |
Loss from operations | | (10,917,663 | ) | (14,252,128 | ) | (30,212,386 | ) | (43,732,995 | ) |
| | | | | | | | | |
Interest income | | 384,720 | | 297,558 | | 1,157,871 | | 771,754 | |
Net loss | | $ | (10,532,943 | ) | $ | (13,954,570 | ) | $ | (29,054,515 | ) | $ | (42,961,241 | ) |
Net loss per share — | | | | | | | | | |
Basic and diluted | | $ | (0.45 | ) | $ | (0.60 | ) | $ | (1.23 | ) | $ | (1.88 | ) |
Weighted average shares outstanding — | | | | | | | | | |
Basic and diluted | | 23,640,393 | | 23,284,925 | | 23,557,757 | | 22,815,559 | |
| | | | | | | | | |
| | | | | | | | | | | | | | | | | | |
The accompanying notes to condensed consolidated financial statements are an integral part of these financial statements.
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NEOPHARM, INC.
Condensed Consolidated Statements of Cash Flows
Nine Months Ended September 30, 2005 and 2004
(Unaudited)
| | Nine Months Ended | |
| | September 30, 2005 | | September 30, 2004 | |
Cash flows from operating activities: | | | | | |
Net loss | | $ | (29,054,515 | ) | $ | (42,961,241 | ) |
Adjustments to reconcile net loss to net cash used in operating activities: | | | | | |
Depreciation and amortization | | 983,291 | | 1,006,620 | |
Stock-based compensation expense | | 469,200 | | 734,504 | |
Loss on retirement of equipment and furniture | | 4,963 | | — | |
Changes in assets and liabilities: | | | | | |
Increase in current assets | | 93,123 | | (768,345 | ) |
Increase in current liabilities | | 1,247,818 | | 2,854,624 | |
Increase in deferred revenue | | 2,000,000 | | — | |
Increase in deferred rent | | 41,978 | | — | |
Net cash and cash equivalents used in operating activities | | (24,214,142 | ) | (39,133,838 | ) |
| | | | | |
Cash flows from investing activities: | | | | | |
Proceeds from maturities of marketable securities | | — | | 1,046,168 | |
Proceeds from sales of marketable securities | | — | | 3,120,183 | |
Purchase of equipment and furniture | | (241,662 | ) | (437,586 | ) |
Net cash and cash equivalents (used in) provided by investing activities | | (241,662 | ) | 3,728,765 | |
| | | | | |
Cash flows from financing activities: | | | | | |
Proceeds from issuance of common stock | | — | | 73,472,948 | |
Proceeds from exercise of stock options | | 1,454,566 | | 729,686 | |
Net cash and cash equivalents provided by financing activities | | 1,454,566 | | 74,202,634 | |
| | | | | |
Net (decrease)/increase in cash and cash equivalents | | (23,001,238 | ) | 38,797,561 | |
Cash and cash equivalents, beginning of period | | 63,106,655 | | 36,958,941 | |
Cash and cash equivalents, end of period | | $ | 40,105,417 | | $ | 75,756,502 | |
| | | | | |
Supplemental schedule of non-cash financing activities: | | | | | |
Issuance of common stock in satisfaction of a liability | | $ | 188,353 | | $ | — | |
| | | | | |
Supplemental disclosure of cash paid for: | | | | | |
Interest | | $ | — | | $ | — | |
Income taxes | | $ | — | | $ | — | |
The accompanying notes to condensed consolidated financial statements are 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 financial information herein is unaudited. The balance sheet as of December 31, 2004 is derived from audited financial statements.
The accompanying unaudited condensed consolidated financial statements of NeoPharm, Inc. and subsidiary (the “Company”) have been prepared in accordance with U.S. generally accepted accounting principles (“GAAP”) for interim financial information and with the instructions to Form 10-Q and Rule 10-01 of Regulation S-X. Accordingly, they do not contain all of the information and notes required by U.S. GAAP for complete financial statements. In the opinion of the Company, the accompanying unaudited condensed consolidated interim financial statements contain all adjustments (consisting of normal recurring adjustments) necessary to present fairly the Company’s financial position as of September 30, 2005, and the results of its operations for the three and nine months ended September 30, 2005 and 2004 and its cash flows for the nine months ended September 30, 2005 and 2004. The results of operations for the three and nine months ended September 30, 2005 are not necessarily indicative of operating results for fiscal 2005 or future interim periods.
The unaudited condensed consolidated financial statements include the accounts of NeoPharm, Inc. and its wholly owned subsidiary, NeoPharm EU Limited. NeoPharm EU Limited was created in 2004 to comply with regulatory requirements enacted for clinical trials conducted in the European Union. This subsidiary has nominal assets and had not conducted any business. All significant intercompany accounts and transactions are eliminated in consolidation.
While the Company believes that the disclosures presented are adequate to make the information not misleading, it is suggested that these financial statements be read in conjunction with the financial statements and notes included in the Company’s 2004 Annual Report on Form 10-K and Amendment No. 1 filed on Form 10-K/A with the Securities and Exchange Commission (“SEC”).
The preparation of financial statements in conformity with U.S. GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the consolidated financial statements and the reported amounts of revenue and expense during the reporting period. Actual results could differ from those estimates.
Certain prior year amounts have been reclassified to conform to current year presentation.
In December 2004, the Financial Accounting Standards Board (“FASB”) issued Statement of Financial Accounting Standards (“SFAS”) No. 123R, Share-Based Payment, a revision of SFAS No. 123, which requires the use of the fair value method of accounting for stock-based employee compensation effective for all awards granted, modified, repurchased or cancelled. This standard is now effective for the first annual reporting period beginning after June 15, 2005. The standard provides for a prospective application of its provisions. Under this method, the Company will begin recognizing compensation cost for equity based compensation for all new or modified grants after the date of adoption. In addition, the Company will recognize the unvested portion of the grant date fair value of awards issued prior to adoption based on the fair values previously calculated under the disclosure provisions of SFAS No. 123. The Company is currently evaluating the impact that the adoption of SFAS No. 123R will have on its financial position, results of operations, and cash flows.
In May 2005, the FASB issued SFAS No. 154, Accounting Changes and Error Corrections, a replacement of Accounting Principles Board (“APB”) Opinion No. 20, Accounting Changes and FASB Statement No. 3, Reporting Accounting Changes in Interim Financial Statements. SFAS No. 154 applies to all voluntary changes in accounting principle. It also applies to changes required by an accounting pronouncement in the unusual instance that the pronouncement does not include specific transition provisions. SFAS No. 154 requires the retrospective application to prior periods’ financial statements of the direct effect of a voluntary change in accounting principle unless it is impracticable to do so. Unless early adoption is elected, SFAS No. 154 is effective for fiscal years beginning after December 15, 2005. Early adoption is permitted for fiscal years beginning after June 1, 2005. SFAS No. 154 does not change the transition provisions of any existing accounting pronouncements, including those that are in a transition phase as of the effective date of this statement. The Company will assess the impact of a retrospective application of a change in accounting principle in accordance with SFAS No. 154, if the need for such a change arises.
Note 2 Liquidity
As of September 30, 2005, the Company had $40,105,417 in cash and cash equivalents. While the Company believes that its current cash and cash equivalents, will be sufficient to meet its anticipated cash needs for working capital, capital expenditures and other activities into the fourth quarter of 2006, in order for the Company to meet its liquidity needs through late 2006 and beyond, the Company will have to obtain additional capital. While the Company has made no decision as to what course of action it will pursue to meet its liquidity needs, the options available to the Company, include, but are not limited to, one or a combination of, the following: consummate additional product licensing arrangements, delay or halt its clinical development process, further reduce its operating expenses, and/or raise additional capital through issuance of equity or debt securities.
Additional financing may not be available when needed or on terms acceptable to the Company. Currently, the Company has the ability to issue approximately $46 million of equity securities, plus permitted increases, via a shelf registration, the expiration of which was recently extended until December 1, 2008, however, use of the shelf registration is conditioned on the Company’s timely filing of all required documents with the SEC.
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Note 3 Stock-based Compensation
The Company applies the intrinsic-value method of accounting prescribed by APB Opinion No. 25, Accounting for Stock Issued to Employees, and related interpretations, to account for its fixed-plan stock options. Under this method, compensation expense is measured on the date of grant if the current market price of the underlying stock exceeded the exercise price or when the number of shares and exercise price are known if both are not determinable at the date of grant. Compensation expense for fixed stock options is recognized ratably over the vesting period. SFAS No. 123, Accounting for Stock-Based Compensation, established accounting and disclosure requirements using a fair-value method of accounting for stock-based employee compensation plans. As allowed by SFAS No. 123, the Company has elected to continue to apply the intrinsic-value-based method of accounting described above, and has adopted only the disclosure requirements of SFAS No. 123.
The following table illustrates the effect on net loss if the fair-value method had been applied in each period:
| | Three months ended | | Nine months ended | |
| | September 30, 2005 | | September 30, 2004 | | September 30, 2005 | | September 30, 2004 | |
| | | | | | | | | |
Net loss, as reported | | $ | (10,532,943 | ) | $ | (13,954,570 | ) | $ | (29,054,515 | ) | $ | (42,961,241 | ) |
Add stock-based employee compensation expense included in reported net loss(1) | | 80,652 | | 103,187 | | 233,077 | | 303,070 | |
Deduct total stock-based employee compensation expense determined under fair-value-based method for all awards | | (315,358 | ) | (2,237,636 | ) | (712,859 | ) | (6,278,036 | ) |
Pro forma net loss | | $ | (10,767,649 | ) | $ | (16,089,019 | ) | $ | (29,534,297 | ) | $ | (48,936,207 | ) |
| | | | | | | | | |
Basic and diluted loss per share of common stock | | | | | | | | | |
As reported | | $ | (0.45 | ) | $ | (0.60 | ) | $ | (1.23 | ) | $ | (1.88 | ) |
Pro forma | | $ | (0.46 | ) | $ | (0.69 | ) | $ | (1.25 | ) | $ | (2.14 | ) |
(1) Value of restricted stock granted to non-employee directors and compensation expense relating to options granted to an executive at 85% of fair value.
Note 4 Cash Equivalents and Investments
The Company considers all highly liquid investments purchased with an original maturity of three months or less to be cash equivalents. Included with cash are cash equivalents of $39,545,839 and $62,919,437 as of September 30, 2005 and December 31 2004, respectively. The carrying value of these investments approximates their fair market value due to their short maturity and liquidity.
Note 5 Inventory
Inventory is comprised solely of finished goods associated with NeoPhectin and is stated at the lower of cost or market, as determined by the first in, first out method (“FIFO”). Inventory cost consists of direct material and direct labor costs. Since products are currently produced in the Company’s research and development facilities, the Company has not allocated any overhead costs as a product cost. Application of overhead as a product cost is not material.
Inventory at September 30, 2005 and December 31, 2004 consisted of the following:
| | September 30, 2005 | | December 31, 2004 | |
| | | | | |
Finished goods on hand | | $ | 4,368 | | $ | 5,413 | |
Inventory subject to return | | — | | 323 | |
| | $ | 4,368 | | $ | 5,736 | |
Inventory subject to return represents NeoPhectin products shipped to wholesale customers that have not been recognized as revenue.
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Note 6 Fixed Assets
Fixed assets are recorded at cost and are depreciated using the straight line method over their estimated useful lives. Maintenance and repairs that do not extend the life of assets are charged to expense when incurred. When properties are disposed of, the related costs and accumulated depreciation are removed from the accounts and any gain or loss is reported in the period the disposition takes place. Total depreciation and amortization expense for the three months ended September 30, 2005 and 2004, was $303,195 and $327,721, respectively. Total depreciation and amortization expense for the nine months ended September 30, 2005 and 2004 was $983,291 and $1,006,620, respectively.
Long-lived assets are reviewed for impairment whenever events or changes in circumstances indicate the carrying amount of an asset may not be recoverable. Recoverability of assets to be held and used is measured by a comparison of the carrying amount of an asset to estimated undiscounted cash flows expected to be generated by the asset. If the carrying amount of an asset exceeds its estimated future cash flows, an impairment charge is recognized by the amount by which the carrying amount of the asset exceeds the fair value of the asset.
Note 7 Stockholders’ Equity
The Company maintains a Stockholder Rights Plan whereby rights to purchase shares of Series A Participating Preferred Stock become exercisable by the Company’s stockholders after any non-excluded party acquires, or announces an intention to acquire, 15% or more of the Company’s outstanding common stock.
On January 27, 2004, the Company received proceeds of $73,980,938 (net of underwriting discounts and commissions of $4,722,188, but before expenses of $507,990) by issuing 4,312,500 shares of common stock in a public offering.
Note 8 Revenue Recognition
The Company recognizes revenue when persuasive evidence of an arrangement exists, delivery has occurred or services have been rendered, the price is fixed or determinable, and collectibility is reasonably assured.
For product sales not subject to rights of return, the Company recognizes revenue upon shipment as title and risk of loss has passed to the customer. For product sales subject to rights of return, the Company recognizes revenue upon shipment when it can reasonably estimate the level of returns at the time of shipment. Given the limited sales history of its products, the Company is currently unable to reasonably estimate the level of returns at the time of shipment. Accordingly, revenue related to shipments to distributors that have been granted a right of return is currently being recognized when the right of return has expired, which occurs upon the earlier of shipment of the product by the distributor to an end user or expiration of the right of return, which is 60-180 days depending upon the distributor. The Company warrants its products in a manner consistent with industry standards and has not incurred any warranty costs related to the sale of NeoPhectin.
The Company enters into collaboration and technology licensing arrangements, which contain multiple deliverables. Under the provisions of Emerging Issues Task Force (“EITF”) Issue No. 00-21, Accounting for Revenue Arrangements with Multiple Deliverables, the Company evaluates whether these deliverables constitute separate units of accounting to which total arrangement consideration is allocated. A deliverable qualifies as a separate unit of accounting when the item delivered to the customer has standalone value, there is objective and reliable evidence of fair value of items that have not been delivered to the customer, and, if there is a general right of return for the items delivered to the customer, delivery or performance of the undelivered items is considered probable and substantially in the control of the Company. Arrangement consideration is allocated to units of accounting on a relative fair basis or the residual method if the Company is unable to determine the fair value of all deliverables in the arrangement. Consideration allocated to a unit of accounting is limited to the amount that is not contingent upon future performance by the Company. Upon determination of separate units of accounting and allocated consideration, the general criteria for revenue recognition are applied to each unit of accounting. In instances where an arrangement provides for up-front non-refundable payments that are not otherwise allocated to a unit of accounting, the Company recognizes these payments ratably over the term of the contract or expected period of performance, whichever is longer.
The Company has entered into collaboration and license agreements with third parties. The terms of one of its collaboration agreements provided for an upfront nonrefundable payment to the Company of $150,000 as well as an additional $350,000 upon delivery of a customized formulation of NeoPhectin to the customer. The Company delivered the customized formulation in June 2005, and the Company has recognized the full contract amount as revenue. The Company has also entered into an agreement with Nippon Kayaku Co., Ltd. (“Nippon”) in which the development and commercialization rights in Japan for cintredekin besudotox (“IL13-PE38QQR”) were licensed. The Company received a $2 million upfront nonrefundable fee in January 2005 and is entitled to receive future additional fees, milestone payments and royalties. Nippon is responsible for all development costs in Japan. The Company has agreed to provide or arrange for contract manufacture of a commercial supply of cintredekin besudotox upon receipt of marketing approval by Nippon. The upfront nonrefundable fee received by the Company will be recognized ratably as revenue once the general criteria for revenue recognition have been met for the unit of accounting to which the fee has been allocated.
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Note 9 Loss Per Share
The following table sets forth the computation of basic and diluted net loss per share:
| | Three months ended | | Nine months ended | |
| | September 30, 2005 | | September 30, 2004 | | September 30, 2005 | | September 30, 2004 | |
Numerator: | | | | | | | | | |
Net loss | | $ | (10,532,943 | ) | $ | (13,954,570 | ) | $ | (29,054,515 | ) | $ | (42,961,241 | ) |
| | | | | | | | | |
Denominator: | | | | | | | | | |
Weighted average shares outstanding | | 23,640,393 | | 23,284,925 | | 23,557,757 | | 22,815,559 | |
| | | | | | | | | |
Loss per share - basic and diluted | | $ | (0.45 | ) | $ | (0.60 | ) | $ | (1.23 | ) | $ | (1.88 | ) |
| | | | | | | | | |
Potential common share equivalents: | | | | | | | | | |
Stock options | | 3,499,387 | | 3,715,020 | | 3,393,307 | | 3,606,729 | |
| | | | | | | | | | | | | | | |
As the Company has incurred a net loss for all periods presented, basic and diluted per share amounts are the same, since the effect of all potential common share equivalents is anti-dilutive.
Note 10 Transactions with Related Parties
The following table provides further information about related party expenses reflected in the condensed consolidated statements of operations.
| | | | Three months ended | | Nine months ended | |
Related Party | | Expense Type | | September 30, 2005 | | September 30, 2004 | | September 30, 2005 | | September 30, 2004 | |
Akorn, Inc. | | Consulting | | $ | — | | $ | — | | $ | — | | $ | 6,250 | |
E.J. Financial Enterprises | | Consulting | | — | | — | | — | | 62,500 | |
E.J. Financial Enterprises | | Direct Expenses | | — | | — | | — | | 620 | |
Total related party expenses | | | | $ | — | | $ | — | | $ | — | | $ | 69,370 | |
Prior to June 30, 2004, the Company received management consulting services from EJ Financial Enterprises, Inc. (“EJ Financial”), a healthcare consulting and investment firm in which John N. Kapoor, Ph.D., (“Dr. Kapoor”) a member of the Company’s Board of Directors and the Company’s former Chairman of the Board of Directors, and a significant stockholder of the Company, is the sole stockholder. The consulting agreement with EJ Financial expired on June 30, 2004 and was not renewed.
The Company had entered into a consulting agreement with an individual who is also an employee of Akorn, Inc., a Louisiana corporation (“Akorn”). Dr. Kapoor is also the Chairman of the Akorn Board of Directors, and a substantial stockholder in both Companies. The consulting agreement was terminated in 2004.
In December 2001, NeoPharm entered into a transaction whereby NeoPharm loaned to Akorn, $3,250,000 to assist Akorn in the completion of its lyophilized products manufacturing facility in Decatur, Illinois. In connection with the loan transaction, NeoPharm entered into the following agreements: Promissory Note, dated December 20, 2001, in the original principal amount of $3,250,000 by Akorn to NeoPharm; Processing Agreement, dated December 20, 2001, by and between Akorn and NeoPharm; Subordination and Intercreditor Agreement, dated December 20, 2001, by and between John N. Kapoor, as Trustee under The John N. Kapoor Trust, dated September 20, 1989 and NeoPharm; and a Subordination, Standby and Intercreditor Agreement, dated December 20, 2001, by and among Akorn, Akorn (New Jersey), Inc., The Northern Trust Company and NeoPharm. The Promissory Note issued by Akorn was due in December 2006, and accrued interest at a rate equal to that received on the Company’s investments in marketable securities, which is lower than the interest rate paid by Akorn on its other outstanding debt. The Processing Agreement granted NeoPharm access to at least 15% of the annual lyophilization manufacturing capacity at Akorn at most favored customer pricing, upon completion of the facility. The Processing Agreement also provided that Akorn was to begin providing lyophilization services on or before June 30, 2003. At the time these transactions were entered into, Akorn represented that the manufacturing facility would be operational in 2003, approximately the time when NeoPharm originally anticipated it would need to manufacture its lyophilized drug product candidates for Phase II/III clinical trials. In 2001, NeoPharm recorded the Promissory Note net of a valuation allowance of $1,266,619 reflecting the difference between the actual loan amount and the present value of the loan using an estimated market interest rate of 10%. As of December 31, 2002, the Company determined the Promissory Note was impaired and recorded a charge to
9
fully reserve for the Promissory Note and related accrued interest. On August 18, 2003, NeoPharm presented Akorn with a formal “Notice of Default” on the Promissory Note. Because the carrying value of the Promissory Note was zero, there was no financial statement impact as a result of any event of default under, or non-payment of, the Promissory Note. In September 2003, Akorn advised NeoPharm that it wished to refinance its senior debt with a new senior lender, which lender would require NeoPharm to subordinate its debt. In order to preserve the possibility of collecting Akorn’s debt to NeoPharm, NeoPharm and Akorn entered into an Amended and Restated Promissory Note in consideration of a higher rate of interest (which would equal that to be charged by the new senior lender, which was the prime rate plus 175 basis points) and the possibility of accelerated mandatory repayments once Akorn’s senior debt was repaid in full. NeoPharm also agreed to waive Akorn’s default, to allow Akorn until October 2004 to provide the required manufacturing rights and to subordinate Akorn’s indebtedness to NeoPharm to Akorn’s indebtedness to its new senior lender. Akorn’s refinancing was completed on October 7, 2003. On October 6, 2004, NeoPharm presented Akorn, with a formal “Notice of Default” on the Amended and Restated Promissory Note resulting from Akorn’s failure to meet its obligations under the Processing Agreement. Because the carrying value of the Promissory Note was zero, there was no financial impact as a result of any event of default under, or non-payment of, the Promissory Note. On May 16, 2005, the Company and Akorn entered into a Note Repayment Agreement (“Repayment Agreement”) whereby the Company agreed to accept $2,500,000 as payment in full for all outstanding principal and interest due and owing under the Promissory Note, which has been paid. In addition, the parties mutually agreed to terminate the Processing Agreement. As a result of the Repayment Agreement, the Company recorded a $2,500,000 benefit which was recorded as “Recovery of Note Receivable” on the Company’s unaudited Condensed Consolidated Statement of Operations for the nine months ended September 30, 2005.
Note 11 Employee Termination Benefits
In an effort to decrease expenses, the Company reduced its workforce by a total of 30 employees (approximately 23%) in November 2004, consisting of 26 employees from its research and development groups and 4 employees from the administrative group. Terminated employees were eligible to receive salary continuation through December 31, 2004, severance, 2004 earned bonus, Company paid insurance benefits and outplacement services. All $1,149,277 of employee termination costs were expensed in 2004 and no additional amounts were expensed in 2005. The $760,759 accrued as of December 31, 2004 was paid during the first quarter of 2005.
Note 12 Commitments
On April 25, 2005, the Company and Mr. Ronald G. Eidell, a director of the Company, finalized an employment agreement (“Employment Agreement”) under which Mr. Eidell is employed, on an interim basis, as the Company’s President and Chief Executive Officer (“CEO”). Mr. Eidell had been serving as President and CEO since March 8, 2005 under a principal terms employment agreement (PTA) executed between the Company and Mr. Eidell on March 10, 2005, which has now been superceded by the terms of the Employment Agreement. Under the Employment Agreement, Mr. Eidell will receive a base salary of $260,000. Under the PTA, Mr. Eidell had agreed to a base salary of $325,000, subject, however, to the Company entering into a separate agreement with Tatum CFO Partners LLP (“Tatum”), of which Mr. Eidell continues to be a partner, providing for up to 20% of Mr. Eidell’s base salary and bonus, if any, to be remitted to Tatum. Under the terms of an agreement entered into with Tatum, an annualized amount of $65,000, prorated for the period of Mr. Eidell’s employment by the Company, is to be paid to Tatum. The amount of the Tatum payment has been deducted from the PTA base salary figure of $325,000, resulting in the new base salary of $260,000 for Mr. Eidell under the Employment Agreement. Additionally, Mr. Eidell is entitled to an annual performance-based milestone bonus payment, of which 20% would be payable to Tatum, as per the Tatum agreement, and a monthly transportation allowance of $1,500. On March 10, 2005, Mr. Eidell received a stock option grant of 80,000 shares at an exercise price equal to the closing price of the Company’s stock on that date. The stock options shall vest at the earlier of the termination of the Employment Agreement as a result of Mr. Eidell’s resignation to allow a new permanent CEO to take office or one year from the date of grant.
On June 17, 2004, NeoPharm entered into an Employment Agreement with Gregory P. Young to serve as the Company’s President, Chief Executive Officer and a director. Mr. Young resigned as the Company’s President and CEO, and as a director, on March 8, 2005, and the Company entered into a Separation Agreement and Full Release of All Claims (the “Separation Agreement”) with Mr. Young. Under the terms of the Separation Agreement, Mr. Young is eligible to receive a salary continuance for 12 months based upon his annual base salary at the time of his resignation ($325,000) and Company paid insurance premiums under the Company’s medical insurance plan. The salary continuance and medical insurance premium payments, but not the other provisions of the Separation Agreement, including but not limited to, the restrictive covenants contained therein, cease at such time as Mr. Young accepts full-time employment or the first date that Mr. Young provides consulting or other services to certain other competing pharmaceutical or biotechnology organizations, other than a charitable entity. The Company was notified in August 2005 that Mr. Young accepted a full-time position. As a result, the Company reversed $197,609 of salary continuance and medical insurance premium expense previously recorded, as outlined under the terms of the Separation Agreement. Additionally, Mr. Young continues to serve as a consultant to the Company until March 11, 2006 or upon the termination of the Separation Agreement, whichever is earlier. During the consulting period, options previously granted to Mr. Young continue to vest and remain exercisable until 90 days after termination of his consulting duties. While 62,500 options have vested during the consulting period to date, no additional options are scheduled to vest prior to the termination of Mr. Young’s consulting duties and all unvested options previously granted to Mr. Young are expected to be
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forfeited. For the three and nine months ended September 30, 2005, the Company recorded compensation expense of $26,772 and $236,125, respectively, relating to the options granted to Mr. Young that have vested during the period of his serving as a consultant to the Company.
On June 17, 2004, James M. Hussey resigned as the Company’s President, Chief Executive Officer and a member of the Board of Directors. In accepting Mr. Hussey’s resignation, the Board of Directors authorized the Company to enter into a Separation Agreement and Full Release of all Claims (the “Hussey Agreement”) with Mr. Hussey. Under the terms of the Hussey Agreement, Mr. Hussey was scheduled to receive a salary continuance for 12 months based upon his annual base salary at the time of his resignation ($339,768), Company paid insurance premiums under the Company’s medical insurance plan, plus a payment of 50% of Mr. Hussey’s target milestone bonus when 2004 bonuses are paid to the Company’s employees. The salary continuance and medical insurance premium payments will cease at such time as Mr. Hussey accepts full-time employment or the first date that Mr. Hussey provides consulting or other services to competing pharmaceutical or biotechnology organizations. Additionally, Mr. Hussey agreed to serve as a consultant to the Company for a period of up to 24 months or upon the termination of the Hussey Agreement, whichever is earlier, during which time all options previously granted to Mr. Hussey continue to vest and remain exercisable until 90 days after termination as a consultant. All compensation expense associated with these options was recorded in 2004 due to the acceleration of vesting that occurred upon the execution of the Hussey Agreement. On March 11, 2005, the Company entered into an amendment to the Hussey Agreement in which Mr. Hussey agreed to accept the Company’s common stock as consideration in lieu of all remaining cash payments due to him under the Hussey Agreement. As of March 10, 2005, the effective date of the amendment, Mr. Hussey was owed $188,353, which represented, at the closing price of the Company’s common stock on March 10, 2005, 23,692 shares of the Company’s common stock, which shares were issued to Mr. Hussey. Mr. Hussey will continue to provide consulting services to the Company until June 17, 2006.
Note 13 Contingencies
The Company has been named in several putative class action lawsuits (the “Class Action Suits”) each of which alleges various violations of the federal securities laws in connection with the Company’s public statements during the period from September 25, 2000 through April 19, 2002 as they relate to the Company’s LEP drug product candidate. The original lawsuits also named as individual defendants John N. Kapoor, former Chairman of the Company, and James M. Hussey, the Company’s former President and CEO, and Dr. Aquilur Rahman, a former director and executive officer of the Company. The first of these Class Action Suits was filed on April 26, 2002 and all of the Class Action Suits have been filed in the United States District Court for the Northern District of Illinois, Eastern District. On September 16, 2002, a consolidated amended complaint was filed against NeoPharm in this matter. The amended complaint shortened the class period to October 31, 2001 through April 19, 2002, removed Dr. Rahman as a defendant, and added Dr. Imran Ahmad, the Company’s current Chief Scientific Officer and Executive Vice President of Research and Development, as a defendant. The Company intends to vigorously defend each and every claim in the Class Action Suits and, on November 4, 2002, moved to have the complaint dismissed. The Company’s motion to dismiss was granted in part and denied in part in February 2003. Dr. Kapoor was dismissed from the lawsuit at that time. In November 2004, the plaintiffs filed a motion to amend and a motion for summary adjudication. The motion to amend seeks to again make Dr. Kapoor a defendant, and realleges that certain pre-class period statements are actionable. The Company has opposed both motions. No trial date has been set and discovery is ongoing. Management is unable to estimate the potential outcome or a range of possible losses, if any. In addition, the Company maintains insurance coverage to mitigate the financial impact of any potential loss.
On March 26, 2004, the Company received a letter from the Securities and Exchange Commission (“SEC”) stating that the SEC is conducting a formal investigation of the Company. The SEC stated in its letter that it has made no determination of any violation of law by the Company or any individual at this time. Previously, this matter had been the subject of an informal SEC inquiry. The Company continues to fully cooperate with the SEC and intends to continue to do so in order to bring the inquiry to a conclusion as promptly as possible. The Company believes the investigation is an outgrowth of the arbitration claim filed by the Company against Pharmacia (now Pfizer) regarding the development of its LEP and LED drug product candidates and the Class Action Suits which have been filed against the Company relating to its public statements regarding the development of LEP. The Company cannot predict with certainty the direction the investigation will take or its ultimate outcome, and therefore is unable to determine whether the results of the investigation will have a material adverse impact on the Company’s results of operations or financial position.
The pharmaceutical industry has traditionally experienced difficulty in maintaining product liability insurance coverage at desired levels. To date, no significant product liability suit has ever been filed against the Company. However, if a suit were filed and a judgment entered against the Company, it could have a material adverse effect upon the Company’s operations and financial position. While the Company maintains insurance to cover the use of its drug product candidates in clinical trials, the Company does not maintain insurance covering the sale of its drug product candidates nor is there any assurance that it will be able to obtain or maintain such insurance on acceptable terms or with adequate coverage against potential liabilities.
Note 14 Subsequent Events
On October 28, 2005, NeoPharm entered into an Employment Agreement with Guillermo A. Herrera to serve as the Company’s
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President, Chief Executive Officer and a member of the Board of Directors. Under the terms of his Employment Agreement, Mr. Herrera will receive an annual base salary of $425,000 and a grant of shares of the Company’s common stock, at the time of hire, equal to a total fair market value of $200,000 based upon the closing share price as of October 28, 2005. Mr. Herrera is also eligible for an annual performance-based bonus payment and receives a monthly car allowance of $1,000. Additionally, Mr. Herrera will receive a common stock option grant of 500,000 options with a grant price equal to the fair market value on the date of grant. The options vest in four equal annual installments on the anniversary of the option grant date.
On October 28, 2005, Mr. Ronald Eidell resigned as interim President and CEO to allow Mr. Herrera to take office as President and CEO. In accordance with the terms of Mr. Eidell’s Employment Agreement, a $96,000 performance based bonus will be paid to him. In addition, under the terms of an agreement between the Company and Tatum, of which Mr. Eidell is a partner, the Company will pay $24,000 to Tatum upon making the bonus payment to Mr. Eidell. Additionally, 80,000 options, previously granted to Mr. Eidell, will now be exercisable pursuant to the original terms of the option grant. Mr. Eidell will remain a member of the Board of Directors and will serve on the Audit Committee, as a non-independent member of the Audit Committee.
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Item 2 - Management’s Discussion and Analysis of Financial Condition and Results of Operations
Any statements made by NeoPharm, Inc. (“we”, “us”, “our”, or the “Company”) in this quarterly report that are forward looking are made pursuant to the safe harbor provisions of the Private Securities Litigation Reform Act of 1995. The Company cautions readers that important factors may affect the Company’s actual results and could cause such results to differ materially from forward-looking statements made by or on behalf of the Company. Such factors include, but are not limited to, those risks and uncertainties relating to difficulties or delays in development, testing, regulatory approval, recruitment of patients, production and marketing of the Company’s drug candidates, including, but not limited to cintredekin besudotox (“IL13-PE38QQR”), including the PRECISE trial, the marketing of non-drug products such as NeoPhectin™ and NeoPhectin-AT™, uncertainty regarding the outcome of class action litigation against the Company, resolution of the ongoing SEC investigation, unexpected adverse side effects or inadequate therapeutic efficacy of the Company’s drug candidates that could slow or prevent products coming to market, the uncertainty of patent protection for the Company’s intellectual property or trade secrets, the ability of the Company to raise additional funds on terms acceptable to the Company and other factors referenced under “Risk Factors” in the Company’s Annual Report on Form 10-K and Amendment No. 1 filed on Form 10-K/A for the fiscal year ended December 31, 2004.
The following should be read in conjunction with the financial statements and related notes and Management’s Discussion and Analysis of Financial Condition and Results of Operations and the Risk Factors section included in the Company’s 2004 Annual Report on Form 10-K and Amendment No. 1 filed on Form 10-K/A. The results discussed below are not necessarily indicative of the results to be expected in any future periods. The following discussion contains forward-looking statements that are subject to risks and uncertainties, which could cause actual results to differ from statements made.
Overview
We are a biopharmaceutical company engaged in the research, development, and commercialization of drugs for the treatment of various cancers. Our corporate strategy is to become a leader in the research, development, and commercialization of new and innovative anti-cancer treatments. We currently operate at two locations, and had 94 full time employees as of September 30, 2005. Our corporate headquarters and research and development facility are located in Waukegan, Illinois and our clinical development personnel are located in Lake Forest, Illinois.
Since we began doing business in June 1990, we have devoted our resources primarily to funding research and product development programs. To date, we have not received Food and Drug Administration (“FDA”) approval of any of our drug product candidates. We expect to continue to incur losses for the foreseeable future as we continue our research and development activities, which include the sponsorship of human clinical trials for our drug product candidates. Until we are able to consistently generate revenue through the sale of drug or non-drug products, we anticipate that we will be required to fund the development of our pre-clinical compounds and drug product candidates primarily by other means, including, but not limited to, licensing the development rights to some of our drug product candidates to third parties, collaborating with third parties to develop formulations of their compounds using our technology, or selling Company issued securities.
In the quarter ended September 30, 2005, management’s efforts were primarily devoted to overseeing the Phase III PRECISE clinical trial for our lead drug product candidate, cintredekin besudotox (IL13-PE38QQR), advancing our NeoLipid drug product candidates (LEP-ETU, LE-SN38, and LErafAON) through the clinical development process, engaging potential partners in discussions pertaining to potential licensing of our drug product candidates, and exploring potential opportunities to reduce expenses in an effort to reduce the amount of cash used in operations.
Our lead drug product candidate, cintredekin besudotox, is currently in a Phase III clinical trial (the “PRECISE trial”) for the treatment of glioblastoma multiforme (“GBM”) at first recurrence. Cintredekin besudotox is a fusion protein comprised of Interleukin-13 (“IL13”) as the targeting mechanism and Pseudomonas Exotoxin A (“PEA”) as the cytotoxin. This treatment is highly selective for malignant glioma cells since these tumors express a high number of receptors for IL13 while normal brain tissue elements have minimal to no detectable IL13 binding. To date, cintredekin besudotox has received orphan drug status (which provides extended marketing exclusivity) in both the U.S. and Europe, fast track designation (which facilitate development and expedite review of new drug compounds) in the U.S., and was included by the FDA as the oncologic biologic therapeutic in the Continuous Marketing Application (“CMA”) Pilot 2 Program, where the FDA and fast track drug applicants enter into an agreement to engage in frequent scientific feedback and interactions.
We began enrolling patients in the PRECISE trial in March 2004 and, as of October 31, 2005, 277 patients have been enrolled. In June 2005, the independent Data Monitoring Committee responsible for overseeing our PRECISE trial met, analyzed, and reviewed the data for the trial’s first futility analysis and recommended that the PRECISE trial continue as planned. If current enrollment rates continue, we anticipate the completion of enrollment (up to 300 patients total) for PRECISE in 2005 and, assuming a favorable trial result, the submission of a Biologics License Application (“BLA”) with the FDA in 2006 seeking marketing approval of the drug. However, there can be no assurance the trial will meet its endpoint in the time anticipated, that the FDA will approve the BLA or that the FDA will not require additional data or testing. Assuming that we receive authorization to begin selling cintredekin besudotox, we currently anticipate the first sales of the product in 2007. Enrollment also continues in our Phase I clinical trial of cintredekin besudotox for malignant glioma patients at initial diagnosis.
During the quarter ended September 30, 2005, we completed our bioequivalence study of LEP-ETU and bioequivalence to paclitaxel (Taxol®) was demonstrated. The clinical program of LEP-ETU will be accelerated to support a 505(b)(2) New Drug application (“NDA”) submission to the FDA. Preparations are being finalized for a 100-patient comparator study in metastatic breast cancer for which we expect to commence enrollment in the first quarter of 2006. Additionally, we continued our efforts in collaboration with Cancer and Leukemia Group B (“CALGB”), a national oncology clinical research group sponsored by the U.S. National Cancer Institute (“NCI”)
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to begin a Phase II clinical trial for LE-SN38 for patients suffering from recurrent metastatic colorectal cancer, which is expected by CALGB to obtain final NCI and FDA approvals, later in 2005. We also continued enrollment in our Phase I clinical trial of our LErafAON drug product candidate, with completion of enrollment dependent on the number of dose levels studied.
It is difficult to predict with any certainty the timing of and total estimated costs to complete development of drug product candidates in early stage, or Phase I/II, clinical development, as well as the estimated date such drug product candidates would be available for sale, if approved by the FDA. A number of factors contribute to this uncertainty, including, but not limited to: side effects encountered in early stage clinical trials, ability to scale up manufacturing for commercial supply, and the fact that the size and scope of pivotal Phase III clinical trials are unknown until sufficient data is available to present a Phase III plan to the FDA for approval. In addition, our drug product candidates are required to be approved by the FDA after completing Phase III clinical trials before we can sell the drugs to generate revenue and, potentially, realize net cash inflows. Because our lead drug product candidate, cintredekin besudotox, has entered a Phase III clinical trial, we are able to estimate that we will incur further direct expenses of approximately $8 million to complete the Phase III PRECISE study. Additional Phase I and Phase II expenses will also be incurred for cintredekin besudotox as we are conducting other clinical trials to investigate the potential of cintredekin besudotox in other stages of glioblastoma multiforme, such as initial diagnosis, in addition to recurrent glioblastoma multiforme. Furthermore, additional expense will need to be incurred to file a BLA to complete our efforts to commercialize cintredekin besudotox.
The table below includes a summary of identified direct project costs incurred to date for our major research and development projects. Generally, identified project costs include expenses incurred specifically for clinical trials and pre-clinical studies we conduct, and exclude expenses incurred for salaries paid to our professional staff, overhead expenses for our Lake Forest and Waukegan facilities and general laboratory supplies used in our research, which are included as non-project specific.
Research Project | | Costs Incurred in
Current Quarter | | Costs Incurred Year to Date | | Total Costs
Incurred Since
Beginning of Project | |
Cintredekin besudotox | | $ | 4,621,694 | | $ | 12,245,662 | | $ | 51,216,269 | |
LEP-ETU | | 747,974 | | 2,232,937 | | 6,256,312 | |
LE-SN38 | | 146,933 | | 476,776 | | 4,944,366 | |
LErafAON | | 43,791 | | 268,634 | | 7,701,239 | |
Non-project specific | | 2,977,976 | | 9,349,035 | | N/A | |
Total research and development expenses | | $ | 8,538,368 | | $ | 24,573,044 | | N/A | |
| | | | | | | | | | |
In order to decrease expenses, we reduced our workforce by a total of 30 employees (approximately 23%) in November 2004, consisting of 26 employees from our research and development groups and 4 employees from our selling, general, and administrative group. Terminated employees were eligible to receive continued salary and insurance benefits through December 31, 2004 (the termination date), 2004 earned bonus payable in February 2005 (contingent on Board of Directors’ approval of the 2004 bonus pool, which was subsequently given), two months severance pay in 2005, two months of Company paid medical insurance premiums paid in 2005, and outplacement services.
We successfully completed negotiations on two collaborations in December 2004. The first collaboration resulted in 2005 revenue of $500,000 as we provided a customized NeoPhectin formulation to our customer, a privately held biotechnology company, of their proprietary compound. The collaboration allows us to negotiate a license agreement for any customized formulation using our NeoPhectin technology that may be developed commercially. Additionally, we entered into an exclusive license agreement with Nippon Kayaku Co., Ltd. (“Nippon”) for the Japanese development rights for cintredekin besudotox. In addition to the $2 million up-front licensing fee we received in January 2005, we have also contracted to receive future additional license fees, milestone payments and royalties. Nippon is responsible for all development costs in Japan.
On October 31, 2005, we announced the appointment of Guillermo A. Herrera as our new President and CEO and the resignation of Ronald G. Eidell as interim President and CEO to allow Mr. Herrera to take office. Mr. Eidell will remain as a member of the Board of Directors and will serve on the Audit Committee, as a non-independent member of the Audit Committee.
In addition to our ongoing efforts to enter into additional collaborations, we continue to monitor and analyze our expenses in an effort to further reduce our net loss. We currently estimate that the fiscal year 2005 net loss will be between $37 and $38 million, or $1.57 to $1.61 per share, and we now expect that cash used in operations will be less than $34 million for 2005. This compares to our fiscal year 2004 net loss of approximately $57.6 million, or $2.51 per share, and cash used in operations of approximately $52.2 million.
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Results of Operations — Three Months Ended September 30, 2005 vs. Three Months Ended September 30, 2004.
The Company recorded product revenue of $9,480 for the three months ended September 30, 2005 as compared to $84,740 for the three months ended September 30, 2004. The sole source of product revenue in both periods was from sales of NeoPhectin and NeoPhectin-AT. No collaboration revenue was recognized in the three months ended September 30, 2005 and 2004.
Research and development expense for the three months ended September 30, 2005 decreased by approximately $2.1 million as compared to the same period in 2004. The decrease in research and development expenses was primarily related to a reduction in the number of clinical trials being conducted by the Company in 2005, resulting in a reduction in expenses of approximately $0.6 million, reduced research and development payroll related expenses of approximately $1.3 million primarily resulting from the 2004 workforce reduction, and a reduction of approximately $0.2 million in expenses related to non-project specific research.
Selling, general, and administrative expenses were approximately $2.4 million for the three months ended September 30, 2005 and $3.7 million for the three months ended September 30, 2004. The decrease was primarily due to $0.3 reduced compensation and severance related costs for former CEOs James Hussey and Gregory Young, lower legal expenses of $0.6 million, principally due to a consent solicitation initiated by Dr. Kapoor, former Chairman and a current board member initiated in 2004, and $0.4 million reduction of stock compensation expense in 2005 for former CEO, James Hussey, for options that remained exercisable while he provided consulting services to NeoPharm.
The Company generated interest income on cash and investments of approximately $0.4 million and $0.3 million for the three months ended September 30, 2005 and 2004, respectively. The increase in interest income during the period was primarily due to increases in short-term interest rates offset by the decline in average cash and cash equivalents.
Results of Operations — Nine Months Ended September 30, 2005 vs. Nine Months Ended September 30, 2004.
The Company recorded product revenue of $35,380 for the nine months ended September 30, 2005 as compared to $116,020 for the nine months ended September 30, 2004. The sole source of product revenue in both periods was from sales of NeoPhectin and NeoPhectin-AT. During the nine months ended September 30, 2005, we also recognized a total of $500,000 of revenue related to collaboration fees earned in 2005 for a customized NeoPhectin formulation. No collaboration revenue was recognized in 2004.
Research and development expense for the nine months ended September 30, 2005 decreased by approximately $9.3 million as compared to the same period in 2004. The decrease in research and development expenses was primarily related to a reduction in the number of clinical trials being conducted by the Company in 2005, resulting in a reduction in expenses of approximately $4.0 million, reduced research and development payroll related expenses of approximately $3.0 million primarily resulting from the 2004 workforce reduction, and a reduction of approximately $2.3 million in expenses related to non-project specific research.
Selling, general, and administrative expenses were approximately $8.7 million for the nine months ended September 30, 2005 and $9.9 million for the nine months ended September 30, 2004. The reduction in selling, general and administrative expenses during the period was due to a $1.6 million reduction in legal and accounting expenses principally due to the conclusion of our arbitration case against Pharmacia (now Pfizer) in 2004 and legal fees associated with the consent solicitation filed by Dr. Kapoor, former Chairman of the Board of Directors and a current director initiated in 2004 and to a lesser extent decreased accounting costs associated with regulatory compliance, offset by a $0.4 million increase for product licensing milestone payments.
On May 16, 2005, NeoPharm accepted $2.5 million as payment in full for all outstanding principal and interest due and owing on a promissory note that had previously been determined to be impaired. As a result of the payment, a $2.5 million benefit was recorded as Recovery of Note Receivable.
The Company generated interest income on cash and investments of approximately $1.2 million and $0.8 million for the nine months ended September 30, 2005 and 2004, respectively. The increase in interest income in 2005 was primarily due to increases in short-term interest rates offset by the decline in average cash and cash equivalents.
Liquidity and Capital Resources
As of September 30, 2005, the Company had $40,105,417 in cash and cash equivalents. While the Company believes that its current cash and cash equivalents, will be sufficient to meet its anticipated cash needs for working capital, capital expenditures and other activities into the fourth quarter of 2006, in order for the Company to meet its liquidity needs through late 2006 and beyond, the Company will have to obtain additional capital. While the Company has made no decision as to what course of action it will pursue to meet its liquidity needs, the options available to the Company, include, but are not limited to, one or a combination of, the following: consummate additional product licensing arrangements, delay or halt its clinical development process, further reduce its operating expenses, and/or raise additional capital through issuance of equity or debt securities.
Additional financing may not be available when needed or on terms acceptable to the Company. Currently, the Company has the ability to issue approximately $46 million of equity securities, plus permitted increases, via a shelf registration, the expiration of which was recently extended until December 1, 2008, however, use of the shelf registration is conditioned on the Company’s timely filing of all required documents with the SEC.
In January 2004, we received approximately $73.5 million, after underwriting fees and expenses, through the sale of common stock via a shelf registration.
The primary use of cash over the next 15 months will be to fund our clinical and pre-clinical research and development efforts and commercialization of cintredekin besudotox. The most significant expenses will be incurred in relation to the PRECISE trial for our brain tumor drug product candidate, cintredekin besudotox. At the present time, we expect to spend approximately $8 million over the next 15 months to complete the PRECISE trial. Additional expenses are also expected to be incurred as we continue to move our Phase I and Phase II drug product candidates towards, and potentially into, Phase II and Phase III clinical trials.
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NeoPharm has no debt, no capital leases, no exposure to off-balance sheet arrangements, no special purpose entities, nor activities that include non-exchange-traded contracts accounted for at fair value.
The following table summarizes our estimated contractual obligations as of September 30, 2005:
| | Payments Due by Period | |
Contractual Obligations | | Total | | Less than
1 year | | 1-3 years | | 3-5 years | | More than
5 years | |
Operating lease | | $ | 1,111,015 | | $ | 448,699 | | $ | 662,316 | | $ | — | | $ | — | |
Clinical trial monitoring (CRO) agreements (1) | | 1,426,274 | | 1,426,274 | | — | | — | | — | |
License agreements—milestone based payments (2) | | 2,350,000 | | 50,000 | | 1,200,000 | | — | | 1,100,000 | |
Total | | $ | 4,887,289 | | $ | 1,924,973 | | $ | 1,862,316 | | $ | — | | $ | 1,100,000 | |
| | | | | | | | | | | | | | | | | | | | | |
(1) These amounts include only contractual obligations for direct expenses for the PRECISE trial, exclusive of clinical trial site costs for treating patients.
(2) These amounts do not include potential sales-based royalty payments that may be required under the various license agreements. Milestone based payment obligations are contingent upon successfully reaching objectively determinable stages in the development of drug product candidates. The Company has estimated the period the payment may be due, if at all, based upon its expectations of the timeline for continued successful development of the drug product candidates.
Critical Accounting Policies
In preparing the Company’s financial statements in conformity with U.S. generally accepted accounting principles (“GAAP”), management must make a variety of decisions that impact the reported amounts and related disclosures. Such decisions include the selection of the appropriate accounting principles to be applied, the assumptions on which to base accounting estimates, and the consistent application of those accounting principles. Due to the type of industry in which the Company operates and the nature of its business, the following accounting policies are those that management believes are most important to the portrayal of the Company’s financial condition and results and that require management’s most difficult, subjective or complex judgments, often as a result of the need to make estimates about the effect of matters that are inherently uncertain.
Income Taxes
In assessing the realizability of deferred tax assets, management considers whether it is more likely than not that some portion or all of the deferred tax assets will not be realized. The ultimate realization of deferred tax assets is dependent upon the generation of future taxable income during the periods in which those temporary differences become deductible. Management considers the scheduled reversal of deferred tax liabilities, projected future taxable income, and tax planning strategies in making this assessment. Significant judgments are required to estimate the generation of future taxable income and the timing of the reversal of deferred tax liabilities.
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Contingencies
To properly account for and provide disclosure of loss contingencies, management must apply judgment in determining whether a loss contingency is: probable, reasonably possible, or remote. In instances where management has determined that a loss contingency is probable, it must make use of estimates to determine the amount of probable loss. Management must apply judgment in determining whether or not it can make a reasonable estimate. Management must also apply judgment in determining whether or not disclosure of loss contingencies that have been accrued should be made for the consolidated financial statements not to be misleading.
Stock-Based Compensation
The Company applies the intrinsic-value-based method of accounting prescribed by Accounting Principles Board (“APB”) Opinion No. 25, Accounting for Stock Issued to Employees, and related interpretations including FASB Interpretation No. 44, Accounting for Certain Transactions Involving Stock Compensation, an Interpretation of APB Opinion No. 25, issued in March 2000, to account for its fixed-plan stock options. Under this method, compensation expense is measured on the date of grant only if the current market price of the underlying stock exceeded the exercise price or when the number of shares and exercise price are known if both are not determinable at the date of grant. Compensation expense for fixed stock options is recognized ratably over the vesting period. Statement of Financial Accounting Standards (“SFAS”) No. 123, Accounting for Stock-Based Compensation, established accounting and disclosure requirements using a fair value method of accounting for stock-based employee compensation plans. As allowed by SFAS No. 123, the Company has elected to continue to apply the intrinsic value method of accounting described above, and has adopted only the disclosure requirements of SFAS No. 123. Significant judgments are required in determining an appropriate method for determining the fair value of stock-based compensation. The Company has elected to utilize the Black-Scholes option-pricing model to make the fair value determination. Inputs into the option-pricing model are subject to estimation that may affect the determination of fair value.
Revenue Recognition
The Company follows the provisions as set forth by current accounting rules, which primarily include Staff Accounting Bulletin (“SAB”) 104, Revenue Recognition, and Emerging Issues Task Force (“EITF”) Issue No. 00-21, Accounting for Revenue Arrangements with Multiple Deliverables. Generally, revenue is recognized when evidence of an arrangement exists, delivery has occurred or services have been rendered, the price is fixed and determinable, and collectibility is reasonably assured.
The Company provides for general rights of return of products sold to its distributors. Appropriately determining revenue recognition when the general right of return exists requires the use of judgment in estimating the level of returns. In certain circumstances, management may not be able to develop a reasonable estimate of the level of returns. Making such a determination also requires the use of significant judgment. Management has determined that given the limited sales history of NeoPhectin, the Company is currently unable to develop a reasonable estimate of the level of returns. Accordingly, the Company is currently recognizing revenue for products shipped to its distributor upon the expiration of the right of return which occurs upon the earlier of shipment of product by the distributor to an end-user or, depending on the distributor, 60 to 180 days.
The Company has recently entered in collaboration and license agreements with third parties that contain multiple deliverables. Under the provisions of EITF Issue No. 00-21, a determination must be made on each contract as to whether a deliverable constitutes a separate unit of accounting. The amount of revenue to be recognized is based on the fair value for each unit of accounting within the arrangement. Management’s judgment is required to determine, based upon the facts and circumstances of each arrangement, whether or not each deliverable has standalone value and whether or not there exists a sufficient level of objective and reliable evidence of fair value of the undelivered items. Additionally, units of accounting may be delivered over an indeterminate period of time. Management judgment is required to estimate the period over which recognition of allocated revenue occurs.
Item 3 — Quantitative and Qualitative Disclosures about Market Risk
As of September 30, 2005, we did not own any derivative instruments, but we were exposed to market risks, primarily changes in U.S. interest rates. As of September 30, 2005, we held total cash and cash equivalents of $40,105,417. All cash equivalents have a maturity less than 90 days. Declines in interest rates over time will reduce our interest income from our investments. Based upon our balance of cash and cash equivalents as of September 30, 2005, a decrease in interest rates of 1.0% would cause a corresponding decrease in our annual interest income of approximately $401,054.
Item 4 — Controls and Procedures
As of September 30, 2005, we carried out an evaluation, under the supervision and with the participation of our management,
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including our Chief Executive Officer and Chief Financial Officer, of the effectiveness of the design and operation of our disclosure controls and procedures. Based on that evaluation, our management, including the Chief Executive Officer and Chief Financial Officer, concluded that our disclosure controls and procedures are operating effectively as designed.
There have been no significant changes in our internal control over financial reporting that occurred during the period covered by this report that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.
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PART II - OTHER INFORMATION
Item 1 - Legal Proceedings
The Company has been named in several putative class action lawsuits (the “Class Action Suits”) each of which alleges various violations of the federal securities laws in connection with the Company’s public statements during the period from September 25, 2000 through April 19, 2002 as they relate to the Company’s LEP drug product candidate. The original lawsuits also named as individual defendants John N. Kapoor, Chairman of the Company, and James M. Hussey, the Company’s former President and CEO, and Dr. Aquilur Rahman, a former director and executive officer of the Company. The first of these Class Action Suits was filed on April 26, 2002 and all of the Class Action Suits have been filed in the United States District Court for the Northern District of Illinois, Eastern District. On September 16, 2002, a consolidated amended complaint was filed against NeoPharm in this matter. The amended complaint shortened the class period to October 31, 2001 through April 19, 2002, removed Dr. Rahman as a defendant, and added Dr. Imran Ahmad, the Company’s current Chief Scientific Officer and Executive Vice President of Research and Development, as a defendant. The Company intends to vigorously defend each and every claim in the class action suits and, on November 4, 2002, moved to have the complaint dismissed. The Company’s motion to dismiss was granted in part and denied in part in February 2003. Dr. Kapoor was dismissed from the lawsuit at that time. In November 2004, the plaintiffs filed a motion to amend and a motion for summary adjudication. The motion to amend seeks to again make Dr. Kapoor a defendant, and realleges that certain pre-class period statements are actionable. The Company has opposed both motions. No trial date has been set and discovery is ongoing. Management is unable to estimate the potential outcome or a range of possible losses, if any. In addition, the Company maintains insurance coverage to mitigate the financial impact of any potential loss.
On March 26, 2004, the Company received a letter from the Securities and Exchange Commission (“SEC”) stating that the SEC is conducting a formal investigation of the Company. The SEC stated in its letter that it has made no determination of any violation of law by the Company or any individual at this time. Previously, this matter had been the subject of an informal SEC inquiry. The Company continues to fully cooperate with the SEC and intends to continue to do so in order to bring the inquiry to a conclusion as promptly as possible. The Company believes the investigation is an outgrowth of the Company’s previously concluded arbitration with Pharmacia (now Pfizer) regarding the development of its LEP and LED drug product candidates and the class action lawsuits which have been filed against the Company relating to its public statements regarding the development of LEP. The Company cannot predict with certainty the direction the investigation will take or its ultimate outcome, and therefore is unable to determine whether the results of the investigation will have a material adverse impact on the Company’s results of operations and financial position.
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds
None
Item 3. Defaults Upon Senior Securities
None
Item 4. Submission of Matters to a Vote of Security Holders
None
Item 5. Other Information
None
Item 6. Exhibits
Exhibit 31.1 | | Certification of the Chief Executive Officer |
| | |
Exhibit 31.2 | | Certification of the Chief Financial Officer |
| | |
Exhibit 32.1 | | Certification pursuant to section 906 of the Sarbanes-Oxley Act |
| | |
Exhibit 32.2 | | Certification pursuant to section 906 of the Sarbanes-Oxley Act |
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SIGNATURE PAGE
Pursuant to the requirements of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.
| | NEOPHARM, INC. |
Date: November 8, 2005 | By: | /s/ Lawrence A. Kenyon |
| | Lawrence A. Kenyon, |
| | Chief Financial Officer
(Principal Accounting Officer and
Principal Financial Officer) |
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